You may have seen posts or videos online about "how to retire in the zero percent tax bracket." That sounds great, but is it really possible? First, let's take a look at the two most popular sources of retirement income and explain how they keep you *out* of the zero percent tax bracket.

Traditional Retirement Accounts

Traditional retirement accounts include 401(k)s and IRAs. The selling point for these accounts is the tax break you get right now. You fund these accounts with pre-tax money, usually taken directly from your paycheck. The bonus for you? You don't pay tax on that money while your principal and the gains grow tax-free. Essentially, the government is giving you a tax break now, during a time when taxes are low. In return, you'll pay that tax later...unfortunately, what are the odds that those taxes will be lower when it comes time to pay them?

That future tax rate is what's worrying a lot of my clients lately.

What’s the point in growing a tax-free account if the government can take it all back in the future with higher taxes? While it’s highly unlikely the government will take all of it back, we don’t know exactly what they will take back.

We know they have a massive funding shortfall. And we know higher taxes are an easy way to start making up that difference. But that’s not all.

Social Security

The situation gets a little more complicated when we bring Social Security into the picture. Why? Because Social Security benefits are taxable at the federal level based on your income.

Depending on that taxable income, up to 85% of your benefits can be taxed. To make matters worse, the income thresholds that trigger taxation have NEVER been adjusted for inflation; they’re the same as they were in 1984, the first year Social Security benefits were taxed. While only 1 in 10 recipients paid tax on their benefits back then, today, it affects about 50% of those who get benefits. (Source: The Motley Fool)

As of the 2021 tax year, if you are married filing jointly and your income exceeds $32,000, up to 50% of your Social Security benefits are likely taxable. If you're single, that income threshold drops to $25,000. If you're married filing jointly and make a little bit more, over $44,000, up to 85% of your benefits could be taxable (over $34,000 if you're single).

So what's the problem here? All your distributions from that 401(k) you funded for decades will count as income.

Now you see the problem, don't you? The more money you have in your 401(k), the more you'll lose to tax. And the more you receive from your 401(k) or IRA, the more of your Social Security will be taxed.

Isn't there a better way?

The Solution: Reduce Taxable Income

If too much tax is the problem, there’s one clear solution: reduce the amount of taxable income. How can you do this? By making sure you have different streams of income in retirement, including some or all that are non-taxable.

So what doesn’t count as taxable income?

  • Roth IRA distributions (assuming you are over age 59.5 and had the account for at least 5 years)
  • Life insurance policy loans, which do incur a bit of interest
  • Immediate annuity payments (up to the initial investment amount)
  • Some capital gains, depending on length of time held and taxable income

In a nutshell, you want to have as much money as possible in these tax-free vehicles. If you can do this and keep your taxable income below the threshold stated above to keep 100% of your Social Security benefits, it's possible to retire in the zero percent federal tax bracket.

This is a very simplified explanation - but don't worry. We can go into more detail when you contact me and talk about your specific situation.

Ready to Take Control of Your Retirement?

Call me or email me to get started. Let's talk about ways to get you into a lower tax bracket using as many tax-free income streams as possible!

This is general information and not intended to serve as legal, tax, or other financial advice. Please consult with your attorney and/or CPA regarding your specific situation.