Strategic Tax-Free Retirement Income: A Case Study Part I

This tax-free retirement income case study illustrates the power of a strategic income plan for your retirement years.

The following tax-free retirement income case study has been adapted from the book Tax-Free Income for Life by David McKnight and references The Power of Zero, also by David McKnight.

In last month’s article, I reviewed a comprehensive approach to tax-free retirement income; specifically, the approach discussed by David McKnight in The Power of Zero. In this article, I’ll add to it by introducing a case study that illustrates the strategic use of the “three buckets.” This article represents part one in this three-part tax-free retirement income case study series. Let’s dive in.

Mitigating Tax Rate Risk and Longevity Risk

While my last article reviewed how to insulate your retirement plan from higher taxes, my goal with this one is to show you a step-by-step approach to eliminating tax rate risk and longevity risk. This is a good time to remind you that this process will add a bit of complexity to your retirement plan in the short term. Just remember that when things do veer into the complex, I’ll do my best to explain and clarify every step along the way.

To help illustrate this step-by-step strategy, I’ll discuss the case of Mike and Julie. Before I proceed with their tax-free retirement income case study, it is important to note that their financial scenario is likely very different from yours. In fact, there may be massive disparities between their retirement picture and your own. Keep in mind, however, that there will be much in this example that does pertain to you, so take time to consider how these principles might apply to your specific situation.

Tax-Free Retirement Income Case Study: Mike and Julie

Mike and Julie just retired at age sixty. Their financial profile is as follows:


Mike’s age: 60

Julia’s age: 60

Annual after-tax lifestyle requirement: $80,000

Anticipated inflation rate: 3 percent


Taxable Bucket

  • Mutual funds: $400,000

Tax-Deferred Bucket

  • Mike’s IRA $750,000
  • Julie’s IRA $750,000

Tax-Free Bucket

  • $0

Social Security Combined

  • $40,000 at age 65


  • No life insurance
  • No long-term care insurance


Three adult children, ages 35, 33, and 30.


Mike and Julie believe taxes will rise dramatically over time and want to execute their asset-shifting program before the current tax cuts expire in 2026.

SEE ALSO: Why Americans Aren’t Using the Best Approach to Lifetime Income


How Long Will Mike and Julie (And YOU!) Live?

One of the key details you’ll need when formulating your retirement plan is a clear idea of how long you are going to live. This critical data can inform a number of key decisions in your retirement plan:

Social Security

When should you draw Social Security? This is an easier decision to make once you determine how long you’re going to live. The longer you live, the more likely you are to reach your Social Security break-even age. This is the age at which you’d come out ahead by postponing Social Security rather than taking it early.

Retirement Date

Establishing the ideal retirement date is much easier once you know your life expectancy. The last thing you want is to work all the way until age seventy, collect your gold watch, only to die at age seventy-one!

Income Annuity Owner

In a scenario in which both you and your spouse have substantial IRAs, you’re faced with an important question: Whose IRA do you use to guarantee lifetime income? If you know which spouse will live longer, then the guaranteed lifetime income should be drawn from that spouse’s IRA. By choosing to receive the income over the longer of the two spouses’ lives, you can generally maximize your cumulative distributions over time.

So, How Do You Calculate Life Expectancy? Utilize the Oddsmakers in Vegas

Knowing how long you’re going to live is a critical variable in retirement planning, but is there an accurate way to determine the answer? Turns out there is a rather scientific way of doing so. As an important first step in vanquishing both tax rate risk and longevity risk, I typically suggest you go through the underwriting process for the LIRP. This may sound a bit macabre, but life insurance underwriters are in the business of predicting how long you’re going to live.

That’s their whole job! They’re like odds-makers in Vegas. When they give you a life insurance rating they are, in essence, predicting your life expectancy. And they’re willing to put their money where their mouth is in the form of a death benefit. Once you know how long you and your spouse are expected to live, you can make the aforementioned retirement decisions with a much higher degree of confidence.

A Step-by-Step Plan to Mitigate Tax Rate Risk and Longevity Risk

Now is the point where I’ll begin discussing the exact steps taken in Mike and Julie’s tax-free retirement income case study. We’ll walk through Step 1 in this article and pick up with Step 2 in my next installment.

Step 1: Qualify for the LIRP

The first step in the retirement planning process is to qualify for the LIRP. As part of the underwriting process, Mike and Julie will meet with a traveling nurse, answer a series of health questions, and provide blood and urine samples. They’ll also have to sign a HIPAA waiver giving the underwriter full access to their medical records.

The underwriter gathers this information, evaluates it, and then comes back with a prediction as to how long Mike and Julie are going to live. The underwriter expresses this prediction in the form of a life insurance rating. It’s important to note that you can receive as many as thirty different life insurance ratings. If you get the top one, that means you walk on water; you’re going to live forever. If you get the bottom one, they basically have to hold out a mirror to see if you fog it. The closer Mike and Julie are to that top rating, the more it makes sense to include the LIRP as part of their plan to mitigate tax rate risk and longevity risk.

SEE ALSO: Aligning Your Tax-Free Stars


Before beginning their LIRP qualification process, Mike and Julie must determine the size of their respective death benefits. If they’re using the LIRP to protect against a long-term care event, then they should each have at least $400,000 of the death benefit. Here’s why: should one of them end up needing long-term care, they’ll receive 25 percent of that death benefit every year for four years. That’s $100,000 per year over that four-year time frame.

When coupled with their Social Security, that should be more than enough to cover their monthly expenses over the arc of a typical long-term care stay. And should they die peacefully in their sleep thirty years from now, never having needed long-term care, their beneficiaries will receive a tax-free death benefit. This approach eliminates the heartburn associated with the traditional use-it-or-lose-it approach to long-term care insurance.

For the purpose of this case study, let’s assume that Julie received the top rating and Mike received the third-best rating. Given this result, it would make sense for both Mike and Julie to implement their respective LIRPs.

More to Come in the Next Installment

Are you interested in the subsequent steps in this process? We’ll pick back up with Mike and Julie’s second step in my next article. In the meantime, feel free to check out many other financial education articles on my blog.

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