Please ensure Javascript is enabled for purposes of website accessibility
Free Article Join Over 1 Million Premium Members And Get More In-Depth Stock Guidance and Research

3 Sources of Tax-Free Income for Retirees

By Maurie Backman - Oct 30, 2020 at 8:02AM

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More

Want to pay the IRS less as a senior? Then stick to these income streams.

There are certain expenses that tend to cause seniors a lot of stress: healthcare, housing, and taxes. Taxes are unavoidable earlier in life, and they're also a mainstay during retirement.

The good news, however, is that a few strategic moves could lower your tax burden tremendously at a time in life when that's so important. Here are a few sources of tax-free retirement income you may benefit from.

1. Roth IRAs

Though Roth IRAs don't offer tax breaks when you make contributions, the benefit is that any withdrawals you take during retirement will be yours to enjoy tax-free. Investment gains in a Roth IRA are also tax-free. Furthermore, the Roth IRA is the only tax-advantaged retirement plan to not impose required minimum distributions, giving you more flexibility with how you take withdrawals.

Smiling older man and woman at table with documents and calculator

Image source: Getty Images.

There is a catch with Roth IRAs: You can't fund one directly if your earnings exceed a certain threshold that changes from year to year. In 2020, you can't contribute to a Roth IRA if your income exceeds $139,000 as a single tax filer, or $206,000 as a married couple filing jointly. In 2021, these limits will increase to $140,000 and $208,000, respectively.

However, if your income renders you ineligible for a Roth IRA, you can always fund a traditional IRA and convert it to a Roth afterward. You'll pay taxes on that conversion, but then you won't have to worry about taxes later in life.

2. Roth 401(k)s

Though not every 401(k) plan comes with a Roth savings feature, this option is growing increasingly popular. And if your employer's plan offers a Roth, it pays to take advantage.

Like Roth IRA withdrawals, distributions from a Roth 401(k) are completely tax-free in retirement. And unlike Roth IRAs, there are no income limits associated with Roth 401(k)s, so you can fund one directly, even if you're a higher earner.

Furthermore, Roth 401(k)s come with higher contribution limits than Roth IRAs -- $19,500 versus $6,000 for workers under 50, and $26,000 versus $7,000 for those 50 and over. That means you can build a more robust nest egg with a Roth 401(k), and then take that money out tax-free as a retiree.

3. Municipal bonds

Bonds are an appropriate investment for retirees because they're relatively stable and provide steady income in the form of semiannual interest payments. But if you invest in corporate bonds -- those issued by companies -- your interest payments will be taxed.

That's why municipal bonds may be a better choice for your retirement. Municipal bonds are those issued by cities and states and, like corporate bonds, they pay interest twice a year. However, municipal bond interest is always tax-exempt at the federal level. And if you buy municipal bonds issued by the state you reside in, you'll avoid state and local taxes on your interest income, as well.

The less tax you're liable for in retirement, the fewer financial concerns you'll have. It pays to save for retirement in a Roth savings plan and put some money into municipal bonds. That way, you'll enjoy tax-free income that makes your senior years more comfortable.

Invest Smarter with The Motley Fool

Join Over 1 Million Premium Members Receiving…

  • New Stock Picks Each Month
  • Detailed Analysis of Companies
  • Model Portfolios
  • Live Streaming During Market Hours
  • And Much More
Get Started Now

Related Articles

Motley Fool Returns

Motley Fool Stock Advisor

Market-beating stocks from our award-winning service.

Stock Advisor Returns
673%
 
S&P 500 Returns
142%

Calculated by average return of all stock recommendations since inception of the Stock Advisor service in February of 2002. Returns as of 11/30/2021.

Discounted offers are only available to new members. Stock Advisor list price is $199 per year.

Our Most Popular Articles

Premium Investing Services

Invest better with the Motley Fool. Get stock recommendations, portfolio guidance, and more from the Motley Fool's premium services.