Tax Diversification and Retirement Savings

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Like the stock market, changes in tax rules can be unpredictable. However, tax diversification may help counter the ever-changing tax environment and provide flexibility in retirement.

What you need to know

  • Investing in accounts with different tax treatments can provide you with flexibility (and potentially higher after-tax income) in retirement.
  • The order in which you withdraw income from different types of accounts in retirement can affect your taxes.
  • You might want to consider other ideas that may provide a tax advantage, such as tax-loss harvesting and investing in municipal bonds, and dividend-paying stocks based on your situation.

Using different individual retirement accounts (IRAs) to achieve tax diversification

To achieve tax diversification, we generally believe investors should maintain balance by contributing to traditional and Roth IRAs. But the focus of your contributions may change, depending on your life stage and tax situation:

  • Younger investors and those in low tax brackets – The deductibility of traditional IRA contributions and the pretax deferral of employer plan contributions may be less important to those in lower tax brackets, making a Roth IRA potentially more beneficial.
  • Investors with the majority in traditional IRAs/401(k) accounts – If you can forgo the current tax deduction, consider shifting your contributions to Roth accounts. 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 will also cause a current taxable event).

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 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. Available cash from dividends or interest in taxable accounts
  3. Proceeds from the sale of securities in taxable accounts (Sell positions with losses first, if available, then positions with gains)
  4. Distributions from tax-deferred accounts (traditional IRA)
  5. Distributions from tax-free accounts (Roth IRA)

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.

Tax diversification from an investment perspective

Depending on your situation, we also recommend considering investing in the following: municipal bonds, dividend-paying stocks, annuities and advisory programs that offer tax management features. You may also want to consider other actions, including:

  • Tax-loss harvesting
  • Portfolio rebalancing and reducing overconcentrated positions
  • Increasing contributions to traditional or Roth IRAs and employer-provided retirement plans
  • Converting traditional retirement funds to a Roth account
  • Using tax-advantaged education savings vehicles, such as 529 Education Savings Plans

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 Edward Jones 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. This content should not be depended upon for other than broadly informational purposes. Specific questions should be referred to a qualified tax professional.

Diversification does not guarantee a profit or protect against loss in declining markets.

More resources:

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