Six Streams of Tax-Free Income

Six Streams of Tax-Free Income

November 01, 2021
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We operate upon three beliefs when it comes to tax-free income in retirement.

The first is that tax rates are likely to be dramatically higher in the future than they are today. Possibly much higher. Mathematically speaking, we are past the point of no return, as discussed elsewhere. In addition, we are in the midst of the 'tax sale of a lifetime' today.

The second is that the only way to truly insulate yourself from the impact of higher taxes is to get to the zero percent tax bracket.

The third is that it is nearly impossible to get to the zero percent tax bracket with only one stream of income.

It is nearly impossible to get to the zero percent tax bracket by focusing on just one stream of tax-free income. 

You can't get there by simply contributing to a Roth IRA.  You can't get there by simply owning a LIRP.

To get to the zero percent tax bracket typically requires between four and six different streams of tax-free income - none of which show up on the IRS’s radar - but all of which contribute to you being in the zero percent tax bracket.

People tend to fixate on the LIRP and forget about the rest.

The LIRP is great, but it has a narrow focus and often doesn’t do enough to generate a stream of tax-free income on its own.

Typically, we recommend diversifying your tax-free streams of income because each one is unique and accomplishes different parts of the strategy.

Getting to the zero percent tax bracket is like fitting pieces of a puzzle together. Each situation is different.

If you study the tax code you'll see that there are tax-free benefits there for the taking, and each stream of tax-free income  has something that makes it unique…each has something it can accomplish that none of these other streams of tax-free income can accomplish.

We are going to explore those six different streams of tax free income -

why each one is powerful and each one should be included or at least considered in your tax-free retirement plan. Getting to the zero percent tax bracket is a little like fitting pieces of the puzzle together. Only when you fit pieces of the puzzle together does the zero percent tax bracket come into play.

First  let's review:

What is a real tax-free income stream?

Not only should any income stream be free of federal tax, state tax, and capital gains tax - but also when you take distributions from a true tax-free investment, it should not count as provisional income - e.g. it should not count against the thresholds which cause social security taxation.

Every income stream below satisfies those requirements -  but each stream of tax-free income is unique in its own right and does something that none of the other streams can do. 


The first stream is the Roth IRA. If you’re younger than 50, you can contribute $6000 annually. If you’re older than 50, you can contribute $7000. The thing that makes the Roth IRA unique, besides being tax-free, is that when you put money in, you can take money out right away. It’s the only tax-free stream of income with that feature.

Now you can't touch the growth but you can take out what you've contributed (the basis) to that Roth IRA right away - so there isn't that sensation like with a 401k - that you're locking the money up until age 59 1/2. With a traditional IRA, you don't have that luxury. Any of the other streams of tax-free income we're going to discuss all have different strings attached regarding withdrawals.


The Roth 401(k) is unique because it’s part of a company plan - and they will often have inducements that go with it.  It has a $26,000 limit. But they will give you a free money percentage match many times. This match usually is paid into a traditional plan.

The Secure Retirement Act 2.0 that is working its way through Congress will also allow you to direct that match to your tax-free bucket. This company match is free money and that’s something most people should take advantage of when they can.


The Roth conversion is unique because it can be the workhorse for your retirement planning. It allows you to convert as much as you want at any given year to tax-free because there are no limits at the moment - you just have to be willing to pay the tax. I find most people struggle to understand this; but it makes sense - the Internal Revenue Service wants its money as soon as they can get it. For most, we recommend a systematic strategy of conversion over time.

 If you have a lot of money in your IRA ($10 million+), it probably makes sense to convert all of that money before tax rates go up - possibly by next year on these large accounts.


Required Minimum Distributions are interesting in that they come from your tax-deferred bucket. So, how can they be tax-free? 

The idea is to get the balance in your IRA low enough that your RMDs at age 72 are equal to or less than your standard deduction - and also low enough so they don’t cause Social Security taxation. Remember RMD distributions - even if they are offset by the standard deduction - still count as provisional income. So, you could technically take them out tax-free but still cause social security to become taxable. 

 We want to avoid that. We can do that by making sure that we convert enough money out of our traditional IRA and into our Roth IRA such that the RMDs at age 72, when coupled with one-half of our social security, keep us below the provisional income thresholds at which point our social security gets taxed. 

RMDs done this way are a strategy where you get a deduction on the front end, the money grows tax-deferred, and you can take it out tax-free. This is the holy grail of financial planning! None of the other streams we discuss here do that. The only other thing that functions similarly is the Health Savings Account HSA. And the HSA is a great tool; but the HSA is very limited in how it can be funded and used.


The Life Insurance Retirement Plan (PRA or LIRP) has a lot of things going for it, because it's tax-free and you can put as much money as you want into it. There are no income limitations, and it is safe and productive.

While all of those things are true -  one thing that really stands out with this tool is the death benefit. Should you die prematurely, your heirs will get that tax-free.

With the right LIRP, you can also receive that death benefit in advance of your death for the purpose of paying for long-term care. Many folks looking to retirement today have parents facing long-term-care (LTC) challenges, so they see the issues and expenses first-hand. People want to avoid having to deal with LTC, without having to deal with expensive LTC policies. If you do it with the right company, you can accelerate the death benefit and use it while still living . If you have a $400,000 death benefit, for example, and you wake up one day and can't do 2 of the 6 activities of daily living, you get a doctor to write a letter and you can get about $100,000 of this death benefit to use for up to four years (depending upon your age). They will give you the death benefit while you are alive for the purposes of LTC. 

This is huge This avoids the heartburn of traditional policies where you are paying for something you hope you never use.  If you die peacefully in your sleep never needing it, someone still gets the death benefit. Probably your kids. Yes, all the other benefits exist - tax-free distributions, no effect on RMDs, etc. But the big thing is the potential for LTC coverage.


Social Security is the final stream of tax-free income. As long as your provisional income is below certain thresholds ($25K for single and $32K for married), it’s tax-free and functions like an inflation-adjusted annuity. It can help you mitigate longevity risk (which is a risk multiplier), inflation, and sequence of return risk. The longer you live, the better it gets…the greater the return on your investment. If you take it out tax-free that's even a bigger plus. If your Social Security benefit Is taxed, you will end up taking more money out of your other accounts - usually an IRA or 401K.

I've done the math many times, and  with dozens of different clients, and have concluded that when your social security gets taxed, you run out of money five to seven years faster than people who do not have their social security taxed.  Why? because the act of compensating for social security taxation to maintain your lifestyle forces you to spend down all your other assets that much faster. 

The Power of Zero approach is a multi-pronged approach built around having multiple streams of tax-free income.  Each stream of tax-free income is unique in its own right and contributes something to your retirement plan that none of the others can do.

If your advisor is not talking in these terms, it's time for you to consider working with a true tax-free income advisor!

Contact us here:

Join us at Income for Life and help yourself and others get off the tax freight train.