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Wisely investing in diverse income tax accounts can pave way to robust retirement

by Maurice Draine | Contributor
August 3, 2020

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We are used to hearing about how we should be saving money, the different kinds of equity we can have and how important it is to accumulate wealth during our working years. We hear less about decumulation or the time when we’ll spend the money we’ve worked so many years to save. Part of planning for retirement is accumulating saved wealth and investing that money in various income tax accounts that can help you maintain financial health well into your retirement.

In the United States, the silent generation and baby boomers are already retired or getting close to retiring. According to Forbes, these generations have accumulated about 75% of the $107 trillion that makes up the United States’ total household wealth. Some of this accumulated wealth will be used to support individuals in their retirement years.

What is income tax diversification?

Income tax diversification is made up of three types of financial accounts:

  • Accounts that are taxed annually
  • Tax-deferred accounts
  • Accounts that are rarely taxed

By utilizing all three types, individuals can take advantage of the benefits that each category has. Different types of accounts will accumulate interest at different rates, have varying fees associated with them, or have account withdrawal limitations that might limit access to those funds. Some will have taxes taken out annually, while others will not. Balancing the savings and costs associated with each kind of account makes up an income tax diversification strategy.

Income tax diversification means putting accumulated wealth into a series of financial accounts without relying on one type of account.

Achieving income tax diversification

How do you achieve income tax diversification? First, it’s essential to meet with a financial professional. An expert can assess your finances and discuss the options that might be best for you and your goals. No financial plan is a one-size-fits-all; you will need to tweak your financial plans to get the most bang for your buck.

Achieving income tax diversification is often quoted as being “simple but not easy.” It means investing your money in multiple kinds of accounts that are regularly taxed, tax-deferred or rarely taxed.

What that looks like personally depends on your unique financial situation. Most people tend to gravitate toward tax-deferred options because those are the kinds of accounts that we hear the most about. However, too much dependence on tax-deferred accounts like a 401(k) can mean real income tax diversification remains out of reach.

Our annually taxed accounts take the form of investment brokerage accounts, checking accounts or other accounts that produce interest and dividends.

Deferred tax accounts include 401(k) and 403(b) accounts and financial transactions like real estate sales. Selling your home, property or other hard goods will be taxed when you sell, not before.

Rarely taxed accounts can include Roth IRA accounts, municipal bond account interest or some kinds of life insurance payouts. These will rarely, if ever, be taxed as income.

How do I start planning for income tax diversification?

Just like your retirement, it’s essential to start diversifying early. You should already consider your retirement budget, goals and how much money you can reasonably live on.

There will be income sources like Social Security or a retirement pension that will remain consistent income. Many seniors set aside funds for health insurance or the potential need for eventual full-time care. Additionally, money might be set aside for donations or as an inheritance.

Start exploring your financial options now to see what kind of investment accounts work best for you. Many people choose to diversify their portfolio to include more stable sources of investment, such as a Roth IRA or a 401(k), in addition to riskier investments in equities. However, this is entirely dependent on you.

Treat your money wisely. Many experts recommend gradually spending tax-deferred or tax-exempt money at a sustainable rate. This ensures that you can estimate your tax bracket, so you aren’t taken by surprise when tax time rolls around. Additionally, keep in mind any required minimum distributions or withdrawal limits on your accounts.

What are the pros and cons of income tax diversification?

There are benefits and detractions to income tax diversification.

Pros

Your money is invested in different places; there is inherent strength in diversity. If something happens to your finances in one account, you still have other sources of savings. You can choose a balance that gives you one to three years of income through a stable, easy-to-access account, set aside a few more years in another account, and save a little more in a higher-risk investment.

Cons

Your money might seem hard to keep track of. Maintaining control over different accounts can be challenging, especially with the number of financial investment accounts available. Many people find managing a diverse portfolio hard, which is where a financial professional can come in handy.

As there isn’t a one-size-fits-all financial retirement plan, you will also have to revisit your financial plan every so often to make sure it is still working for you. This can take time and thought but is ultimately worth it.

Prepare for retirement well

Retirement is an active part of life. There can be periods of rest and extensive travel, learning new things and spending time doing what you want to do. Your money should be just as dynamic as your goals and plans, and investing now can make all the difference.

There are financial situations that you can’t control, like inflation or market returns. However, a sound financial strategy can allow you to weather market downturns or uncertain economic times during your retirement. Taking time to understand your financial options can let you create a diverse income tax portfolio, save your money wisely and know that you have prepared for retirement well.

Alliance America can help

Alliance America is an insurance and financial services company. Our financial professionals can assist you in maximizing your retirement resources and achieving your future goals. We have access to an array of products and services, all focused on helping you enjoy the retirement lifestyle you want and deserve. You can request a no-cost, no-obligation consultation by calling (833) 219-6884 today.

Legacy

Your legacy is vastly more than an amount of money left to your surviving beneficiaries. Part your legacy can be the example of a life well-lived that’s achieved through proper planning.

Liabilities

Too many people enter retirement with burdensome mortgages, car payments and credit-card debt that they’ve amassed during their working years. Proper management of these liabilities is fundamental to your current and future financial viability.

Love

Financial planning often is motivated by our love for our life partners, children, family members and friends.

Taxes

Taxes have a significant impact your finances and can siphon assets unless you have a prudent approach to meet your objectives.