"Tax-free retirement" has a nice ring to it. If, like two-thirds of Americans, you are unsure you've saved enough for your out years, it's especially nice to know that Uncle Sam won't be pinching a slice of your meager pie. Or maybe you're an ample saver convinced by the tax talk in Washington that the feds will undo your careful planning by raising taxes by the time you call it quits.
No wonder financial advisors say that current clients and prospects have taxes on their minds, or that titles containing "tax free" are popping up on the personal finance shelves at the bookstore.
As enticing as a completely tax-free income stream may sound, however, it's difficult to create. The most common retirement savings vehicles, tax-deferred IRAs and 401(k)s, are unwieldy investments when it comes to taxation. And while most retirees have less income to tax, they also have fewer deductions, reducing the opportunities to shelter their reduced revenue.
Some financial advisors question whether avoiding taxes should be a priority at all in retirement planning.
"The goal is not to pay the least tax possible but to maximize the after-tax return," said Rande Spiegelman, vice president of financial planning at the Schwab Center for Financial Research.
But there's good reason to pursue as much tax-free income as possible.
"If you ignore their impact, taxes can change the old mantra that you can live on 80 percent of what you make pre-retirement," said Greg Stevens, senior financial counselor at Cabot Money Management, in Salem, Mass.
At a time of life when returns are low and health-care expenses are high, it makes sense to preserve every retirement dollar you can.
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The retirees' primary source for tax-free income is the Roth IRA. After-tax dollars go in and grow tax-free, and you pay no tax on withdrawals. Roths have an advantage over municipal bonds, the time-honored tax-free instrument because, unlike with munis, Roth disbursements aren't counted as income for early recipients of Social Security, whose payments are docked if they make as little as $15,000.