Today’s question is: What steps can I take to generate low-tax or tax-free income in retirement?

First and foremost, it’s essential to have a tax plan – one that fits within the context of your overall financial picture. To begin optimizing your retirement income, start by withdrawing from tax-efficient or tax-free sources.

Join Jake Doser, CFP®, CPWA® in this week’s Money Wisdom Question Series to learn more about tax-wise strategies for your retirement.

Tax-Free: Roth Account

A key benefit of a Roth IRA or Roth 401(k) is tax-free income. Roth accounts allow you to pay taxes up front so that, when you reach retirement age, both the earnings and contributions can be withdrawn tax-free. If you haven’t been contributing to a Roth during your working years, you might want to consider a Roth conversion.

This tax strategy lets you transfer funds from a traditional, tax-deferred IRA or 401(k) to a tax-free Roth. Not only is the principal – already taxed – available for tax-free withdrawal, but also the gains, which could have been growing in your account for years.

Low-Tax: Bank or Brokerage Account

One source from which you can make withdrawals at a lower tax rate is a bank or brokerage account. For instance, if you have $100,000 in your savings account earning 4% interest, you will pay taxes on $4,000 per year. However, the principal can still be withdrawn tax-free. Similarly, with a brokerage account (which may hold mutual funds, stocks, or bonds), you’ve already paid taxes on the principal. Therefore, you’ll only pay taxes on the gains when you withdraw.

Maintain Tax Efficiency

It’s important that the investments included in your tax plan serve a tax-efficient purpose. For example, if you’re not withdrawing from a fund that’s regularly paying out capital gains distributions or dividends each month, you’ll have to pay taxes on gains that aren’t being utilized. Whether this scenario or similar situations are tax-efficient can all be addressed within your tax plan.

Tax planning plays a crucial role in a successful retirement strategy. A financial advisor can help you assess and manage your tax situation effectively. By taking the time now to consider your options and plan your withdrawals carefully, you can maximize your retirement income while minimizing your tax liability.