Retirement Spending Is Ridiculously Tax Advantaged

Want to pay less in taxes? Retire. I'm serious. It's ridiculous how little retirees pay in taxes. You know why? Because our tax system is a progressive income tax system, and retirees have less income. And the income that they do have is typically tax-advantaged—sometimes extremely tax-advantaged.

Don't get me wrong. I'm not bitter. I plan to be a retiree myself someday, and I'm already taking advantage of many of these retiree tax breaks.

No Payroll Taxes

The first tax that retirees don't pay is payroll taxes (Social Security and Medicare). This is despite being the primary beneficiaries of the payroll tax benefits. These are huge taxes, particularly for lower earners who earn less than the Social Security wage limit. Payroll taxes for employees are 7.65%. Double that for the self-employed. But it's not applicable to those without earned income, aka retirees.

Social Security Income

You know what else is very favorably taxed? Social Security income. Forty percent of retirees live on Social Security alone. If it's less than $25,000 ($32,000 Married Filing Jointly), it isn't taxed at all. Even if your income is over $34,000 ($44,000 MFJ), only 85% of it is taxable.

More information here:

8 Things You Must Know About Social Security

10 Reasons NOT to Take Social Security Early

Pensions

Pension income might be the worst kind of income to have in retirement. It's still payroll tax-free, but the rest will be taxable at ordinary income tax rates. I'd take a pension if someone offered it to me, but there are better ways to reduce taxes.

Principal

You know that money you saved for retirement? Whether you put it in the mattress, in a coffee can, in a bank, or in some type of investment, it's already been taxed (when you earned it). You can now spend it on anything you like without paying any more tax on it. With investments, you might have to pay taxes on the gains, but you don't have to pay anything on the principal.

Rents

Rents, just like a pension, are not subject to payroll taxes, but they are subject to ordinary income tax rates. However, depreciation can be used to offset that income. It's not unusual at all for the rent from a property (or a fund that invests in properties) to be mostly or completely income tax-free for many years.

Municipal Bond Interest

The interest from municipal bonds or money market securities is federal and sometimes even state tax-free (if the bonds were issued in your state).

Treasury Bond Interest

Treasury bond interest, including that from TIPS and savings bonds, is state tax-free. You do owe federal income taxes at ordinary income tax rates on the interest, however.

Health Savings Account Withdrawals

Withdrawals from Health Savings Accounts (HSAs) used for healthcare are always income tax- and penalty-free. Even Medicare premiums are eligible expenses. After age 65, you don't even have to use the money for healthcare to avoid the penalty (but not the tax).

Roth IRA, 401(k), 403(b), and 457(b) Withdrawals

Roth account withdrawals are tax-free.

More information here:

Pennies and the Backdoor Roth IRA

The Backdoor Roth IRA When Life Is in Flux (and Why to Beware a Contribution in January)

Traditional IRA, 401(k), 403(b), and 457(b) Withdrawals

Withdrawals (including Required Minimum Withdrawals) from traditional IRAs and similar are taxed at ordinary income tax rates (but are payroll tax-free). However, the tax on these withdrawals can often be paid at a much lower marginal tax rate than the rate you were paying when you made the contribution. In addition, you can use Qualified Charitable Distributions to avoid taxation on up to $100,000 a year given to charity, even without itemizing your deductions.

Borrowed Money

You can borrow against your assets completely tax-free—whether that asset is your house, your car, your portfolio, or your whole life insurance policy. None of these loans are interest-free, but they are tax-free.

Whole Life Insurance

Whole life insurance isn't subject to payroll taxes, but otherwise, all of the rules above apply. The principal is tax-free—borrowed money is tax-free but not interest-free—and earnings are taxed at ordinary income tax rates. However, the coolest thing about whole life insurance is that, unlike annuities (earnings first) and traditional investments (gains and principal are pro-rated), the principal comes out first when you do partial surrenders. Dividends are also considered a return of principal, and they can be spent tax-free.

Qualified Dividends

Qualified dividends (typically from stocks and funds that you've held for at least 60 days) are taxed at much lower rates than ordinary income. In fact, many retirees are in the 0% qualified dividend bracket.

Long-Term Capital Gains

Long-Term Capital Gains (LTCGs) are also taxed at lower rates, and they share the same 0% bracket as qualified dividends. Even better, if you use specific identification, you can preferentially sell the shares with the highest basis. Thus, most of your withdrawal will be tax-free principal and the rest will be the lightly taxed LTCG. These withdrawals can also be offset by losses you have harvested over the years, and, thus, they can be tax-free. Combining these techniques might allow you to access $200,000 in spending money while only using up $20,000 of losses.

Higher Standard Deduction

Did you know that your standard deduction goes up as soon as you turn 65? In 2025, the standard deduction is $15,000 ($30,000 MFJ). But if you're over 65, it's $18,550 ($33,900). That's up to $3,550 more in tax-free income.

Annuities

If you buy an annuity, not all of the income it pays out is taxable because some of it is considered principal (the rest is paid at ordinary income tax rates). There's a ratio (the exclusion ratio) for a non-qualified annuity that has been annuitized. But if you just pull money randomly out of an annuity, the gains come out first, and they are taxable at ordinary income tax rates. Note that this is the opposite of what happens with whole life insurance.

More information here:

What You Need to Know About Annuities

The Wrong Annuities Are Being Sold (Bought?)

Add It All Up

Combine all of this together, and it can be pretty amazing how much income one can have while paying very little tax at all. I can imagine a scenario where a couple does all of the following and still pays absolutely nothing in income taxes:

Pulls $32,000 out of a traditional IRA Pulls $100,000 out of a Roth IRA Surrenders $200,000 worth of a whole life insurance policy (a partial surrender) Receives $50,000 in interest from a state-specific municipal bond fund Pulls $10,000 out of an HSA Receives $20,000 in Social Security Sells $500,000 in high basis securities Borrows another $100,000 against their whole life policy, house, or investment portfolio Receives $50,000 in rental income that is offset by depreciation

Total spending amount: $1,062,000

Tax due: $0

Pretty amazing. So, if you hate paying taxes, quit your job and retire. You'll be amazed by how much your tax bill goes down.

What do you think? Are you retired? How much did you pay in federal income tax last year? How much did you spend last year? If you're not retired, what is your plan to keep your tax bill down in retirement? Know somebody who could use this information? Make sure to share it with them.

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