3 Tax-Free Income Sources Every Retiree Should Know

• Roth account withdrawals are yours to enjoy without the IRS getting in the way.

• HSA withdrawals are tax-free as long as the money is used for qualifying health care expenses.

• Municipal bond interest is always federally tax-free. And you can potentially avoid state and local taxes.

• $23,760 Social Security Bonus Most Retirees Completely Ignore ›

One of the most stressful expenses for workers today is none other than taxes. Not only do people have to pay taxes on their wages, but in many cases, they are also subject to taxes on investment gains.

Unfortunately, taxes don’t magically go away in retirement. But with the right strategy, you can reduce them substantially and potentially get out of paying them altogether. Here are three tax-free retirement income sources that everyone should know about.

There’s a reason many people choose to save in a traditional retirement plan instead of a Roth account for their senior years. Traditional IRA or 401(k) contributions go on a pre-tax basis, allowing you to pay less money to the IRS each year. Roth IRAs and 401(k)s, by contrast, are funded with after-tax dollars.

But Roth IRAs and 401(k)s not only allow your money to grow tax-free, but also give you tax-free withdrawals. That’s huge for two reasons.

First, you may find that money is tighter in retirement because you’re no longer working. So not paying a portion of your withdrawals to the IRS gives you more breathing room in your overall budget.

Second, we don’t know what tax rates will look like in the future. If they go high enough, savers with traditional IRAs and 401(k)s could pay much more to access their money. A Roth account protects you from that.

HSAs are one of the best savings tools out there because they effectively combine the benefits of traditional and Roth retirement plans. With an HSA, your money goes on a pre-tax basis, investment gains are tax-free, and withdrawals are tax-free as long as the funds are spent on qualifying health care expenses.

You should know that once you turn 65, an HSA can be used for any purpose. You will not be penalized for non-medical withdrawals beginning at that point.

But if you take non-medical withdrawal, it will not be counted as tax-free income. While health care may be a significant retirement expense, you may find that you have no problem using your HSA funds in a tax-free manner.

Once you retire, it’s important to have access to investments that are stable enough and pay you back on a predictable basis. Municipal bonds fit that bill. They have a historically low default rate, and the interest they pay can nicely supplement your retirement plan withdrawals and Social Security checks.