The Ultimate Guide to a Tax-Free Retirement!

Hey, what's up, everyone, and welcome to the School of Personal Finance. So, you know, I think a lot about taxes and retirement and what it might look like. And now with the current administration throwing around, having no taxes for anybody who makes under one hundred and fifty thousand dollars a year really got me thinking about tax diversification. And is it actually possible to enjoy a tax free retirement? And even if it isn't, even if that never goes through or who knows what it will look like by the time we get to retirement? But it still has me thinking a lot about what is the right amount that you should target in Roth accounts compared to traditional accounts? So I'll go into that in more depth here and also come up with strategies. How you should start now building that tax free bucket is no matter what it looks like when we get to retirement, the more you have in tax free, the happier you are going to be. But it's a balance. So let's get into it. I hope you find this one helpful. All right. Let's get to it. All right. So let's just start with what Trump is proposing and how it would completely change planning for retirement. Just imagine if you did not have to pay any income taxes, if you made less than one hundred and fifty thousand dollars. Now, distributions from retirement accounts wasn't really addressed in this proposal, and it's very premature. But we are making the assumption that distributions will be counted as income and Social Security benefits are not going to be counted as income. So basically what that means is that you are able to withdraw up to one hundred and fifty thousand dollars or maybe you have some other income like interest from savings accounts or capital gains or whatever, but you're able to take distributions up to that one hundred and fifty thousand dollar level and not owe any income taxes. Imagine a retirement like that. That would mean that as you're deferring money into your traditional 401ks or traditional IRAs and you're getting tax breaks throughout all those years, then that money grows tax deferred. Then when you take it out in retirement, as long as you stay under that one hundred and fifty thousand dollar income level, you would not owe any income taxes. I can't believe that that would actually come to fruition, but that is what they're targeting. And it would be pretty crazy if that was actually able to happen. Now, as a financial planner, I can't make assumptions about what the tax code is going to look like in the future, right? Especially when I'm working with people that are around my age, aren't going to retire for another 20 years or so. So we really have to go based on the current tax code and what it looks like in the brackets historically are very low right now. Right. There is a very good possibility that we could be facing much higher tax brackets, considering the debt in this country is at like thirty six trillion dollars. We don't know how it's all going to play out as far as are we actually going to be able to reduce that debt? Historically, what people tend to do is they fund their pre-tax retirement accounts, right? So they are funding their traditional 401ks and they take the tax deduction. Now, depending on what tax bracket you are in, that could very well be a smart move if you're in a 32 percent tax bracket or higher than taking the deduction. Now, on your 401k contributions is a smart move, and it's what I typically recommend. If you are in a 22 percent tax bracket or lower, then I typically recommend doing Roth 401k contributions and contributing to a Roth IRA. If you're in a 24 percent tax bracket, then it really depends on what your current tax diversification is. How much money do you have in traditional versus how much money do you have in Roth? And if you have no money in Roth, then I typically say, all right, let's go Roth and start building out that portion of your retirement account. So once you get into retirement, you're able to have tax free money that you could pull on. So let's talk about strategy in retirement. Let's say you walk into retirement and you just have Social Security as a guaranteed income. All right. So you have Social Security that's coming in. You have no pension. And you save the few million dollars in your 401k and IRA accounts. And now let's say that your take all you have is traditional. In that case, every dollar that you take out is going to be taxable. Right. So it's going to add to your income and you're going to have to pay income taxes on it, according to whatever the brackets are at that time. So now if you are able to defer money throughout your life at a 32 percent tax bracket in retirement, if you are in a lower tax bracket, then you won in that scenario. Right. You're getting a deduction of 32 when you put it in. And then when you take it out, if you're only in a 22 percent tax bracket, then you did well in that scenario. The risk is that because our country is in so much debt and because the tax brackets are historically low right now, that you could be in a substantially higher tax bracket in retirement. And then you deferred money at 32 percent and now you're taking it out and maybe you're paying 50 percent on it and you don't want to be in that situation. So the move is to build up money in your traditional IRA, but then also have a nice pot of money in Roth 401ks and Roth IRAs so that what you could do is you could take distributions from your traditional accounts up to the top of a certain tax bracket and then additional income that you need. You can then go ahead and take from Roth accounts so you don't bump yourself up into higher tax brackets. That is the power of tax diversification. And if you have savings accounts, brokerage accounts, things that are not under the retirement account umbrellas, then that plays into the mix as well. Now, as I'm recording this video, it is the first week of April in 2025. So you have up until April 15th