Tax Diversification For a More Secure Retirement

Just as you allocate assets to a combination of stocks, bonds, cash, and other investments, you may want to consider allocating retirement assets among tax-deferred, tax-free, and taxable accounts for a potentially greater retirement income.

FIRST TAKE ADVANTAGE OF TAX DEFERRAL

Like many Americans, you probably have most of your retirement savings in a traditional 401(k) or similar tax-deferred retirement plan. The benefits of tax-deferred plans have been proven time and time again. You save federal and possibly state income tax while contributing, and your contributions grow tax-deferred until you withdraw them at retirement when many people expect to be in a lower tax bracket.

But that’s the sticking point. If you’ve been successful in business, at retirement time, you may find that you aren’t in a lower tax bracket than you were when you were working. You could lose some of that tax-deferral advantage.

ADD TAX-FREE ACCOUNTS

With Roth 401(k) accounts and IRAs, you invest with after-tax dollars and gain no current tax benefit, but you’ll owe no income or capital gains tax on any withdrawals you make during retirement. Another tax-free vehicles to consider is municipal bonds, which offer income free from federal income tax and state income tax if they are issued in the state where you reside. However, the interest earned may be lower than possible with Roth accounts.

AND A DASH OF TAXABLE ACCOUNTS

Taxable accounts offer a wide range of investment choices, including stocks, bonds, mutual funds, and real estate. They also require you to invest with after-tax dollars and pay taxes every year on any income you earn or capital gains you realize.

As the old TV commercial said, “It's not what you make, it’s what you keep.” Tax diversification can spell the difference between having income choices or having taxes force you to downgrade your lifestyle. Note: Tax diversification isn’t a DIY strategy. It requires a thorough understanding of tax codes and your overall financial situation.