I’m not saying it doesn’t require some planning, but completely avoiding taxes on $100,000+ of retirement income is far more attainable than you might think. As you can imagine, creating a “zero-tax year” comes down to knowing the ins and outs of the US tax code. However, with the right combination of income from various accounts, the IRS can be much kinder than its reputation leads us to believe.
As a caveat, it’s worth mentioning that zero-tax years are much more realistic for those who are retired. During our working years we have far less flexibility in dictating what our tax return looks like because of our employment income. Whereas, in retirement we have significantly more control over how much income we’re recognizing, and where it’s coming from. So, for the purposes of the following scenarios, I’ll be focusing on zero-tax strategies for retirees.
Tax Diversification
The term tax diversification means having your money spread across multiple account types, each with different tax treatments. More specifically, there are three account types or “buckets” where we can invest our money–tax-defferred, taxable, and tax-free. Each of which are taxed differently when we withdraw from them. Initially that might sound overly complex, but some quick examples should clear things up.
More than likely, each of us will retire with some portion of our wealth in two, maybe even three of these buckets. For example, if you have a 401k and a Roth IRA, you have money in two separate tax buckets. Add in a joint investment account with your spouse and you have all three. The degree to which your nestegg is spread across all three of these buckets is ultimately what determines how much tax diversification you have. For example, a couple with a third of their money in each bucket has more tax diversification than a couple who has all of their money in 401ks.
The financial value that tax diversification provides will be self-evident momentarily. However, the foundational point is that tax diversification provides flexibility in which bucket your retirement income is coming from, and therefore how that income is taxed. The more money you have spread across these three account types, the higher the potential for zero-tax years.
Zero-Tax Scenario - Jack & Diane
Jack and Diane are each age 65, and have recently retired. They, like anyone, are interested in paying as little as legally possible in taxes throughout their retirement years. Both were diligent savers and now find themselves with reasonably strong tax diversification. The majority of their nestegg is held in traditional 401ks, but they’ve also collectively built up balances of several hundred thousand dollars in both a joint investment account and Roth accounts. They know they need $150,000 of income per year to live comfortably, and want to prioritize paying zero-tax for as long as possible.
401k Withdrawal - $33,200
The couple knows that they will have a standard deduction of $33,200 in 2025. Therefore, they can receive up to that amount in ordinary income and pay zero Federal tax on that income. They also know that their 401k accounts are considered “tax-deferred”. In other words, they’ve delayed paying taxes on their 401k savings throughout their working years, so they will now have to pay taxes on the withdrawals they take during retirement.
The magic is in identifying the standard or itemized deduction amount the couple will have each year. Once that number is identified, in their case $33,200, the couple can take up to that amount from their tax-deferred bucket each year and pay no taxes on that income. Alternatively, if the couple had itemized deductions of $40,000 that would give them an even higher ceiling for paying no tax on their 401k withdrawals.
Joint Investment Account - $96,700
After determining that their tax-deferred withdrawals will max out at $33,200, they turn their attention to their joint investment account for additional income. The couple knows that this second bucket of their nestegg is considered “taxable”, and it gets treated differently than their 401k withdrawals. Taxable investment accounts (basically all investment accounts that are not IRAs) have a separate set of tax brackets that apply.
While those tax brackets can be easily found online, Jack and Diane really only care about the 0% bracket. In 2025, the couple can sell investments in their joint account, and recognize up to $96,700 in dividends and gains before they would owe any taxes. Meanwhile, throughout the year the couple can take those investment proceeds as additional monthly withdrawals, and still owe the government zero-tax on that income.
Roth IRA Withdrawal - $20,100
Jack and Diane are now at the point where their tax return would show $129,900 of income, but they would owe nothing to the IRS. However, they still need an additional $20,100 to reach their desired retirement spending of $150,000 per year. The final, and perhaps most advantageous, tax bucket for the couple is their Roth accounts.
Roth accounts are considered “tax-free” because withdrawals from these accounts are not taxable by the IRS if the account has been opened for at least 5 years, and the owner is over age 59.5. Both of which Jack and Diane satisfy. The couple can use their Roth accounts to top-up their income, reach $150,000 of spending, and maintain a zero-tax year for 2025.
There’s no doubt that successful implementation requires a sharp eye for detail and close monitoring. However, this same strategy can be repeated year after year for as long as Jack and Diane can maintain it. Typically zero-tax years come to a head after one or several of the buckets run dry, and the couple no longer has the flexibility to strategically choose their income sources. It’s also worth noting that a zero-tax strategy is not always optimal. For example, a strong case can be made that diminishing Roth accounts in the early stages of retirement does more harm than good. That said, the opportunity for zero-tax years should not be ignored, and might be more attainable than you think.
*The above article should not be taken as specific financial advice. It is intended to share general knowledge. You should consult with your financial / tax professional before acting on any of its information.
