Strategic Tax Diversification: A Guide to Optimizing Retirement Income
Presented by Tim Stowell CFP®, AIF®
What is Tax Diversification?
Tax diversification is a wealth management strategy that involves holding assets in various accounts with different tax treatments. While investment diversification manages market risk, tax diversification manages tax-rate risk.
By spreading your retirement savings across three specific "tax buckets," you gain the ability to control your reported income and minimize the impact of future tax law changes.
The Three Buckets of Tax Diversification
To optimize your withdrawal strategy, your portfolio should be balanced across these three account types:
1. Pre-Tax (Tax-Deferred) Accounts
Examples: Traditional 401(k), 403(b), SEP IRA, and Traditional IRA.
Tax Treatment: Contributions are made with "pre-tax" dollars, reducing your current taxable income. Growth is deferred, but withdrawals are taxed as ordinary income.
Best For: High-income earners looking to reduce their current tax bracket.
2. Taxable (Post-Tax) Accounts
Examples: Individual Brokerage accounts, Joint accounts, and Revocable Living Trusts.
Tax Treatment: Funded with "after-tax" dollars. While you pay tax on dividends and interest annually, long-term gains are taxed at the favorable Capital Gains tax rate (0%,15%, or 20% depending on tax bracket https://www.irs.gov/taxtopics/tc409)
Best For: Liquidity and flexibility before age 59 1/2
3. Tax-Free (Tax-Exempt) Accounts
Examples: Roth IRA, Roth 401(k), and Health Savings Accounts (HSAs).
Tax Treatment: Contributions are made after-tax, but all qualified growth and withdrawals are 100% tax-free.
Best For: Long-term growth and protection against future tax rate increases.
Why Tax Diversification Matters for Retirement Planning
Having a "tax-aware" portfolio offers four distinct advantages:
Lower Lifetime Taxes: You can "fill" lower tax brackets by taking income from pre-tax accounts and then switch to tax-free buckets once you hit a higher threshold.
Medicare Premium Control: High taxable income can trigger IRMAA surcharges, increasing your Medicare Part B and D costs. Tax-free withdrawals do not count toward this income calculation. (https://www.ssa.gov/benefits/medicare/medicare-premiums.html)
Required Minimum Distribution (RMD) Management: Large pre-tax balances force you to take RMDs at age 73 or 75. Tax diversification allows you to reduce these forced distributions through Roth conversions.
Legacy Planning: Passing a Roth IRA to heirs provides them with tax-free income, whereas a Traditional IRA creates a future tax liability for your beneficiaries.
Atlantic Wealth Advisors, LLC does not provide legal or tax advice. You should consult a legal or tax professional regarding your individual situation.
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