We're here for you – ready to listen, support and navigate this together.

In the interest of the health and well-being of the communities we serve, our branch offices are not meeting in person with new and existing clients at this time. We will continue to serve you through several virtual options. Learn More

Tax Diversification: A Tale of Two Investors

March 01, 2020

Changes in tax rules can be unpredictable. But having money in accounts with different tax treatments, or "tax diversification ," may help you keep up with the ever-changing tax landscape and provide you flexibility in retirement.

Placing money in tax-deferred accounts could help you benefit from tax deductions now, while contributing to after-tax accounts may offer tax-free income in retirement. The focus of your contributions may change depending on your life stage and tax situation, but having money in both types of accounts could be beneficial.

Consider this hypothetical story of two nearly identical investors who pay significantly different amounts in taxes: Robert and James. Both are 68 years old, have saved $1.75 million for retirement and need $65,000 in after-tax income to supplement their retirement spending.

Robert

All of his money is in a traditional (tax-deferred) IRA.

Withdrawals from Robert's traditional IRA are taxed as ordinary income. He must withdraw nearly $75,000 to cover both the tax due on the distribution and meet his $65,000 income requirement. This puts him into the 22% tax bracket. (Part of his withdrawal is taxed at 10%, part at 12% and the rest at 22%.)

James

His investments are in traditional and Roth IRAs, so he can withdraw money from his traditional IRA (which will be taxed) and/or make tax-free withdrawals from his Roth (provided he has met specific qualifications).

James withdraws from his traditional IRA only up to the maximum income amount for the 12% tax bracket. Then he switches to his Roth IRA for the remaining amount, taking tax-free withdrawals. This helps prevent him from moving into the 22% tax bracket.

Because James was able to withdraw from accounts that have different tax treatments, he received the same $65,000 in income while paying $4,800 less in taxes than Robert.

(Incorporates the standard deduction.)

What the above example tells us: While your situation and the tax code may be anything but constant, one thing is certain: Tax diversification can help provide flexibility in retirement. *These are just hypothetical examples; any withdrawal strategy should be discussed with your financial advisor and tax professional.

Important Information:

The above example is for illustrative purposes only. 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.

More Resources:

Edward Jones Perspective Newsletter

Want our free e-newsletter sent to you each month? Ask your financial advisor to sign you up.

Tax Questions? Visit Our Tax Resource Center

Taxes aren’t just for tax season. These resources can help you year-round.

Find a Financial Advisor

Find a Financial Advisor

Select a State and then enter a last name

    Tax Diversification Strategies

    Changes in tax rules, much like the stock market, can be unpredictable. Tax diversification may help counter the tax environment and provide flexibility in retirement.

    Read more

    IRA Contribution Limits & Deadlines

    What you need to know about 2019 and 2020 IRA contribution limits and deadlines.

    Read more