4 Tax-Free Income Sources to Supplement Retirement
Choosing your investments with taxes in mind is a smart strategy as you approach retirement. Here are four income-generating possibilities that won’t trigger big tax bills.


Would you rather retire with taxable or tax-free income? With tax rates at historical lows, it is imperative to plan your next move before they rise in the future. Here are four tax-free income sources and their benefits.
Roth IRAs
In contrast to a traditional IRA, a Roth IRA requires you to pay taxes up front on your account contributions, but after age 59½, as long as you’ve held the account for at least five years, you can withdraw the money and interest earned tax-free. This allows you to protect more money for retirement.
The annual contribution limit is equivalent for the traditional IRA and Roth IRA, and both are subject to income restrictions in their own ways. For 2017, the maximum contribution is $5,500 ($6,500 if age 50 or over). For Roth IRAs, if your Modified Adjusted Gross Income (MAGI) is between $118,000–$133,000 as a single individual or $186,000–$196,000 as a married couple, the amount you can contribute to a Roth IRA will be reduced. For traditional IRAs, your contribution isn't limited by your income, but the amount that you can deduct on your tax return could be if you or your spouse has access through a retirement plan through your jobs. See the IRS IRA Deduction Limits page for details.

Sign up for Kiplinger’s Free E-Newsletters
Profit and prosper with the best of expert advice on investing, taxes, retirement, personal finance and more - straight to your e-mail.
Profit and prosper with the best of expert advice - straight to your e-mail.
For some, the Roth IRA is the best option, because its after-tax income compounds tax-free. If you will most likely retain a high level of income, it would be more profitable to fund a retirement account with after-tax dollars and reap the benefits in the long run.
Roth IRAs are also attractive because your contributions can be withdrawn at any time, penalty-free and tax-free. It’s only the gains on which you would face taxes and the 10% early-withdrawal penalty if you withdraw them before age 59½. And even those penalties can be avoided if the withdrawal is covered by one of several exemptions, including:
- First-time home purchase (up to a lifetime maximum of $10,000);
- Higher-education expenses at a qualified institution;
- Unreimbursed medical expenses or health insurance premiums (if unemployed); and
- Become disabled.
Life Insurance Cash Value
The primary reason people purchase life insurance is for the death benefit; but certain policies can accrue cash value restriction-free and penalty-free. Cash value in a life insurance policy is not a company-sponsored or retirement plan, but an alternate way to accumulate savings into a non-correlated asset class. Some of the different types of policies have been around for hundreds of years and have helped protect families against potential hardships during a recession or depression.
Although the most commonly used retirement accounts are restricted in some regard, life insurance such as whole or universal life, gives the opportunity to accrue retirement savings and guarantees that are not contingent on stock market returns. Just like one would insure his or her home, car or health, several people use life insurance’s cash value to insure their retirement. Similar to a Roth IRA, withdrawals are potentially tax-free under section 7702 of the Internal Revenue Code.
Key tax advantages from life insurance include:
- No income restrictions;
- Tax-deferred cash value accrual;
- Tax-free withdrawals (or loans);
- Not included into Social Security taxation equation;
- Pre-bankruptcy, lawsuit and creditor protection (subject to state laws);
- Withdrawals prior to age 59½ are not subject to IRS penalty; and
- Tax-free death benefit.
Unlike other investments or retirement accounts, withdrawals escape income taxes and capital gains taxes. You can allocate otherwise taxable investments inside a tax-free life insurance policy, producing large sums of tax-free compounded gains.
Municipal bonds
Municipal bonds (or “munis” for short) are debt obligations issued by cities, counties, states or any political subdivision of the United States and a source of tax-free income.
Besides the typical risks with investing (such as credit and liquidity), the greatest is your Social Security being taxed up to 85% due to municipal bond income. In fact, if you’re retired and already in a high tax bracket, this may not be a feasible solution. Unfortunately, many financial advisers aren’t aware that although municipal bond income is tax-free, it is factored into the equation for Social Security taxation.
Sale of your home
If you’re downsizing and have lived in your home for the last two out of five years from the date of sale, you can exclude up to $250,000 of capital gains taxes from the proceeds if you’re single. If you’re married, you can double that amount, essentially excluding up to $500,000.
Make sure to discuss with a qualified financial adviser on the unique factors of your life and retirement plan to determine which ones would be most appropriate or helpful.
Profit and prosper with the best of Kiplinger's advice on investing, taxes, retirement, personal finance and much more. Delivered daily. Enter your email in the box and click Sign Me Up.

Carlos Dias Jr. is a financial adviser, public speaker and president of Dias Wealth, LLC, headquartered in the Orlando, Fla., area, but working with clients nationwide. His expertise spans a diverse clientele, including business owners, retirees, lottery winners and professional athletes with wealth management, tax planning, estate planning, long-term care, annuities and life insurance. Carlos has contributed to Kiplinger, Forbes and MarketWatch, and his work has been featured in CNN, CNBC, The Wall Street Journal, U.S. News & World Report, USA Today and other publications. He’s spoken at various CPA societies across the United States, and Carlos’ presentations often focus on innovative tax strategies, retirement planning and asset protection, providing valuable knowledge to accountants, attorneys and financial professionals.
-
Cord Cutting Could Help You Save Over $10,000 in 10 Years
How cutting the cord can save you money and how those savings can grow over time.
-
The '8-Year Rule of Social Security' — A Retirement Rule
The '8-Year Rule of Social Security' holds that it's best to be like Ike — Eisenhower, that is. The five-star General knew a thing or two about good timing.
-
You Were Planning to Retire This Year: Should You Go Ahead?
If the economic climate is making you doubt whether you should retire this year, these three questions will help you make up your mind.
-
Are You Owed Money Thanks to the SSFA? You Might Need to Do Something to Get It
The Social Security Fairness Act removed restrictions on benefits for people with government pensions. If you're one of them, don't leave money on the table. Here's how you can be proactive in claiming what you're due.
-
From Wills to Wishes: An Expert Guide to Your Estate Planning Playbook
Consider supplementing your traditional legal documents with this essential road map to guide your loved ones through the emotional and logistical details that will follow your loss.
-
Your Home + Your IRA = Your Long-Term Care Solution
If you're worried that long-term care costs will drain your retirement savings, consider a personalized retirement plan that could solve your problem.
-
I'm a Financial Planner: Retirees Should Never Do These Four Things in a Recession
Recessions are scary business, especially for retirees. They can scare even the most prepared folks into making bad moves — like these.
-
A Retirement Planner's Advice for Taking the Guesswork Out of Income Planning
Once you've saved for retirement, you'll need your nest egg to support you for as many as 30 years. For that, you need a clear income strategy, not guesswork.
-
Ask the Editor, June 27: Tax Questions on Disaster Losses, IRAs
Ask the Editor In this week's Ask the Editor Q&A, we answer tax questions from readers on paper checks, hurricane losses, IRAs and timeshares.
-
Why Smart Retirees Are Ditching Traditional Financial Plans
Financial plans based purely on growth, like the 60/40 portfolio, are built for a different era. Today’s retirees need plans based on real-life risks and goals and that feature these four elements.