How Tax Diversification Could Change Your Retirement

By Elsie Dudukovich0 Comments

If you are planning to live primarily on the savings in your 401(k) and IRAs in retirement, make sure you know the tax implications of your decisions.  For example, if you have a traditional IRA, you can most likely expect the required minimum distributions (RMD) for that account to be included in your taxable income.  This withdrawal could be enough to put you into a higher tax bracket.  As you can see, diversifying your tax environments can be as important as the diversification of your investment portfolio.

As you may have heard, about 36 percent of Americans do not have anything saved for retirement.  When you realize most people live for about 18 to 20 years after they retire, maximizing your savings in every way possible makes a lot of sense.  U.S. News & World Report examines this topic in their article “How to Add Tax Diversification to your Retirement Investments,” and it can be a good starting point in exploring these options. 

According to the article, the order of how you save and the order of how you spend are no small details.  Working on funding the accounts with the highest rate of return, such as a company match on your 401(k), should be priority while you build your accounts.

When you become eligible and ready to take withdrawals from your savings, distributions first from the accounts with taxable withdrawals like a traditional IRA or 401(k) might be in your best interest, the article says.  Unlike the traditional IRA which is funded with pre-tax income, your Roth earnings are tax-free.  Saving those funds for later in your retirement might be more advantageous.

When it comes to taxable accounts like your ‘regular’ bank savings account, you will pay yearly taxes on your gains and will most likely not see any tax benefits from your contributions.  Still, these accounts are often seen as highly useful if you need to take money out to handle an emergency.  While your bank may have their own rules about withdrawing funds, your savings account doesn’t have a tax penalty if you need to take a withdrawal at any age.  With your traditional or Roth IRA, taking any funds from the account’s earnings before you reach age 59½ can result in possible taxes and penalties for premature distribution.

Ultimately, it pays to explore and utilize any options available.  People often hold traditional and Roth IRAs, in addition to their 401(k) and various savings accounts in order to make the most of any eligible tax advantages.  Seeking the guidance of your tax and/or financial advisor can yield some interesting opportunities as you develop your retirement strategy.

Equity Trust can help you review the retirement accounts available. Schedule a free IRA checkup with one of our Senior Account Executives and discover the options for diversifying the tax aspect of your portfolio.