Wealth Management & Financial Planning

Wealth Management & Financial Planning

Tax Diversification: Why It Matters

When it comes to taxes, most of us view them through the lens of how we can reduce the amount we pay today. We also view saving for retirement as just putting money in our 401(k)s and forgetting about it. This strategy is fine other than the fact that unless you are aware of where that money goes, almost always it will be tax-deferred, meaning you do not pay taxes on that money today but rather down the road. But what happens when we need income from that tax-deferred account? And what happens if we want to stay under a certain amount on our Adjusted Gross Income (AGI), but we only have tax-deferred dollars on which we are taxed? The answer: tax diversification.

Think of tax diversification in terms of three buckets in which you can put your money, each with its own unique purpose. You can put money in the tax-deferred bucket, which does not get taxed today but will be in the future; you can put it in the Roth bucket, which is money that has already been taxed that you can use tax-free down the road; and the taxable bucket, which would be a brokerage account or Trust account. In an ideal world, when we look at a portfolio, we like to see one-third of the total portfolio in each bucket. If you have $1 million saved, about $330,000 in each bucket is ideal.

Take Jack and Diane as a sample couple. At age 62, both Jack and Diane need Marketplace insurance to provide their healthcare coverage until they reach age 65. We know they need to stay under a certain income threshold to qualify for the health insurance premium tax credit; if their income exceeds the limit, they will not qualify. If all their money is tax-deferred, then any money they pull that year will count towards their AGI, thus taking away their options for strategic tax planning. But if we have tax diversification, we can pull tax-deferred money up to a certain amount, then depending on the situation, we can pull Roth or taxable money to supplement the rest of Jack and Diane’s income needs.

Start diversifying your tax situation by doing the following:

  1. As with all investing, the key is to start early. The earlier you start, the easier it is to have options in retirement.
  2. Start contributing to a Roth 401(k), if your employer offers that option.
  3. If you have money each month you can save, put that into a Roth IRA or a taxable brokerage account.
  4. Depending on your situation, consider a Roth conversion.


The biggest takeaway for tax diversification is that if done correctly, you have options that you would not have otherwise. Starting early and being consistent will set you on a great trajectory toward the vision you have of your future.

Financial Enhancement Group is an SEC Registered Investment Advisor. Securities offered through World Equity Group, Inc. Member FINRA/SIPC. Advisory services can be provided by Financial Enhancement Group (FEG) or World Equity Group. FEG and World Equity Group are separately owned and operated.

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