Two neighbors withdrew the same $95,000. The difference came down to where the money was sitting.
Kevin Lum met a woman named Diane last year. She pulled about $95,000 from her various retirement accounts to live on, and her federal tax bill was basically zero. Her neighbor across the street pulled the same $95,000 from his retirement account and paid $10,000 in federal taxes. Same income, same city, same year.
The difference was where the money came from. In retirement, the IRS does not tax what someone is worth. It taxes the accounts that withdrawals come from.
Many articles on this topic pad their lists with items like inheritances and life insurance, which are not really retirement income. Kevin's approach is narrower: five genuine sources, how each works, and the guardrails that keep each one tax-free. In his video "5 Sources of Tax-Free Income Most People Miss", he walks through each one.
How Can I Get Tax-Free Income in Retirement?
Five sources stand out, and each comes with a catch. The catch is usually where costly mistakes happen.
1. Roth Accounts
Traditional accounts such as a 401(k) or traditional IRA give a tax break upfront, then tax every withdrawal dollar as ordinary income. A Roth flips the script. There is no upfront deduction, but the money grows for years, often completely tax-free.
Consider someone earning $45,000 who contributes $5,000. A traditional IRA means tax on only $40,000; a Roth IRA means tax on the full $45,000. Decades later, if each account has grown to half a million dollars, every dollar pulled from the traditional IRA is taxed, while the Roth withdrawals are not.
The guardrail: "qualified" is the key word. Tax-free withdrawals generally require age 59½ or older and a satisfied five-year rule. There is no income limit on a Roth 401(k) if the employer offers one, and a backdoor Roth may be available for those above Roth IRA limits. The deeper reason Roth dollars matter: nobody knows what tax rates will be in 15 or 20 years, and a Roth contribution controls the future rate on those dollars.
Ask yourself: How much of my retirement money will still be taxable when I withdraw it?
2. Health Savings Accounts (HSAs)
Most people treat an HSA like a debit card for doctor visits. It is actually triple tax-advantaged: contributions are deductible, growth is tax-free, and withdrawals are tax-free for qualified medical expenses. Fidelity estimates the average couple aged 65 and older will spend about $345,000 on healthcare, before long-term care costs.
The common mistake is spending the HSA as fast as it is funded. A better approach, for those who can afford it, is the "shoebox strategy": small medical bills are paid out of pocket, receipts are saved, and the account compounds. There is no limit on reimbursing oneself later, so those receipts become tax-free income.
For example, an HSA funded with $5,000 a year for 20 years might grow to $250,000. If $50,000 of medical expenses were paid out of pocket over those years, a $50,000 tax-free reimbursement still leaves $200,000 in the account.
The guardrails: the strategy takes discipline, and receipts must substantiate each reimbursement. It also requires an HSA-eligible health plan, and only expenses incurred after the account was opened qualify.
Ask yourself: Could I afford to pay small medical bills out of pocket and let my HSA keep growing?
3. Municipal Bonds
A municipal bond is a loan to a state or local government. The interest is generally exempt from federal tax, and often from state tax when the bond was issued in the investor's home state.
The mistake is judging a municipal bond by its sticker yield. What matters is the after-tax yield. For someone in the 37% bracket, a 4% municipal bond is equivalent to roughly a 6% to 6.5% taxable yield, which is a strong return for a bond. In the 12% bracket, it is probably not worth it.
The guardrail: tax-free does not mean invisible. Municipal bond interest still counts toward the income that sets Medicare IRMAA surcharges and determines how much of a Social Security benefit is taxed. Municipal bonds lower the tax rate, but not the reported income.
Ask yourself: Does my tax bracket actually make municipal bond yields worth it?
4. The Home Sale Exclusion
Under Section 121, a primary residence that was owned and lived in for two of the last five years qualifies for an exclusion on the gain from a sale. The limit is $250,000 for a single filer and $500,000 for a married couple filing jointly. For a couple who bought decades ago and is considering downsizing, that can mean up to half a million dollars of profit with zero capital gains tax.
