What We Mean When We Talk About a Tax-Free Retirement

At Hosler Wealth Management, we’re passionate about building a tax-free future for our clients.

Yes, tax free.

Most people like the sound of “tax free,” but what do we mean when we talk about creating a tax-free retirement? And how do we work to make that happen?

How We Define ‘Tax Free’

In the simplest terms, when we refer to something as tax free, we are talking about certain investment vehicles or financial products that provide some sort of income or growth that is not subject to federal or state income taxes and isn’t grouped into an individual’s provisional income, which is what determines whether you pay taxes on Social Security.

When planning for retirement, many people are more focused on maximizing income and may not always put thought into tax implications. That’s why we focus on getting our clients to as close to a zero tax rate as possible by leveraging certain vehicles to create tax-free income.

For many people we work with, one of their biggest annual expenses is their income taxes. Being able to minimize that amount, or even, in some cases, eliminate it, is a huge benefit for people nearing or in retirement.

Now that we know what tax free means, let’s discuss our two main strategies for building tax-free income in retirement.

Roth IRA: The Workhorse to Creating Tax-Free Income

The primary investment vehicle we use when planning for tax-free retirement income is the Roth IRA.

Unlike a traditional IRA, where you pay taxes on withdrawals, a Roth IRA generates growth and income tax free because contributions are made with after-tax funds.

In other words, you pay taxes on the way into a Roth IRA whereas you pay taxes on the way out with a traditional IRA.

Because you pay taxes on the frontend with a Roth, once you meet certain age and distribution requirements, you withdraw without ever paying any taxes.

Another significant benefit of a Roth IRA is there are no required minimum distributions (RMDs).

Whereas traditional IRAs and 401k accounts that require you to take minimum distributions at a certain point (essentially forcing you to pay taxes), you are under no requirement to withdraw from your Roth.

Because of this benefit, we often tell clients that their Roth money is their most sacred asset. Depending on your unique financial situation and tax strategy, funds in a Roth should be the last bucket of money you draw from.

Creating Tax-Free Income with a Life Insurance Retirement Plan

The Roth IRA plays a big role in any tax-free strategy, but another strategy in our tax-free toolbox is the life insurance retirement plan (LIRP).

A LIRP uses a permanent cash value life insurance policy to invest in the stock market, thus creating tax-free income for retirement.

Rather than purchasing as much death benefit for the lowest cost, we flip it upside down and buy the least amount of death benefit for the maximum amount of premium we’re allowed to invest in the cash value portion of the policy.

This allows us to “overfund” the policy and create income that is not subject to federal or state income taxes and doesn’t count toward provisional income.

Ready to Plan Your Tax-Free Retirement?

You’ve worked hard to build your wealth. The experienced team at Hosler Wealth Management can work with you to reduce and limit the probable amount of taxes you pay today and into the future.

Our comprehensive approach provides customized plans that incorporate every aspect of your financial picture to guide you toward a tax-free retirement.

Request a call or send us a message to see how our financial advisors in Scottsdale and Prescott can help you achieve your financial goals and plot your path to a tax-free future.

Disclosure: Securities and advisory services offered through Commonwealth Financial Network®, Member www.FINRA.org/www.SIPC.org, a Registered Investment Adviser. 700 S. Montezuma Street, Prescott, AZ 86303. Phone: 928.778.7666. This communication is strictly intended for individuals residing in AK, AZ, CA, CO, FL, GA, HI, ID, IL, MA, ME, NE, NJ, NM, NV, OH, TX, UT, VA, WA, WI. No offers may be made or accepted from any resident outside these states due to various state requirements and registration requirements regarding products and services. Fixed Insurance products and services offered through CES Insurance Agency. Tax preparation and accounting service offered by Hosler Wealth Management, LLC are separate and unrelated to Commonwealth. Any tax advice contained in this article is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding Federal or State tax penalties or (ii) promoting, marketing, or recommending to another party any transaction or matter addressed herein.

Considerations for using a LIRP.

Life insurance retirement plans (LIRPs) have special qualification requirements and may not be suitable or available to all investors.  LIRP retirement plans are long term strategies, and even though they can provide access to tax-free cash value via policy loans, if they are cancelled prematurely generally in the first 10 years, you can potentially incur an expensive surrender penalty.  The IUL (Indexed Universal Life) policies referenced in this article have flexible premiums requirements unlike some other cash value life insurance policies.  The LIRP generally invests in an equity index like the S&P 500, with a floor of zero (If the market loses value, {i.e., -22%} you earn zero for that year) and with a cap in the ranges of 8%-9.5% as an example).  If you have a cap of 9% and the S&P 500 earns 12% for the year you will only earn the cap of 9%.  Potentially the LIRP could experience lower investment returns than traditional retirement plans like IRAs, and 401K that invest in the markets without a cap.  The LIRP could also protect your plan value with the 0% floor in down markets.  If you borrow from the policy the insurance company will charge an interest rate (i.e., 4%) but will leave your investments fully invested with a potential average long term historically return of around 6%.  Potentially allowing you to enjoy the benefit of arbitrage of about 2%  (6%-4%) on the amounts you have borrowed for income purposes.  The premiums (investment amounts) for LIRPs are generally much higher than normal life insurance policies as you are attempting to overfund the life insurance policy to the maximum extent allowed by the IRS.  This enables you to build cash value in the policy, and shelter that cash value from future income taxation.  Allowing you to take tax-free income during your retirement and leave a tax-free death benefit to your loved ones when you die.

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