How Tax Diversification Can Increase Your Retirement Savings
We all want to save for
retirement but many fail to realize that planning how you are going to spend your
retirement savings is almost as important as saving for it. If you're not
careful, taking money out of your retirement plan can involve taking a big tax
hit. The more you take out in a year the
more income tax you pay, especially if that withdrawal bumps you into a higher
tax bracket. Because of this, protecting
after-tax income should be a primary goal for retirees.
The good news is that you
can save thousands of dollars with the right financial advice. Tax
diversification, also known as the tax control triangle, is a model you can use
to ensure you get the most out of your retirement savings planning.
As shown below, there
are three types of retirement savings categories, each having different
taxation consequences.
Point
1 - Tax-Free Accounts
At
the pinnacle of the triangle is the tax-free category. These are the most ideal. Who
doesn't love tax-free money? The idea is that you place money into these accounts
and it grows, and it does so tax-free. In the future when withdrawals are needed
for living expenses, they are tax free. These accounts are:
- Roth IRA
- Roth 401k
- Health Savings Accounts
- 529 Plans/Educational Savings Accounts
- Cash Value Life Insurance
Point
2 - Tax-Deferred Accounts
The next point on the triangle is tax deferred. These are accounts where you invest money
and it grows tax deferred. In other words, you do not pay taxes on the money until you use it. The accounts that fall into this
category are:
- 401k/IRA
- Real Estate
- Annuities
Point
3 - Taxable Accounts
The final point of the triangle is present taxable. Meaning, these accounts are taxable
every year. Examples of these accounts are:
- Savings Accounts
- Money Na
- Brokerage Account
Bottom Line
At some time in the future, you are going to use your net worth for income. It makes sense to protect your money from taxes as much as possible especially during retirement. The tax triangle shows where you are, and what your future income is going to look like later in life. The table below illustrates how tax rates have changed throughout history. Could tax rates go higher in the future? Potentially. Since we can't know for certain, why not create a strategy to have more control of how much and when you pay taxes. By diversifying where you save your money, you may be able to keep more of it.
If you would like to receive more information on making smart money moves for your future, be sure to contact us today!
