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How Retirees Can Legally Pay $0 in Taxes on Their Retirement Income Thumbnail

How Retirees Can Legally Pay $0 in Taxes on Their Retirement Income

Retirement should be a time to enjoy the fruits of your years of hard work. You've saved diligently in your 401(k), IRA, and other investment accounts to build up a nest egg that will see you through your golden years. The last thing you want is for Uncle Sam to swoop in and take a huge chunk of your retirement income in taxes.

The good news is, it's entirely possible to have retirement income exceeding $100,000 and pay $0 in federal income taxes on it! This comprehensive guide will show you how to legally avoid owing any income tax on your retirement payouts. By understanding and applying principles of tax efficiency in retirement, you can take advantage of little-known provisions in the tax code that encourage retirees to claim their benefits tax-free.

Key Takeaways

  • Married couples can earn up to $116,950 in 2023 and pay $0 federal income tax by combining the standard deduction and 0% capital gains rate.
  • Long-term capital gains and qualified dividends are taxed at 0% for incomes under $89,250 (married filing jointly).
  • Contributing to pre-tax retirement accounts helps reduce taxable income. Max out 401(k)s, HSAs, etc if possible.
  • Itemizing deductions, converting retirement assets to Roth accounts, and tax-loss harvesting are other ways to lower taxable income.
  • While powerful, make sure to use this strategy carefully and work with a tax pro to avoid mistakes.

Overview of the Strategy

The key to paying no taxes on 6-figure retirement income lies in two main elements of the tax code:

  • The 0% capital gains rate for lower income levels
  • The standard deduction for married couples

By optimizing your income sources and deductions, a married couple can earn up to $116,950 tax-free in 2023. Here's a breakdown:

  • Up to $89,250 investment income at 0% rate: If your taxable income is under $89,250 as a married couple, your long-term capital gains and qualified dividends are taxed at 0%.
  • $27,700 standard deduction: This deduction eliminates your first $27,700 of taxable income.

When you combine the two, you get $116,950 in tax-free income! Let's look at the details of how to use each element.

Taking Advantage of the 0% Capital Gains Rate

One of the best parts of the tax code is the 0% rate on long-term capital gains and qualified dividends for lower income earners. Under current 2023 brackets, married couples with taxable income under $89,250 qualify for this special rate.

For singles, the 0% cutoff is $44,625. See the table below for the exact brackets based on filing status:

Filing Status                0% Rate Up To

Single                                        $44,625

Married Filing Jointly                 $89,250

Married Filing Separately          $44,625

Head of Household                   $59,750

This means if you're married and your taxable income is less than $89,250, any long-term capital gains or qualified dividends will be 100% tax-free!

What Counts as Qualified Investment Income?

To take full advantage of the 0% rate, your investment income must meet certain qualifications:

  • Long-term capital gains: Profits from selling investments held over 1 year. Short-term gains don't qualify.
  • Qualified dividends: Most normal dividends from US stocks. Must meet holding period rules.

In short, income from your stock market investments will generally be eligible, provided you're following a buy-and-hold strategy.

Be careful - if you have other sources of ordinary income like wages or self-employment income, those will raise your taxable income and reduce the amount of investment income you can claim tax-free. That's where the standard deduction comes in...

Using the Standard Deduction to Your Benefit

All taxpayers can reduce their taxable income by taking the standard deduction or itemizing deductions. For 2023, the standard deduction amounts are:

        Filing Status          Standard Deduction

Single                                       $13,850

Married Filing Jointly                $27,700

Head of Household                  $20,800

Married couples get a whopping $27,700 standard deduction, allowing them to further shelter investment income.

For example, say you had $60,000 in qualified dividends and capital gains. After taking the $27,700 deduction, your taxable income would only be $32,300 - qualifying you for the 0% rate!

The standard deduction eliminates taxes on your first portion of income from any source, including retirement account withdrawals or Social Security benefits in excess of your cost basis.

When you pair the deduction with the 0% capital gains rate, you get a powerful one-two punch to avoid taxes.

Real World Example

Let's look at a hypothetical couple - John and Jane Smith - to see how this would work in the real world.

