How Tax Diversification Can Add Value
A mix of pre-tax, taxable, and Roth assets can do more than diversify taxes. It can create flexibility, support tax efficiency, and enable better decisions throughout life.
Most investors understand the value of diversification in a portfolio. Spreading assets across different investments can help manage risk and reduce dependence on any one outcome. But there is another kind of diversification that can be just as important over time: tax diversification.
Tax diversification means building wealth across accounts that are taxed differently. That often means a mix of pre-tax retirement accounts, taxable accounts, and Roth accounts.
Each one has its own tax characteristics. Pre-tax retirement accounts may offer a deduction up front, tax-deferred growth, and taxable withdrawals later in life. Taxable accounts are funded with after-tax dollars and may generate taxable income or capital gains along the way. Roth accounts are also funded with after-tax dollars, but qualified withdrawals are generally tax-free.
Built-in flexibility
When all or most of a household’s wealth sits in one type of account, future choices may become more constrained. Someone whose wealth is heavily concentrated in pre-tax retirement accounts, for example, may face less flexibility when it comes time to draw income. Withdrawals can increase taxable income, affect Medicare premiums, and reduce the ability to manage taxes year by year.
On the other hand, someone who has built a mix of account types may have more control over where cash flow comes from and how much taxable income to recognize in a given year. One of the clearest benefits of tax diversification is exactly that: better control over your taxable income over time.
Flexible at every stage of life
Tax diversification can matter while building wealth, while living on wealth, and while transferring wealth.
During working years, tax diversification can influence how you save in the first place. Should contributions go into a traditional retirement account, a Roth option, or both? Does it make sense to build more taxable assets outside retirement plans as well? These are not just questions about current deductions. They are also questions about future optionality.
In retirement, tax diversification can become even more valuable. If all spending must come from one tax bucket, your ability to manage income efficiently may be limited. But if you can draw from a combination of pre-tax, taxable, and Roth assets, you may have more room to respond to changing circumstances, tax law, and spending needs. That can make retirement-income planning more flexible and more resilient.
It can also matter in wealth transfer planning. A taxable account, a traditional IRA, and a Roth IRA may all leave very different after-tax outcomes for heirs. In some cases, tax diversification can help families think more clearly not only about how to build wealth, but also about how to spend it and ultimately transfer it. That is one reason tax diversification is useful across the full financial lifecycle: while building wealth, while living on wealth, and while transferring wealth.
Be ready to respond
Another reason tax diversification can help is uncertainty. Tax policy changes. Rules around deductions, retirement accounts, and estate planning evolve, sometimes in ways that are hard to anticipate. A household with wealth spread across multiple account types may be better positioned to respond when they do.
Consider what happens when tax rates rise. Someone drawing entirely from pre-tax retirement accounts has little room to maneuver. Someone with a mix of pre-tax, taxable, and Roth assets can shift where income comes from, potentially keeping more of it. That kind of flexibility is hard to create after the fact.
Not every investor needs the same account mix. The right balance will depend on income, age, goals, tax bracket, time horizon, and estate considerations. But every investor should look beyond portfolio allocation alone and consider how taxes are diversified too.
At Corient, we believe tax planning works best when it is integrated into a broader wealth plan. Tax diversification is one of the clearest examples of why.
ABOUT THE AUTHOR
Neil Teubel
Neil is a Partner and Head of Wealth Planning at Corient. He oversees the entire team of planning experts across the country. He designs and manages the firm’s wealth planning vision and strategy with the goal of ensuring clients receive comprehensive expertise and have a unique experience. Neil believes in the critical importance of having an integrated wealth experience and finds it rewarding to help clients navigate the complexities of wealth to achieve their goals. Prior to Corient, Neil’s experience includes positions with legacy firm Balasa Diverno Foltz (BDF). He holds bachelor’s and master’s degrees in financial planning and is a CERTIFIED FINANCIAL PLANNER® professional. Neil and his wife, Jenny, have three young kids and when he’s not in the office, you can find him golfing, hiking, renovating houses, or running after Sienna, Cole and Ford.
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