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Tax Planning for Retirement: Part II

Tax Planning for Retirement: Create Tax Diversification 

In our last post, we wrote about the most important tax planning variable to consider in retirement. You can read more about that here: Tax Planning for Retirement: Part I 

Next, we point you to a crucial component of a healthy and secure retirement to accomplish prior to retirement: Create Tax Diversification with Your Investment Portfolio 

Ultimately, creating tax diversification within your investment portfolio is an important tax planning question that accumulators, pre-retirees, and retirees must all confront. 

What is Tax Diversification? 

Tax diversification is having multiple types of investment accounts that you are able to withdraw from in retirement and achieve you long-term spending goals. When we say 'type' of account we are specifically discussing the tax status of the account. For example, a Roth IRA and a Traditional IRA are treated differently by tax authorities. You make contributions to a Roth IRA with after-tax money, and then the account is never taxed again as long as withdrawals occur after age 59 1/2. Conversely, Traditional IRA contributions are tax-deferred, meaning they aren't taxed in the year of contribution, but instead are taxed when withdrawn in retirement. 

Having multiple buckets to withdraw from in terms of tax status allows you a great deal of flexibility when deciding which accounts should fund cash flow needs. 

What are the Three Tax Buckets to Focus on in Retirement? 

There are three core tax buckets to focus on in retirement: 

  • Pre-Tax or Deferred Accounts (Traditional IRA, Sep-IRA, Simple IRA, Traditional 401k, etc.) 
  • Roth-style accounts (Roth IRA, Roth-401k) 
  • Taxable or After-Tax Investment Accounts 

Why Does Tax Diversification Matter in Retirement? 

Tax Diversification is hugely important for retirement because it increases the options you have when taking withdrawals in your retirement years. More options, in terms of the type of account you withdraw from, allows you to manage your annual tax burden in retirement.

For example, let's say you and your spouses taxable income in retirement was going to be around $81,000 to keep you in the 12% marginal tax bracket. However, you need to replace the roof on your house and you need $20,000 from your investment portfolio. If you all your money is in Pre-Tax accounts, the $20,000 withdrawal will be taxed at 22% rather than 12% because now your income is being pushed into the next tax bracket. 

Conversely, if you have Roth IRA or taxable investment accounts at your disposal, you could likely withdraw $20,000 without incurring much additional or any (depending on the account) taxable income. This would keep you in the 12% marginal tax bracket and greatly improve the tax-efficiency of your retirement withdrawals. 

Diversify your tax buckets across taxable, pre-tax, and Roth-style accounts to increase tax-efficiency in retirement: 

Diversify your tax buckets in retirement to increase retirement success. Good tax diversification looks like a healthy amount in taxable accounts, pre-tax accounts, and roth accounts. Bad diversification generally has the majority of assets in a pre-tax account with small or no investments in taxable or Roth style accounts.


In retirement, higher income can effect the following: 
  • Social Security Taxation
  • Medicare Premiums
  • Federal Marginal Tax Bracket
  • State Marginal Tax Bracket 
  • Capital Gains Tax Rate 

Importantly, since retirement security is dependent on the amount you can sustainably withdraw and spend from your investments, increasing the tax efficiency of your withdrawals, thereby reducing your tax payments and maximizing your discretionary cash flow, greatly improves retirement outcomes. 

Interest in planning for a secure and tax-savvy retirement? Schedule a call with one of our Certified Financial Planners™ below: 

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