to make Roth IRA contributions for 2024. If you don't have a Roth IRA yet or if you haven't funded it for 2024, I highly recommend that you go ahead and you do so. So you could do $7,000 in a Roth IRA for 2024. And if you're married, you and your spouse do Roth IRAs for $7,000 each. And they're very easy to set up. You could go to one of the big brokerage houses like Fidelity or Schwab or Vanguard, open up a Roth IRA, link your bank account, send the money over to it, and there it is. You make your Roth contribution. And if you have no clue how to invest inside of your Roth IRA, you could really start out by investing in just a broad based market index fund, like a total stock market index fund. And each of those three brokers that I just named, they have their own flavor of a total stock market index fund or an S&P 500 index fund. Now, again, none of this is investment advice, right? I don't know anything about you, but if you're investing for the long term, putting that money in the market is going to be a good idea because you have a long time period. And historically, the S&P 500 has returned over 10% per year, even though you mix in very bad years along the way, right? But over the long term, the market has done fairly well, and hopefully it'll continue doing that. And now one thing you have to make sure of is that you are under the income limits to be able to contribute to a Roth IRA. So in 2024, if you file single, then your modified adjusted gross income has to be under $146,000. And then there is a phase out. If you make a little bit more than that, you still might be able to contribute a portion. And then if you are married filing jointly, then you have to be under $230,000 of modified adjusted gross income. And same thing, there's a phase out up to $240,000. So if you make $235,000, for example, you still will be able to make a contribution, but just not the full $7,000. If you're married filing jointly, then both you and your spouse make those Roth IRA contributions. Now, if you're one of the lucky ones who makes more than those income limits, then you could still contribute to a Roth IRA, but you have to do what's called a backdoor Roth contribution. And I'm not going to go through the steps here. One thing that makes it complicated is if you already have traditional IRAs, then it's not as easy to do a backdoor Roth contribution, and it's not as beneficial. But if you don't have any traditional IRAs, then it's pretty simple to set up a backdoor Roth IRA contribution. And I do have a video on my YouTube channel, walking you through step-by-step exactly how to do that. All right. So now beyond Roth IRAs, you could also contribute to what's called a Roth 401k. And we talked a little bit about how you decide if a Roth 401k is better than a traditional 401k for your situation, depending on your tax bracket. But most companies these days, they offer a Roth 401k. So if you just set up your 401k or your 403b many years ago, and you have it just set it and forget it, and haven't really looked at it, it's definitely worth going in and seeing what you're contributing to, looking at your personal tax situation, your tax brackets, making the decision, why not have any money in Roth? Should I go ahead and now switch to doing a Roth 401k or a Roth 401k or a Roth 457? Now, if you do that, you are giving up the tax deduction that you're getting now. So your taxes, you're going to pay more taxes in the current years as you're contributing to Roth. But the benefit is that that money will grow tax free basically forever. When you go into retirement, then you could take it out and there are no taxes that will be due. This is very powerful. Once you get into retirement, it gives you control over your tax brackets. All right. So just circling back to the Trump proposal, if that actually did go through, then obviously you want to be targeting where in retirement you are taking out $150,000 or up to that $150,000 limit from your traditional accounts, which would be a home run, right? Cause that's a lot of money to take out and not owe any taxes on it. And then any additional money that you would need to live on, well you would have social security and who knows what that will look like at that time, right? I do still think that it will be there for us, but maybe the age will be a little bit later. We don't know, but you'll have social security, which is not included in that $150,000. Then you'll have $150,000 or up to $150,000 that you can take out of your traditional accounts. And then if you need more income, then you take from the Roth accounts. And in that scenario, you're paying zero taxes every time that which would be total insanity. So we can only plan for the future based on the things that we know. It's very hard to plan on the unknown. Just the fact that these proposals are getting thrown around out there does make me want to maybe save a little bit more than before in traditional accounts. Right? If I could get that deferral now and then be able to take out up to $150,000 in retirement tax free, then having a little bit more in traditional and starting to lean back towards that way. Cause I've been such a fan of Roth that I'd really like to go into retirement with a good healthy portion of my accounts in Roth. So I don't have to worry about taxes, but it would be silly to not take advantage of withdrawing that much money and being able for it to come out completely tax free. So the best advice I could give is just be tax diversified, right? Have some in each of these buckets, walk into retirement where you have a portion of pre-tax, you have a portion of savings and brokerage accounts. Then you have a nice portion of Roth accounts as well. I think the strategy stays the same, but it might look a little bit different once we actually get to retirement. All right, everyone. I hope that you found this one helpful. Please leave a comment down below. If you enjoyed this one, I will see you again in the next video.