Just because you’ve stopped working doesn’t mean you’re done paying taxes.
Much of the income you receive in retirement, even if it’s not directly from employment, can still be taxed. But not all of it is subject to federal taxes — especially if you play your cards right.
You can or might be able to avoid paying federal income taxes on the following types of retirement income.
1. Social Security benefits
If what the Social Security Administration characterizes as your “combined income” is below a certain amount, you generally won’t face federal taxes on your Social Security retirement benefits.
The exact amount depends on whether you file a tax return as an unmarried individual, jointly with your spouse or separately from your spouse. The Social Security Administration lays out the details on its website.
However, even if your combined income is high enough that you would owe taxes on your benefits, there are ways to get around it — legally. We detail them in “5 Ways to Avoid Paying Taxes on Social Security Income.”
2. Health savings account distributions
Health savings accounts are popular specifically for their tax advantages, as we explain in “3 Ways a Health Savings Account Can Improve Your Finances.”
In short, your contributions to an HSA are tax-deductible, they grow tax-free and withdrawals are tax-free when used for eligible medical expenses.
So, you will never pay federal taxes on money you put in an HSA, provided that you follow the IRS rules for this type of account.
3. Reverse mortgage payments
The IRS plainly says:
“Reverse mortgage payments aren’t taxable.”
The federal agency considers these to be loan proceeds, not income.
Whether you get those payments as a lump sum, a monthly advance, a line of credit or all three, you won’t face federal income taxes on the funds.
If this feature alone is making you wonder whether a reverse mortgage is right for you, check out what Money Talks News founder Stacy Johnson has to say in “Should I Get a Reverse Mortgage?” This source of retirement income is not for everyone.
4. Roth IRA distributions
One advantage of a Roth individual retirement account (IRA) over a traditional IRA is that qualified distributions are not taxed.
Distributions that you receive upon or after reaching age 59 ½, for example, are generally among those that can be considered “qualified.”
This doesn’t mean you’re entirely escaping taxes though. You’re just paying them at a different time.
One way that deposits into a Roth IRA differ from those made into a traditional IRA is that you pay federal income taxes on them for the tax year in which you earned the money, as opposed to the year for which you withdraw the money. You’re paying on the front end instead of the back end.
This often makes Roth accounts attractive to people who want to avoid taxation in retirement and those who expect to be in a higher tax bracket during retirement than during their working years.
To learn more about the two types of IRAs, check out “Which Is Better — a Traditional or Roth Retirement Plan?”
5. Life insurance proceeds
The proceeds of a life insurance policy that you receive due to the insured person’s death usually aren’t considered taxable income, according to the IRS. You don’t even have to report proceeds on federal income tax returns. But any interest is taxable.
6. Municipal bond interest
Municipal bonds are essentially loans to state or local governments, and it would be awfully rude for the federal government to tax you on any interest you make from such loans. The IRS even refers to them as “tax-exempt governmental bonds.”
That doesn’t mean municipal bond interest is completely tax-free. You may end up paying in other ways.
For instance, your earnings from municipal bond interest could raise your combined income enough that you must pay federal taxes on your Social Security benefits.
7. Profit from selling your home
Capital gains from the sale of your primary home might not be subject to federal income tax, depending on how much you made.
“You may qualify to exclude up to $250,000 of that gain from your income, or up to $500,000 of that gain if you file a joint return with your spouse,” the IRS says.
The qualifications for this tax break include having owned the property and used it as your main home for at least two years of the five years prior to your selling it.
8. Veterans benefits
A wide variety of benefits paid through the U.S. Department of Veterans Affairs (VA) are not treated as income.
These benefits, which are laid out in IRS Publication 525, include:
- Disability compensation and pension payments for disabilities that are paid to veterans or their families
- Veterans’ insurance proceeds and dividends paid to veterans or their beneficiaries
- Interest on insurance dividends left on deposit with the VA
9. Reimbursements and expenses for volunteering
Certain kinds of funds that you receive related to volunteer work for federal programs are not subject to federal taxes.
As laid out in IRS Publication 525, they include various reimbursements to volunteers in:
- The Service Corps of Retired Executives (SCORE)
- National Senior Service Corps programs
- The Tax Counseling for the Elderly program
“In most cases, property you receive as a gift, bequest, or inheritance isn’t included in your income,” IRS Publication 554 says. However, income generated from property received as gifts does — for instance, interest, dividends, or rent.
And if a thoughtful person tried to skirt taxes by gifting you just the income from the property instead — such as by putting the property in a trust — that would still be taxable.
11. Insurance premiums of retired public safety officers
If you worked as a firefighter, emergency responder or in law enforcement, you may be eligible to exclude up to $3,000 in income from retirement plans used to pay premiums for health, accident or long-term care insurance. This is also true of coverage for your spouse or dependents.
12. Public assistance benefits
Various types of public assistance are usually excluded from taxable income, according to IRS Publication 554:
- Welfare benefits
- Crime victim payments
- Mortgage assistance
- Food benefits through the Nutrition Program for the Elderly
- State reemployment assistance
- Medicare benefits