John and Jane have $50,000 in dividends and capital gains from their brokerage account. They also withdraw $30,000 from their Traditional IRA. And they receive $40,000 from Social Security benefits.

Their total income is $120,000. But here is their tax calculation:

  • Investment Income: $50,000
  • IRA Withdrawal: $30,000
  • Social Security Benefits: $40,000
  • Total Income: $120,000
  • Standard Deduction: -$27,700
  • Taxable Income: $92,300

Their taxable income is less than $89,250, so the $50,000 in qualified dividends and long-term capital gains are taxed at 0%. The IRA and Social Security income fills up the remaining taxable income space.

John and Jane pay $0 income tax on their $120,000 retirement income!

This example shows how powerful these two strategies are together. You reduce taxable income with the standard deduction, then use the 0% rate to shelter investment income.

Turning Retirement Assets Into Tax-Free Income

A key part of this strategy is having assets that produce qualified dividends and long-term capital gains. This usually means having a sizable investment portfolio. Here are some tips for converting your nest egg into tax-free income sources:

  • Gradually shift 401(k) funds into a taxable brokerage account. You can move money over time using Roth conversions or 72(t) early withdrawals.
  • Make sure your portfolio is generating dividends from stocks that meet the holding qualifications. Focus on US companies.
  • Structure your withdrawals to stay under the 0% capital gains threshold each year. Work with a financial planner to develop an optimized distribution strategy.
  • Move to a total market stock index fund to simplify managing qualified dividends.

With the right withdrawal techniques, you can produce tax-free income from your pre-tax retirement accounts too!

Limitations and Risks

While this strategy is perfectly legal, it's important to be aware of the limitations and potential risks:

  • You must have sufficient assets generating qualified dividends and long-term capital gains to take full advantage of the 0% rate.
  • You still have to pay payroll taxes on earned income like wages. The strategies here only help avoid income tax.
  • Income thresholds and tax rates are adjusted periodically. Be sure to review annually to account for changes.
  • State income tax treatment of retirement income varies. You may still owe state taxes even if you avoid federal tax.
  • Future tax law changes could impact the strategy. However, lower rates on capital gains/dividends have bipartisan support.

As with any tax strategy, work closely with a financial planner and tax professional to ensure you follow the rules correctly. But used properly, these two powerful elements of the tax code can help retirees claim six-figure income 100% tax-free!

Now let's look at how to optimize this strategy...

5 Ways to Maximize Tax-Free Income in Retirement

The baseline for a married couple is $116,950 of tax-free income. But you can often earn much more than that and still pay $0 in income tax with the right planning.

Here are 5 tips to maximize your tax-free retirement income:

1. Save money to a Roth IRA or do Roth conversion

Contributing to a Roth IRA or doing Roth conversions from a traditional IRA are great ways to build tax-free income in retirement. The key benefit of Roth accounts is that future withdrawals are not taxed. This allows your savings to compound more quickly than tax-deferred accounts like 401(k)s.

Max out contributions to Roth IRAs whenever possible, up to the annual limit of $6,000 for those under age 50. For those over 50, you can contribute an extra $1,000 as a catch-up contribution. If you have saved in traditional IRAs or 401(k)s, consider strategic Roth conversions during low income years to build up your pool of assets that can be withdrawn tax-free in retirement. Work closely with a financial planner to model different scenarios and determine the best Roth conversion strategy for your situation.

2. Move to a Tax-Free Retirement State

While Social Security benefits and most retirement account withdrawals have preferential federal tax treatment, state taxes on retirement income vary widely. Moving to one of the 9 states with no income tax - Alaska, Florida, Nevada, South Dakota, Texas, Washington, Wyoming, Tennessee, and New Hampshire - could save you tens of thousands in state taxes during your retirement years.

For those already residing in a high-tax state, making a move may be unrealistic. In those cases, consider states like Mississippi, Pennsylvania, and Illinois which exempt some types of retirement income, like pension payments or Social Security benefits, from state tax. Consult details on individual state tax policies before making a retirement location decision. Fully understanding the impacts on your overall tax burden and after-tax retirement income is crucial.

