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Ways to Retire (Almost) Tax Free: Just Explain It

Samantha Wender

Most Americans will retire at age 67 with only 38 percent of those retirees reporting enough in savings to live comfortably throughout retirement. With Uncle Sam dipping into dreams of cruises and beachfront property -- taking 15 to 25 percent of the average retiree's income -- finding ways to minimize taxation is a priority on the mind of baby boomers and younger generations alike.

When retirement comes around, there are a variety of sources one can dip into (but only if retirees plan properly). Social Security, IRAs, pensions, 401(k)s and other plans provide a financial cushion for the later years. Advisors recommend that at least one source of income for retirement be non-taxable. With a little knowledge, planning ahead can go a long way in reducing taxation for retirement and making that financial cushion even plusher.

Retirees can pay federal income tax on up to 85 percent of their Social Security benefits so knowing whether ones benefits are partially or fully taxed are an important part of the retirement strategy.

Related story: Here's Why Your Taxes are Going Up Next Year

Likewise, pension income and IRA distributions may be fully or partially taxable or completely tax-free depending on the type of account. If money put into a pension or IRA were tax-deferred, when the money is taken out, Uncle Sam gets his share. If some after-tax dollars were used in the accounts, they may only be taxed partially.

Related story: The Big Downside of Raising the Retirement Age

The more control and knowledge a retiree has the more they can save.
Here are five tips financial planners say can reduce taxation for retirement and put more money aside to enjoy:

Number 1. Only take taxable retirement distributions when they are needed. This will spread taxable income over more years.

Number 2. While they may be subject to state taxes, income distributions from municipal bonds are not subject to federal income taxes. Taxpayers can also exclude up to $500,000 in capital gains from selling a primary residence.

Number 3. For 401(k) and Traditional IRA plans, taxpayers must begin withdrawing funds at age 70 and a half -- a term called the "required beginning date" -- but Roth IRAs and some Roth 401(k) accounts are not subject to the required beginning date rules which allows retirees to make a plan when considering withdrawal. Money withdrawn from a Roth in retirement are tax-free and unlike the Roth IRA there are no income limits.

Related Story: Average 401(k) Balance Reaches New High

Number 4. Health savings account holders can withdraw funds for past or current medical expenses and no taxes are paid. Retirees can hold the funds in the HSA and reimburse themselves in retirement. This money can be another source of income.

Number 5. And finally, the IRS has a tax credit for those retiring at age 65 or older. There are income provisions but the "Credit for the Elderly or Disabled" is just another way, if retirees plan carefully, that they can enjoy what they've worked hard to build.

Did you learn something? Or have a topic you'd like explained? Give us your feedback in the comments below or on Twitter using hash-tag JustExplainIt.