When saving for retirement, many factors determine the most efficient and effective way to save. Should I be saving my money pre-tax or after-tax? Should I also have a bucket of taxable money? What may feel good today is not always what is best for our future. A successful retirement requires that proper planning must start today.

The benefit of saving money in a tax-deferred account such as an IRA or a 401(k) is you do not have to pay taxes on the money today. The money goes into the account tax-deferred, and the assets grow tax-deferred. Not paying taxes on your investments feels good today, but it may not be what is best for you in the future. Your distribution period will begin 10, 20, or 30 even years from now. While the current tax code puts that at age 72, the future tax code is unknown. When you need the money you have saved, you will be at the mercy of the IRS future tax code.

Conversely, pros and cons exist for saving money with a Roth IRA or Roth 401k. No tax benefit is reaped today, but the assets in a Roth account grow tax-deferred and are tax-free when pulled out in retirement. Eliminating unknowns from your retirement plan – taxes, in this case – is beneficial in helping you more accurately estimate your retirement income.

The third type of investment account is a taxable account, such as a regular brokerage account. The money invested is not tax-deductible, nor does it grow tax-deferred. The investor pays taxes on dividends received during the year and on capital gains if the investment is sold at a price higher than it was purchased. Unlike a tax-deferred or Roth account, a brokerage account is not a retirement account. You can access these funds at any age without a penalty.

As you may have already guessed, tax diversification benefits are similar to those of investment diversification – they reduce risk. Consider a couple who has decided to retire at the age of 60. This couple needs to start drawing from their assets to fund their living expenses. After reviewing their budget, they determined that they need $120,000 to replace their standard of living. If this couple’s only savings were tax-deferred funds, they would need to withdraw $120,000 plus extra funds to pay the income taxes on that $120,000. Consider in a different scenario that this couple has saved funds into tax-deferred, after-tax, and taxable buckets of money. The couple now has options for withdrawing funds to maintain their standard of living. They can be very strategic in pulling out funds from their tax-deferred account to take advantage of a current tax bracket. For the income above that bracket, they can pull from their tax-free and taxable accounts.

Nothing can separate you from a successful retirement like the IRS. When we are strategic and include tax diversification strategies for our investments, we will have the options we need to achieve our plans and goals.

Joseph A. Clark is a Certified Financial Planner and Managing Partner of The Financial Enhancement Group, and an SEC Registered Investment Advisor. Contact Joe at yourlifeafterwork.com or 800-928-4001. Securities offered through World Equity Group, Inc. Member FINRA/SIPC. Advisory services can be provided by the Financial Enhancement Group (FEG) or World Equity Group. FEG and World Equity Group are separately owned and operated. World Equity Group, Inc. does not provide tax. For tax advice consult with a qualified tax professional.

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