5 Retirement Income Streams That Won’t Trigger a Bigger Tax Bill

When mapping out a retirement strategy, it's important to be mindful of your tax bill. You can make the most of your savings in your golden years by avoiding wasting money on taxes, and prioritizing the right income streams can make all the difference.

To get started, here are five types of retirement income streams that can help you avoid a big bill and lower your tax burden, plus some smart strategies to reduce your tax liability.

First things first, let's take a quick look at how taxes work. It starts with tax brackets, which correlate a tax rate to your income. A note on our progressive tax system: the tax rate associated with your income doesn't represent the amount of taxes you'll pay. Instead, it represents how much you'll pay on a portion of your income.

For example, let's say you earn $100,000, which puts you into the 22% tax bracket. Your tax bill would start with a 10% rate on $0 to $11,600 in taxable income, a 12% rate on $11,601 to $47,150 in taxable income, and finally, a 22% tax rate on $47,151 to $100,000 in taxable income.

As you can see, you'll pay more in total taxes as your income rises. But regardless of where you fall on the income scale, you likely want to keep your tax bill to a minimum, especially when trying to stretch out your nest egg in retirement. Here are some retirement income streams that won't trigger higher taxes below.

When you make contributions to a Roth IRA, you do so with post-tax dollars. From there, you can allow your investments to grow. When it's time to pay for retirement expenses, using Roth IRA distributions is tax-free if you meet the minimum age and holding period requirements. Ultimately, this means your Roth IRA qualified distributions are not subject to federal income tax.

If you have a nest egg in a Roth IRA, you can lean on that to fund expenses when you don't want a higher tax bill. For example, if you sell a property for a profit and push your taxable income higher for the year, tapping into your Roth IRA to fund any other expenses can help you avoid a higher tax bill.

A Roth 401(k) works similarly to a Roth IRA because you'll make contributions with post-tax income. With that, you can make qualified withdrawals from your Roth 401(k) tax-free. For retirees seeking to avoid a major bill from the IRS, a Roth 401(k) can be a useful tool.

Let's say you pick up a part-time job during retirement. The new income stream is pushing your taxable income higher. Leaning on your Roth 401(k) to fund any necessary living expenses can help you avoid pushing your taxable income too high.

If you have a traditional IRA, the withdrawals you make usually count as taxable income due to their tax-deferred approach.

At age 73, retirees must start taking required minimum distributions (RMDs) from their IRAs. For some, taking an RMD from their traditional IRA could push their taxable income higher than they'd like. But one way to avoid the tax hit is to opt for a Qualified Charitable Distribution (QCD), which counts toward the required withdrawal but doesn't increase your taxable income.

With a QCD, you can essentially donate money from your IRA directly to charity, directly excluding money from your taxable income, rather than providing a deduction. For generous retirees seeking ways to donate funds and keep their taxable income relatively low, using QCDs can help.

Health Savings Accounts (HSAs) offer a triple tax advantage. You can make tax-deductible contributions, the funds can grow tax-free, and withdrawals for qualified medical expenses are tax-free at any age. 

If you've built up funds in an HSA, you can lean on these in your retirement years for expenses without pushing up your taxable income.

The majority of municipal bonds are considered tax-exempt because interest from them is excluded from gross income for federal income tax purposes (and sometimes state and local tax-free for bonds issued by your home state). That means they don't increase your taxable income or push you into a higher tax bracket.

You're now familiar with specific retirement income streams, but if you want to reduce your retirement taxes, the following strategies could help you reduce your tax liability.

Start by spreading out your withdrawals. Rather than taking out one large lump sum, spacing out your withdrawals over many years can help you avoid facing a sky-high tax bill in one year. While this may require some thoughtful planning, the tax savings could be worth it.

Tax loss harvesting refers to the idea that you can harness losses from your portfolio to offset some of your gains. You can use tax loss harvesting to potentially reduce your taxable income by up to $3,000 for the year.

For example, let's say you plan to sell a stock for a $10,000 gain, locking in a $10,000 capital gain and the attached capital gains taxes. If you have an underperforming stock in your portfolio, selling it at a loss can help to offset a portion of your capital gain and ultimately lower your tax bill.

A tax professional knows all the ins and outs of the tax code. Even if you have a fairly good idea of what to do to minimize your tax bills, it's often smart to work with a competent professional. They can help you map out a withdrawal strategy that helps you accomplish your goals.

If you want to supplement your income in retirement, opting for tax-savvy income streams can help you get the most out of your savings.

Generally, thoughtful plans to use the appropriate income stream start early. As you approach your golden years or navigate retirement, consider working with a professional to help you craft the most efficient withdrawal strategy for your situation.