Strategies to Convert Earnings Into Tax-Free Income

Paying taxes does more than just lower your take-home income. It is money you cannot save, invest or leave to your loved ones as a future inheritance. Taxes are not going away anytime soon, but you can take action to reduce the government tax bite. You can use several different investment strategies to legally reduce the amount of tax you pay. Turning your taxable earnings into tax-free income can help fatten your paycheck on payday.

Whole Life Insurance

Whole life insurance policies are more than just a way to provide for your family after your demise. You can use the policy to generate tax-free income through withdrawals and loans. You can withdraw the dollar amount of the premiums you paid as tax-free income. If you take out a loan against the policy, the Internal Revenue Service considers it a debt instead of taxable income. You do not have to repay your policy loans, but the loan amount and interest will be deducted from the policy value when you die.

Roth IRA

With a Roth IRA, you do not deduct the contributions off your income tax return. Instead, your future Roth IRA withdrawals are considered tax-free income in retirement. As of 2013, the maximum Roth IRA contribution you can make for is $5,500, or $6,500 if you are 50 years or older, as long as you earned at least that much in taxable compensation. If you reach retirement age and still work, you can continue contributing to your Roth IRA. Also, unlike with traditional IRAs, you do not have to take required minimum distributions when you reach age 70 1/2. When you die, your beneficiaries do not pay income tax on the inherited Roth IRA.

Reverse Mortgage

When you turn 62 years old, you can receive tax-free income with a reverse mortgage. A reverse mortgage allows you to tap into your home’s equity without having to sell it. You decide how much equity you want to use and whether you want the money in a lump sum or in monthly payments. You do not have to repay the loan as long as you live in your home. Home Equity Conversion Loans are federally insured reverse mortgages and are guaranteed by the U.S. Department of Housing and Urban Development.

Municipal Bonds

Investing in municipal bonds does more than support your local community or state. The interest payments you receive are tax-exempt on the state and federal level. Corporate bonds may offer you have a higher interest rate, but after taxes can pay less interest than municipal bonds. States that have an income tax normally do not tax their own municipal bonds. If you invest in municipal bonds issued by another state, the interest may be taxed if your state imposes an income tax. Make sure the out-of-state bond yield makes up for the tax bite.

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About the Author

Based in St. Petersburg, Fla., Karen Rogers covers the financial markets for several online publications. She received a bachelor's degree in business administration from the University of South Florida.

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