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3 Strategies for Retirement Tax Planning

Did you know there are different tax buckets your retirement investments can go into? The buckets you choose will have big implications both now and later. And when it comes to retirement tax planning, diversification is key. In order to understand how to diversify your retirement tax planning, let’s start with understanding diversification in general.

What Is Diversification?

In the financial world, diversification is simply allocating your dollars to more than one account type.

We like investment diversification because each type of investment carries its own risks. But when you diversify your portfolio—or in other words, invest in different types of investment buckets—it lowers your risk so that no single investment will destroy your entire portfolio.

We also talk about being diversified in income streams during retirement. Your money may come in through Social Security, pensions, rental income, dividends, interest, and annuities. All of these different avenues can diversify your income in a way that’s sustainable and reliable throughout your retirement.

How Is Diversification Used in Retirement Tax Planning?

Today, many people understand investment and retirement diversification but overlook diversifying their taxes. When it comes to tax strategies for retirement, diversification is one of the strongest. If you’re diversified in different tax buckets, you’ll have some assurance that no matter what happens in the market, you’ll have the income you need throughout retirement. Planning ahead for retirement taxes can minimize what you pay both annually and in the future. You just need to have some variety. 

The Three Buckets of Tax Diversification

There are three different tax buckets you can be diversified in, and each one has a different advantage. Your retirement tax strategy may include investments in all of these buckets already—or maybe just in one.

1. Taxed Now

“Taxed now” refers to investments where you pay the taxes now as you go. That means when you retire, your money is all yours. These investments include:

  • Certificates of Deposit (CDs)
  • Mutual funds held in non-qualified accounts
  • Stocks
  • Bonds
  • Reinvested dividends

These will always be taxed, every year, as dividends are received and capital gains are realized. You will receive 1099 forms for these at the end of each year.

2. Taxed Later

“Taxed later” holds many traditional retirement investments and they’re all tax-deferred. These investments include:

  • Traditional IRAs
  • 401(k), 403(b), or 457(b) accounts
  • Qualified and non-qualified annuities
  • Appreciation of unsold mutual funds and securities
  • Savings bonds

People get excited about tax-deferred accounts because it saves them from owing those taxes now, or at the end of the year. While this is a helpful tax strategy, it’s even better to spread out your retirement using all three buckets. Because when you defer your taxes, the principle money grows, and you will eventually owe taxes on a much larger amount. So even though you’re saving today, you’ll have to pay up later. 

3. Taxed Seldom

“Taxed seldom” (or sometimes even “taxed never” or “tax-free”) accounts include:

  • Roth IRAs
  • Roth 401(k)s
  • Municipal bonds
  • Appreciation of capital assets held until death
  • Life insurance (if properly structured)

Of course, the benefit of these investments is the lack of taxes. Unfortunately, you can’t put everything in this bucket because the IRS puts limits on your contributions. For example, you can only contribute up to $7,000 in a Roth IRA per year (or $6,000 if you’re under 50 years old).1

Regardless of how you feel about politics and our current economy, you’ll likely agree that taxes will probably go up for all of us over the next decade or two. And if you believe your investments will grow over time, you’ll want to have more than 3-15% in the “taxed now” and “taxed seldom” buckets. Deferring most or all of your tax payments until you’re no longer working is a dangerous tax strategy for retirement. The major advantage you have to paying taxes now is that you have income now—so, you’re in a better position to afford those taxes. You don’t want to be surprised by a huge tax bill when you’re already retired and on a fixed income. 

Tweaking Your Retirement Tax Planning Strategy

Maybe you’re reading this and thinking, I wish there was a way I could go back in time and adjust my retirement tax planning strategy to pay more taxes now instead of later. Well, we have good news: there’s an option called a Roth Conversion, where you take part of your tax-deferred investments and start paying taxes on them now.

With a Roth Conversion, you can convert a traditional IRA into a Roth IRA, making the proactive decision to go ahead and pay the taxes now. There are some factors to consider before making the switch, like your age and stage of life. Be sure to talk to a trusted financial advisor about it and see if this is an option for you and your specific goals. 

Retirement Tax Planning Shouldn’t Be Intimidating

Just imagine yourself in the future—when you’re enjoying the retirement lifestyle you’ve been working toward—and how you’re thanking yourself for learning these retirement tax strategies today. 

But there is so much to consider when you’re looking at tax strategies for retirement. Which tax buckets make the most sense for you and your family? How much should you contribute in each bucket? At Beacon Capital Management, our job is to educate you about all your options. When you work with one of our financial advisors, we’ll help you figure out where you stand financially—and whether or not it makes sense for you to minimize, limit, or eliminate taxes on your income and investments.

In fact, we believe it’s so critical to look ahead at your tax bill and create a tax-savings strategy now, that we offer a free retirement tax savings analysis as part of our no-pressure, no-obligation consultation. This analysis looks into the future at your tax situation so we can put retirement tax strategies in place today to potentially reduce the taxes you pay in retirement.

When you meet with one of our financial advisors and get your retirement tax savings analysis, you’ll get an entire Financial Plan Checkup for free.

Or if you’re just at the thinking-about-it stage, download our free guide on “4 Ways You Can Save on Taxes in Retirement.”

A financial plan should be more than just returns. We’d like to help you create a strategy for the retirement goals and priorities that are important to you.

Sources:

1 International Revenue Service. IRS.org. Nov. 27, 2021. “IRA Contribution Limits.” https://www.irs.gov/retirement-plans/plan-participant-employee/retirement-topics-ira-contribution-limits. Accessed Apr. 19, 2022.

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Beacon Capital does not represent in any manner that the tax consequences described herein will be achieved or that Beacon Capital’s activities in managing a clients investments will result in any particular tax consequence. The tax consequences that Beacon Capital may pursue are complex and uncertain and may be challenged by the Internal Revenue Services (“IRS”). The information with regard to this activity was not prepared to be used, and it cannot be used, by any Client to avoid penalties or interest.

Clients should confer with their personal tax advisors regarding the tax consequences of investing with Beacon Capital, based on their particular circumstances. Clients and their personal tax advisors are responsible for how the transactions conducted in an account are reported to the IRS or any other taxing authority on the Client’s personal tax returns.  Beacon Capital assumes no responsibility for the tax consequences to any Client of any transaction. We are not tax professionals. Clients should consult qualified legal or tax professionals, such as tax attorneys or CPAs, regarding their specific situation.