Target: Getting to the 0% tax bracket in retirement / The 3 Types of Tax Portfolios that Exist Now.

Susan L Moore Vault for Inside Tucson Business writes: Retirement is for the rest of your life. The only thing better than a healthy, happy retirement is a tax-free retirement.

With government spending seeming to have no limits, the consequences of the future tax burden are severe. Targeting a low or zero percent tax bracket for retirement will let you enjoy your own money.

First, let’s examine the three types of tax portfolios that exist now.

1. The taxable portfolio: Consists of investments such as stocks, bonds, mutual funds, money market and CDs. Typically owners pay taxes on these investments every year as they grow. So, why have them? They provide liquidity needed for emergencies or unexpected circumstances. Financial experts generally agree you should have about six months of funds to cover unexpected expenses.

2. Tax deferred portfolio: Taxed as ordinary income upon distribution, it will be most effected by the increase in tax rates over time. Tax deferred portfolios consist of:

• IRA. If your goal is the zero percent tax bracket, allowing your IRA to grow unchecked can thwart efforts to reach the zero percent tax bracket. Ask you CPA what your standard deduction is and what your personal exemptions are.

Let’s say it totals $20,000. You could therefore withdraw up to $20,000 from your IRA without incurring taxes as long as you are at least age 59½.

A married couple retiring today (absent any other tax deductions) has a standard deduction of $11,900 (2012 tax year) and personal exemptions of $3,800 each. Therefore, they can withdraw up to $19,500 from their IRA without paying taxes. Determine how many years you have to retirement. Add 3 percent for inflation to target the amount of money you want to have in your IRA to offset what you will be required to start taking at age 70½ when required minimum distributions begin. If you anticipate your distributions will be higher than the combined standard deduction and personal exemptions, consider systematically converting portions of your IRA to a Roth. Yes, you will pay taxes now but it will enable you to have a tax-free distribution at retirement.

• 401(k). Because many employees receive matches from their employers, it’s easy for them to routinely allocate all of their retirement dollars to this account. By growing this account through excessive contributions, you compound the same tax problem experienced with the IRA.

The solution is to consider contributing up to the employer match but not more. The downside is you will lose tax deductions while working. However, the purpose of a retirement account is not to receive tax deductions but to maximize cash flow in retirement, when you can least afford to pay taxes.

3. The tax-free portfolio. There are two qualifications, it must actually be tax-free from federal, state and capital gains taxes and distributions from the portfolio should not count against the Social Security tax threshold. As a caveat, municipal bonds, widely renowned as tax-free investments, fail on both counts. So, what’s left?

Roth IRA

• Contributions up to basis can be withdrawn pre-59½ with no penalty

• Growth on contributions can be withdrawn tax free after 59½

• Distributions do not cause Social Security to be taxed

• There are no required minimum distributions at 70½.

• You may contribute $5,000 per year under age 50 and $6,500 age 50 or older to your Roth

• You can convert any amount of your existing 401(k) or IRA to a Roth at any age

Cash Value Life Insurance

• Death benefit passes to heirs tax-free

• Dollars can be distributed pre-59½ without penalty

• There are no required minimum distributions at 70½

• Contributions are tax-deferred

• Distributions can be tax free and cost free through a combination of withdrawals to basis and zero percent loans on growth.

• There are no contribution limits

• There are no income limitations

• Distributions do not cause Social Security to be taxed

A successful accumulation strategy will enable you to draw tax-free streams of income from a Roth IRA, Cash Value Life Insurance and a traditional IRA (up to the standard deduction and personal exemptions) as well as Social Security. That should put in the zero percent tax bracket, giving you peace of mind and protection even in the fact of higher taxes in the future.