Do You Know How Your Investments Will Be Taxed?

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Changes in tax rules, much like the stock market, can be unpredictable, so how can you anticipate your tax bill in retirement? Having some tax diversification with your accounts may help you counter the ever-changing tax environment and provide you with some flexibility when you retire.

1. Use different IRAs for tax diversification.

You can maintain balance by contributing to traditional and Roth Individual Retirement Accounts. But the focus of your contributions may change depending on your life stage and tax situation:

  • If you’re a younger investor or in a lower tax bracket, a traditional IRA’s tax deduction or a pretax deferral into an employer plan may be less important, making a Roth IRA potentially more beneficial.
  • If you have the majority of your retirement savings in a traditional IRA or 401(k) account and can forgo the current tax deduction, consider shifting some of your contributions to a Roth account. If you have fewer contribution years remaining, converting a portion of retirement assets to a Roth may increase tax diversification and flexibility in retirement (but may also cause a current taxable event).

2. Watch your sequence of withdrawals.

How much you withdraw from your investments may be the most influential factor in how long your money will last. Since every dollar you spend on taxes is one less you have to spend in retirement, the goal is to increase after-tax income. Tax diversification can help you structure withdrawals to potentially reduce taxes and increase the amount of after-tax spendable income.

Generally, we recommend taking withdrawals in the following order:

  1. Required Minimum Distributions (RMDs), if necessary
  2. Dividends and interest from taxable accounts
  3. Taxable accounts (positions with losses first, if available, then gains)
  4. Tax-deferred accounts (traditional IRA)
  5. Tax-free accounts (Roth IRA)

This sequence is just a guide, since the accounts and investments you use for withdrawals may vary from year to year depending on tax and investment considerations. For example, it may make sense to vary this sequence or take from multiple account types to help reduce taxes and prevent moving into a different tax bracket.

Since where you take withdrawals should depend on your tax and financial situation, it’s important to discuss your expected income and withdrawals with your financial advisor and tax professional each year.

3. Consider other investments that may provide a tax advantage.

Ask your financial advisor if the following are appropriate for your situation:

  • Municipal bonds
  • Dividend-paying stocks
  • Annuities
  • Advisory programs that offer tax management features

Together, you can discuss other strategies, including:

  • Tax-loss harvesting
  • Portfolio rebalancing and reducing over-concentrated positions
  • Increasing contributions to traditional or Roth IRAs and employer-provided retirement plans
  • Converting traditional retirement funds to a Roth account

Get diversified

Tax diversification can help provide flexibility and sustainability for retirement savings. While tax codes may be complex and ever-changing, the solution doesn’t have to be. Talk to your financial advisor about how tax diversification can play a part in your long-term retirement goals.

Important information:

Edward Jones, its employees and financial advisors cannot provide tax or legal advice. You should consult your attorney or qualified tax advisor regarding your situation.

Diversification does not ensure a profit or protect against loss.

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