3. Contribute to a Health Savings Account (HSA)

Health Savings Accounts (HSAs) offer a triple tax advantage that makes them uniquely powerful retirement savings tools. Contributions reduce your current taxable income. Growth and investment returns grow tax-free. And withdrawals for qualified medical expenses are also tax-free at any age.

In 2023, individuals with a qualifying high deductible health plan can contribute up to $3,850 to an HSA, while families can contribute $7,750. If over 55, an additional $1,000 catch-up contribution is allowed. Max out HSA contributions each year and invest the money for growth over time. Even if you have medical expenses now, try to pay out-of-pocket to allow your account balance to keep growing. The tax-free withdrawal benefits will be incredibly valuable in retirement to help offset frequent medical costs.

4. Take Advantage of Other Adjustments and Deductions

Beyond the standard or itemized deduction, there are a number of tax adjustments and deductions at your disposal to help minimize your tax liability. These include deductions for mortgage interest, charitable giving, and state/local taxes when itemizing.

There are also above-the-line deductions like traditional IRA contributions that can directly reduce your adjusted gross income. Other adjustments like student loan interest deductions also have the potential to reduce your overall tax burden.

Consult with a savvy CPA or tax planner to discuss your full range of options. Often people leave valuable deductions on the table simply because they aren’t aware these options exist. Just be sure any complex tax minimization strategies align with your personal financial priorities and risk tolerance levels.

5. Use Tax-Loss Harvesting

Tax-loss harvesting involves strategically selling investments at a loss to offset capital gains and income. Up to $3,000 in capital losses can be used to directly offset ordinary income, while any remaining losses carry forward to offset future capital gains.

By consistently harvesting tax losses, you can create a bucket of losses to use as an offset down the road. This allows you to strategically realize gains at opportune times when staying within zero or low tax brackets. The ability to selectively realize investment gains and losses is very powerful.

Model out different loss harvesting and capital gains realization scenarios with your financial advisor. The ideal strategy balances long-term investment performance with strategic tax minimization to maximize your overall after-tax returns. Be sure to factor in the opportunity cost of selling appreciated investments solely for tax loss harvesting purposes.

Frequently Asked Questions

Below are answers to some common questions on using this $0 tax retirement income strategy:

1. Do I have to move to a different state to make this work?

No, the strategies around the standard deduction and 0% capital gains rate apply at the federal level. However, moving to a tax-free retirement state can potentially save you thousands in additional state tax savings.

2. What if my income goes over the 0% tax threshold one year?

If your taxable income exceeds the top of the 0% capital gains bracket in a certain year, only the amount over that level will be taxed at 15% or 20%. With proper planning, you can often avoid exceeding the threshold even with variable income streams.

3. Can I contribute to a Roth IRA too?

Yes, contributing to a Roth can be another tax optimization strategy, as it provides tax-free growth. Just be aware Roth contributions don't reduce your taxable income today. Make sure your total income stays low enough to maximize the 0% capital gains rate.

4. Do I need to worry about the net investment income tax?

If your income is under the specified thresholds, you generally don't need to worry about the 3.8% NIIT. It only applies when your modified adjusted gross income exceeds $250,000 (single) or $500,000 (married filing jointly).

5. What if tax laws change in the future?

Tax law changes are always a possibility, which is why working with a tax professional is recommended. However, preferential rates on capital gains and dividends have historically received bipartisan support and encouraging retirement savings is in the government's interest. Changes may affect exact income thresholds but are unlikely to eliminate the strategy.


Retiring without owing federal income taxes may seem too good to be true, but with careful planning it is an achievable goal. By maximizing deductions, contributing to tax-advantaged accounts, and properly structuring your investments to take advantage of the 0% capital gains rate, couples can potentially earn well into six figures tax-free.

While each investor's situation is unique, the strategies outlined in this guide provide a framework for legally minimizing or eliminating tax owed on retirement income streams. As with any tax planning strategy, work closely with qualified financial and tax professionals to ensure proper implementation based on your personal financial picture and retirement goals. With the right approach, you can enjoy the fruits of your retirement nest egg to the fullest extent possible.

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