Tax Diversification: Why Where You Save Matters as Much as How Much
When most people think about saving for the future, they ask one question: "How much should I be putting away?" It's a great question. But there's a second one that gets far less attention and can matter just as much: "What kind of account am I saving in?"
That's the idea behind tax diversification, and it's one of the ways financial planning, taxes, and estate planning work together as three legs of the same stool.
The Three Buckets
Tax-deferred accounts (like a traditional 401(k) or traditional IRA). Contributions may reduce your taxable income today. In exchange, withdrawals in retirement are generally taxed as ordinary income.
Tax-free accounts (like a Roth IRA or Roth 401(k)). You contribute money you've already paid taxes on, and qualified withdrawals in retirement are generally tax-free.
Taxable accounts (like a brokerage account or savings account). You fund them with after-tax dollars, and you may owe taxes on interest, dividends, or gains along the way. In return, you get flexibility, since there are no age-based rules on when you can access the money.
Why a Mix Can Be Valuable
Nobody knows what tax rates will look like years from now, including your own tax bracket. Having money in more than one type of account gives you choices later, and choices are powerful.
Here's an example to make it real.
Hypothetical example (for illustration only): Imagine two neighbors, Alex and Jordan, who both save diligently for decades. Alex puts every dollar into tax-deferred accounts. Jordan spreads savings across tax-deferred, Roth, and taxable accounts. In retirement, every dollar Alex withdraws counts as taxable income. Jordan can choose which account to draw from in any given year, which may help manage taxable income from year to year and could also influence income-sensitive costs like Medicare premiums. The right answer for any real person depends on their own circumstances.
A couple of other details are worth knowing. Traditional accounts eventually come with required minimum distributions, meaning the law requires you to begin withdrawing at a certain age whether you need the money or not. Roth IRAs don't require withdrawals during the original owner's lifetime, which is one reason they often play a role in legacy planning.
How This Fits Your Journey
Accumulation: This is when you have the most flexibility to build your mix. Each contribution is a chance to decide which bucket it goes in.
Income & Preservation: This is when your mix becomes your toolkit. Coordinating which accounts to draw from, and when, can be one of the most valuable parts of a retirement income plan.
Legacy Planning: Different account types are treated differently when they pass to your beneficiaries, so the mix you build today can shape what your loved ones receive.
Why this month is a good time to look
Fall is open enrollment season. Many employers use this window for benefits elections, and Medicare's annual open enrollment period runs from October 15 through December 7. It's a natural moment to look at your whole picture, including how you're contributing to your retirement accounts and whether your choices still fit your plans.
Three questions to bring to your next planning conversation
- Do I know how my savings are split between tax-deferred, tax-free, and taxable accounts?
- Is that mix intentional, or did it just happen over the years?
- Does it match how I expect to use this money, and who I want to receive it someday?
There's no single "right" mix for everyone. The best one is built around your goals, your timeline, and your tax situation, ideally alongside your financial and tax professionals.
Curious what your own mix looks like? Let's map it out together, schedule a conversation.
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