What is Tax Diversification?
Tax diversification refers to the strategy of allocating your investments across accounts that are taxed in different ways. The goal is to create flexibility and control over how and when your retirement income is taxed.
The three main types of tax buckets are:
1. Taxable accounts – Brokerage accounts where gains, dividends, and interest are taxed annually.
2. Tax-deferred accounts – Traditional IRAs, 401(k)s, and similar vehicles where contributions may be pre-tax, and taxes are deferred until withdrawal.
3. Tax-free accounts – Roth IRAs, Roth 401(k)s, and HSAs (when used for qualified medical expenses), where qualified withdrawals are tax-free.
Each has its role. The key is in how you combine them.
Why Tax Diversification is important
1. Guarding Against Future Tax Changes
No one knows what tax rates will be in the future. They could stay the same, go down… or go up (as many anticipate). Relying too heavily on one tax treatment (like only having traditional 401(k)/IRA money) exposes you to legislative risk. Having a mix of account types gives you flexibility regardless of where tax policy heads.
2. More Control in Retirement
Retirement planning isn’t just about building a big nest egg—it’s about efficiently withdrawing from it. By having money in different tax buckets, you can decide where to pull income from in any given year to optimize your tax bracket and avoid unnecessary tax triggers.
For example, need extra income this year but don’t want to bump into a higher bracket? You might take some from your Roth IRA instead of a traditional IRA. Or use taxable assets with minimal gains.
3. Social Security & Medicare Planning
Higher taxable income in retirement can result in more of your Social Security being taxed and may increase your Medicare premiums through IRMAA (Income-Related Monthly Adjustment Amount). By managing income sources tax-efficiently, you can often reduce or avoid these additional costs.
Final Thoughts: Tax Diversification Is Long-Term Risk Management
Tax diversification isn’t just about minimizing taxes today—it’s about giving your future self more flexibility and options. With careful planning, you can reduce your lifetime tax liability, increase your net retirement income, and protect yourself against future changes in tax law.
At Eagle Valley Wealth Management, we help clients build portfolios that are not just diversified across asset classes—but across tax treatments as well.
If you're unsure whether your current portfolio is truly tax-efficient, we’d be happy to provide a second opinion.
This post is intended for educational purposes only and should not be considered financial advice.