Summer Savings Strategies: Keep Your Assets Tax Diversified

Jul 10, 2019

By Theresa Fry, Senior Vice President and Manager, IRAs, Retirement and Education Planning

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When you retire, your savings and investments will likely become a primary source of income. Did you know that how your retirement income is taxed is impacted by both the type of investments and the type of accounts the income is taken from?  For federal tax purposes, there are three main categories: taxable, tax-deferred, and tax-free.

Taxable accounts include things like your checking and savings accounts, along with single or joint investment accounts.  With investments in these types of accounts, you pay income taxes each year on the interest or dividends that you earn unless the investment itself is tax-exempt.  For example, a tax-free municipal bond is a tax-exempt investment.  When you sell investments in a taxable account to generate cash to spend, you may also have to pay taxes on any capital gains you recognize.

Tax-deferred accounts include most individual and employer-sponsored retirement savings accounts.  Examples would include traditional IRAs, 401(k)s, SEPs, SIMPLEs, profit-sharing plans, pensions, and annuities.  With investments in a tax-deferred account, you do not pay taxes on the interest or dividends when you earn them and you do not have capital gains taxes when you sell the investments in the accounts. Instead, when you distribute cash or assets from a tax-deferred account, you include those amounts in income on your tax return.  Because these accounts are tax-advantaged and designed for retirement, IRS penalties may also apply if you take withdrawals before you are age 59 ½.

Tax-free accounts would include Roth IRAs (when receiving qualified withdrawals for retirement), 529 plans or Education Savings Accounts (when receiving qualified withdrawals for education expenses) or Health Savings Accounts (when receiving qualified withdrawals for medical expenses).  All of these accounts are considered tax-deferred while you accumulate your savings and if you meet the conditions necessary for a “qualified” withdrawal, the income is tax-free.  For example, Roth IRAs provide tax-free income in retirement as long as withdrawals are taken after you have held a Roth IRA for 5 years and you are receiving the withdrawal after age 59 ½, after a disability, or for a first-time home purchase (up to a $10,000 lifetime limit).

Building balances in taxable, tax-deferred and tax-free accounts will give you more flexibility and tax diversification when you need income by giving you the power and control to choose how your income will be taxed. If you are not as tax-diversified as you would like and want to explore how to have a more tax-efficient income stream during retirement,contact a Benjamin F. Edwards financial advisor.

Benjamin F. Edwards & Co. does not provide tax advice, therefore it is also important to consult with your tax professional for additional guidance tailored to your specific situation.