The guardrails: selling a home is a life decision first. Letting the tax tail wag the dog is a mistake. Home improvements also raise the cost basis. If a home was purchased for $200,000, a $100,000 kitchen renovation lifts the basis to $300,000, and $50,000 of bathroom renovations from years earlier lifts it to $350,000. A larger basis means a smaller taxable gain, which matters most when the gain would otherwise exceed the exclusion, and only if the improvements were tracked.
Ask yourself: Have I kept records of the improvements I have made to my home?
5. The 0% Capital Gains Bracket
Anyone with a taxable brokerage account has access to this one. Two details are commonly missed. First, only the gain is taxed. If $50,000 of stock bought for $40,000 is sold, only the $10,000 gain is taxable, and the $40,000 comes back tax-free. The tax lot sold can also be chosen, which helps control the gain.
Second, long-term capital gains can land in the 0% bracket. For 2026, that applies to taxable income up to $98,900 for married couples filing jointly and $49,450 for single filers. Because taxable income is measured after the standard deduction, a couple could realize over $130,000 in gains in a year and owe no federal tax. This is most powerful between retirement and Social Security, when income often hits a lifetime low. It is often sequenced with Roth conversions.
The guardrail: 0% federal tax does not mean zero consequences. Those gains still count as income elsewhere, including insurance marketplace premium credits before age 65 and Medicare IRMAA surcharges later. The strategy needs careful coordination.
Ask yourself: Do I know how much income I would have in the years between retiring and claiming Social Security?
Tax-Free Income Checklist
A quick self-assessment, for reflection rather than a test.
Watch the Full Breakdown
Kevin covers each source, plus the two-neighbor case study, in his video "5 Sources of Tax-Free Income Most People Miss". The Retirement Made Simple podcast covers related topics in the same practical, jargon-free style, and the 5-Minute Retirement Plan Calculator offers a quick read on where things stand.
More from Retirement Made Simple
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Frequently Asked Questions About Tax-Free Retirement Income
What retirement income is tax-free?
Five sources are commonly tax-free: qualified Roth withdrawals, HSA withdrawals for qualified medical expenses, municipal bond interest (federally), up to $250,000 or $500,000 of gain on a primary home sale, and long-term capital gains within the 0% bracket. Each has conditions.
Are Roth IRA withdrawals really tax-free?
Qualified withdrawals are. That generally means the account owner is 59½ or older and the account has met the five-year rule. A traditional IRA taxes every dollar withdrawn as ordinary income, while a Roth does not.
How does the HSA shoebox strategy work?
Small medical bills are paid out of pocket, and the receipts are saved while the HSA compounds. An HSA that grows to $250,000 can later reimburse $50,000 of saved expenses tax-free and still hold $200,000. It requires an HSA-eligible health plan and good record-keeping.
Are municipal bonds worth it in retirement?
It depends on the tax bracket. A 4% municipal bond is equivalent to roughly 6% to 6.5% for someone in the 37% bracket, but probably not worth it in the 12% bracket. The interest still counts toward Medicare IRMAA surcharges and Social Security taxation.
How much profit from selling a home is tax-free?
A primary residence owned and lived in for two of the last five years qualifies for an exclusion of up to $250,000 of gain for a single filer or $500,000 for married couples filing jointly. Tracked improvements raise the cost basis.
What is the 0% capital gains bracket in 2026?
Long-term capital gains are taxed at 0% on taxable income up to $98,900 for married couples filing jointly and $49,450 for single filers. A couple could realize over $130,000 in gains and owe no federal tax, since taxable income is measured after the standard deduction.
Kevin Lum, CFP® | Retirement Made Simple
This article is companion content to the Retirement Made Simple YouTube channel. It is for informational purposes only and does not constitute personalized financial advice.
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