How Can I Pay $0 in Taxes in Retirement?

$0 in taxes? Is this real or a legend? Or a real legend? I’ll let you decide…

Nobody likes paying taxes. We may like some of the benefits taxes pay for (roads, public schools, police, firefighters, etc.), but nobody enjoys seeing a chunk of their paycheck taken away by Uncle Sam every month.

What if I told you that there was a way to eliminate your tax bill in retirement? Does this sound like click-bait? Yes. But is it possible? Also yes.

First, I have to give credit to this blog post from Jeremy at Go Curry Cracker that opened my eyes to this possibility. Jeremy and his family have paid little to no money in taxes while retired.

Bear with me on this one, it’s going to get a little technical.

Bottom line: in 2023, a retired individual can withdraw up to $58,475, and a married couple can withdraw up to $116,950, tax-free. Here’s how. You reduce your tax bill in retirement by taking advantage of two (perfectly legal) tax advantages with investing:

1) Using the standard deduction (a tax benefit all people get when filing taxes) to cancel out any withdrawals from a Traditional IRA.

2) Investing within a taxable brokerage account and withdrawing money under the 0% tax bracket limit so you aren’t taxed on your withdrawals.

Let’s start with the standard deduction. The standard deduction is a fixed amount of money the US government allows you to deduct from your income, reducing the amount of taxes you owe. In 2023, the standard deduction is $13,850 for singles/married couples filing taxes separately and $27,700 for married couples filing jointly. On an annual income of $40,000, a single filer would only owe taxes on $26,150 (40,000 - 13,850 = 26,150).

So, what’s the best way to take advantage of the standard deduction as a retiree? By contributing to a Traditional IRA.

When you contribute money to a Traditional IRA, you reduce your taxable income and save money on taxes upfront (check out this newsletter on IRAs if you forgot how they work). This money grows tax-free until you’re ready to withdraw it, when you would normally be taxed.

However, if you only withdraw up to the standard deduction amount from your Traditional IRA, your tax burden ends up being $0. That’s $13,850 (for those filing taxes solo) or $27,700 (for married couples filing jointly) in tax-free income off the bat.

If you want to retire early, you can accomplish the same thing by using a Roth Conversion Ladder, allowing you to access money from a Traditional IRA before the normal retirement age (59.5), penalty-free.

The Roth Conversion Ladder involves investing primarily within a Traditional IRA while working, while having at least 5 years’ worth of your living expenses within a taxable brokerage account before you retire. When you retire, you convert the minimum amount of money you need to cover your expenses for one year from your Traditional IRA to a Roth IRA. Each conversion is a taxable event, so if you convert any amount of money over the standard deduction, you’ll be taxed on it. You’ll have to wait 5 years before you can touch the converted money without being penalized. This is why you need 5 years’ worth of expenses invested in a taxable brokerage account to cover your living expenses. Every year, convert more money from your Traditional IRA to your Roth IRA. The money you convert after 1 year can be accessed penalty-free in year 6, year 2 money can be accessed in year 7, and so on. Continue the process, and voilà! You’re accessing retirement money early while keeping your taxes low.

For the visual learners out there with decent enough vision to read tiny font, here’s a sweet homemade PowerPoint graphic laying out the process in a little more detail.

Again, if you plan to retire after age 59.5, ignore everything I just said about the Roth Conversion Ladder.

But unless you don’t have a housing payment and/or you photosynthesize for sustenance, you probably need more money than $13,850 or $27,700 to live off of.

That’s where your taxable brokerage account comes into play.

When you withdraw money from a taxable brokerage account, your withdrawals are subject to either short-term or long-term capital gains taxes. Capital gains on any investments held for exactly one year or less are subject to short-term capital gains taxes. The short-term capital gains tax rates are the same as federal income tax rates. Any investments held for over a year are subject to more favorable long-term capital gains tax rates.

Here’s the breakdown of the different tax long-term capital gains tax brackets in 2023 from Bankrate:

What should jump out at you is that single individuals can withdraw up to $44,625 and married couples filing jointly can withdraw up to $89,250 while remaining within the 0% tax bracket. That’s a lot of money.

The downside of investing within a taxable brokerage account is that your contributions aren’t tax-deductible (like they are with a Traditional IRA), dividends are taxable (even if reinvested), and you’ll still owe taxes on any withdrawals over the 0% tax bracket threshold.

So let’s do the math.

In 2023, single individuals can withdraw $13,850 tax-free from a Traditional IRA plus $44,625 from a taxable brokerage account under the 0% tax bracket for a total of $58,475 per year.

Married couples filing taxes jointly can withdraw $27,700 tax-free from a Traditional IRA plus $89,250 from a taxable brokerage account under the 0% tax bracket for a total of $116,950 per year.

The standard deduction and tax brackets generally increase each year too, so the amount you’d be able to withdraw tax-free would increase with it. Not too shabby.

And if you want to withdraw even more money without paying taxes in retirement, investing within a Roth IRA while working can cover the gap. Since you pay taxes when contributing to a Roth IRA, all capital gains (AKA investment growth) are tax-free when you withdraw them. However, the perk of investing within a Traditional IRA over a Roth IRA is that you can avoid taxes both while contributing and withdrawing, as long as you stay under the standard deduction limit.

Just like that, you’ve got yourself a legal way to reduce your taxes. Some may think the pursuit of lower taxes through these methods is immoral. If we were talking about fraudulent “business” write-offs and other skeevy means of tax avoidance, I would agree. But I think using the tax advantages the government offers you for investing is just being smart.

Call to Action

Decide if you need a taxable brokerage account to support your investment goals. If so, pick a brokerage (like Fidelity, Charles Schwab, or Vanguard), and open an account.

What We’re Reading/Listening To:

Audiobook: The 4-Hour Workweek. Nothing will make you want to hire a virtual assistant and create a Squatty-potty-esque product that will pay you forever more than this book. Stuck in the 9-to-5 grind against your will with seemingly no way to escape? Allow this book to open your mind to new opportunities for making money.

Debrief on Deck

Next week, Wilson will cover how to evaluate an index fund or ETF. The answer probably isn’t to just pump your money into the stock of the day on Reddit’s WallStreetBets, although I’m confident my one share of GameStop will go to the moon someday.

As always, please reach out to us with any questions or comments you have. You can reply directly to this email or find us on social media (X (formerly Twitter) and Instagram).

Until then, stay the course.

Disclaimer