With a rising debt load in the United States and historically low tax rates, it lends to the possibility that we will see an increase in income tax rates in the future. This puts those investors, who only use tax deductible retirement vehicles for retirement funding, at great risk of paying higher income tax rates during their retirement years. The million-dollar question (this could be quite literal) is: Do you want to risk paying higher taxes during retirement?

While it may be the right choice for some, is using a tax deductible retirement vehicle like an IRA or 401(k) the best option for your retirement? With a tax deductible account, you receive a tax deduction now, but is it really a tax deduction, or is it just a tax deferral? It’s at least worth looking into.

Did you really save money by deferring your taxes, or did you just defer them and pay them at a higher rate? If you believe tax rates will be higher than they are today because of a growing national debt, un-funded Social Security and Medicare liabilities, and an increase in other entitlement programs, then the need for a tax-free account is more crucial than ever before.

There are three ways to gain tax free income: municipal bonds, Roth IRA’s, and permanent life insurance.

Municipal bonds are most appropriate for those in the highest tax brackets. Typically the gains on these types of investments are lower than most investors need for their portfolios.

Roth IRA’s can be a great retirement option for tax-free income, if investors meet certain financial criteria. As an example, there are annual adjusted gross income limits which must be followed in order to be eligible to contribute to a Roth IRA. 

A married couple who files jointly needs an annual adjusted gross income of $240,000 or less, and a single filer needs $161,000 or less. Also, the IRS restricts how much you can contribute annually and requires earned income in order to make a contribution (unless you are an unemployed spouse).

Permanent life insurance can be purchased in one of four categories. The two categories most advantageous for investors are either Whole Life or Equity Indexed Universal Life. Whole Life is based on the current interest rates, and gives a guaranteed rate of return. This can be useful in knowing exactly how much money one will have accumulated in 20 years, but it is also the most rigid and the most expensive of all the options.

Equity Indexed Universal life insurance has two options for investing. The investor can choose annually either the fixed interest rate option, or follow a specific index, such as the S&P 500. When the investor chooses to follow an index, their account will participate in the gains of that index, yet when the index falls, the investor does not participate in the index losses. Universal Life is one of the most affordable and flexible policies available. The income potential from these types of policies may be greater than Whole Life policies, depending on the index performance during the growth phase of the policy.

Tax-free income is generated from these life insurance products by obtaining loans on the policy’s cash value. These types of loans work similarly to home equity loans in the sense that the investor does not pay income tax on the money borrowed. Unlike a home equity loan though, the investor does not have to make payments to pay back the loan balance. This is pertinent to tax codes 7702 and 72(e).

The need to start diversifying away from taxes is now. With the national debt continuing to grow, social programs in jeopardy and all time low tax rates, taxes will need to go up to pay down the national debt. Tax deferred programs are helping Uncle Sam’s retirement and hurting an investors net spendable dollar during retirement years. All investors want more disposable income. This can be accomplished by cutting the IRS out of your retirement.