Tax Diversification: Building Flexibility Across Your Retirement Accounts
Most investors think about diversification in terms of stocks, bonds and other assets. Tax diversification applies the same idea to the accounts that hold those investments. Instead of keeping nearly everything in one type of account, you build savings across accounts that are taxed in different ways, so you have more choices about where future income comes from.
For professionals, executives and business owners in Milwaukee, Madison and Green Bay, this can matter as much as the investments themselves. A portfolio that looks well balanced on an investment statement can still be concentrated from a tax perspective. If you want a second set of eyes on how your accounts fit together, you can request a complimentary, no-obligation wealth and tax review.
What Tax Diversification Means
Most retirement savings fall into three broad buckets:
Tax-deferred accounts, such as a traditional 401(k) plan or traditional IRA, where contributions may reduce taxable income today and withdrawals are generally taxed as ordinary income later.
Tax-free accounts, such as Roth IRAs and Roth 401(k)s, where contributions are made with after-tax dollars and qualified withdrawals may be tax free.
Taxable accounts, such as brokerage accounts, where investment income and realized gains are taxed along the way, and long-term gains may receive more favorable treatment than wages.
Health savings accounts and certain other vehicles add further variety, but these three buckets are the core of most plans. The goal is not to fill each one equally. It is to hold a mix that fits your situation and leaves room to adapt as tax rules, income and goals change.
Why Tax Diversification Matters for Wealth Planning
Nobody knows what tax rates will look like decades from now. Congress changes the rules, your income shifts as your career evolves, and life events such as a business sale, an inheritance or the death of a spouse can move you into a different bracket. Holding money in several types of accounts can give you levers to pull in retirement.
Consider a hypothetical couple in Appleton who saved diligently, but almost entirely in pre-tax workplace plans. In retirement, every dollar they withdraw adds to taxable income. Large withdrawals for a new roof or a family gift could push them into higher brackets, increase the taxable portion of Social Security benefits, or raise Medicare premiums. A couple with a similar balance spread across pre-tax, Roth and taxable accounts may be able to draw from the account that creates the least tax friction in a given year.
This is where wealth management and tax planning overlap. Investment decisions, withdrawal sequencing and annual tax returns all influence each other, which is why integrated tax and wealth management planning can help keep the pieces aligned.
Common Ways to Build a More Balanced Account Mix
There is no single formula, but several strategies are commonly discussed:
Using Roth options in a workplace plan. Many employer plans now offer a Roth 401(k) feature. Splitting contributions between pre-tax and Roth may be one way to build both buckets at once.
Roth conversions in lower income years. Years after retirement but before other income sources begin, or years with unusual business losses, may create windows to convert part of a pre-tax balance to Roth at a potentially lower cost.
Building a taxable account. Brokerage accounts offer flexibility, no contribution caps and access before retirement age. They can also hold assets that may be tax efficient, such as broad index funds.
Backdoor Roth strategies. Higher earners who exceed income limits for direct Roth IRA contributions sometimes use nondeductible contributions followed by a conversion. The pro-rata rules can make this complicated, so coordination with a tax professional matters.
Each approach involves tradeoffs. Paying tax now to convert means less money invested today, and the benefit depends on future rates, time horizon and how the money is eventually used.
Pairing Account Mix With Asset Location
Tax diversification decides which accounts you hold. Asset location decides which investments go inside each account. The two work together.
For example, investments that produce ordinary income, such as many bond funds, are often considered for tax-deferred accounts. Assets with higher long-term growth expectations are sometimes placed in Roth accounts, where qualified growth may never be taxed. Tax-efficient equity funds may fit well in taxable accounts, where they could benefit from favorable capital gains treatment and a step-up in basis for heirs. These are general patterns, not rules, and the right approach depends on your overall allocation and goals. Our guide to tax-efficient investing strategies covers related ideas.
Tax Diversification in Retirement: Withdrawal Planning
The payoff from tax diversification usually shows up in retirement, when you decide where each year's spending comes from. A thoughtful withdrawal plan might draw from taxable accounts in some years, fill lower brackets with pre-tax withdrawals in others, and tap Roth savings when a large expense would otherwise push income higher.
Required minimum distributions from pre-tax accounts begin at an age set by federal law, and those required amounts can grow over time. Retirees in Eau Claire, Waukesha and La Crosse who planned ahead may have more room to manage those distributions. Wisconsin also has its own rules for retirement income, which our article on retirement tax planning for Wisconsin retirees explores.
Estate planning plays a role too. Heirs who inherit pre-tax accounts may face compressed distribution timelines and owe income tax on withdrawals, while inherited Roth accounts and taxable assets can be treated differently. If legacy goals are part of your plan, it may make sense to coordinate with an estate planning attorney.
Questions to Discuss With a Professional
Before making changes, consider walking through these questions with your wealth and tax professionals:
What share of my savings sits in pre-tax, Roth and taxable accounts today?
Do I expect my income in retirement to be higher, lower or about the same as now?
Are there lower income years ahead that could create Roth conversion opportunities?
How might required distributions affect my brackets, Medicare premiums and Social Security taxation?
How do my estate and charitable goals influence which accounts I draw from first?
These questions connect your investment strategy, tax return and long-term goals, which is the heart of Compound's wealth management services.
Start Planning Your Account Mix
Building tax diversification is rarely a one-time decision. It tends to happen gradually, through contribution choices, conversion decisions and investment placement made over many years. Families and business owners across Wisconsin and surrounding areas often find it helpful to review the mix annually, especially when income, tax law or goals shift.
If you would like to understand how your current accounts are positioned and what options may be worth exploring, schedule a complimentary wealth and tax review with Compound. The conversation is no-obligation and designed to help you see how investment and tax decisions fit together.
Frequently Asked Questions
What is tax diversification?
Tax diversification means holding savings across accounts that are taxed differently, typically tax-deferred accounts such as traditional 401(k)s, tax-free accounts such as Roth IRAs, and taxable brokerage accounts. The idea is to give yourself flexibility in retirement to choose where withdrawals come from, which may help manage taxable income from year to year as rules and personal circumstances change.
Is it better to save in Roth or pre-tax accounts?
It depends on your current bracket, expected future income, time horizon and goals. Pre-tax contributions may reduce taxes today, while Roth contributions may provide tax-free qualified withdrawals later. Many people use a combination. Because no one knows future tax rates, it may make sense to discuss your specific situation with a tax and wealth professional before choosing.
Can Roth conversions help with tax diversification?
Roth conversions can shift money from pre-tax accounts into Roth accounts, which may add tax-free flexibility later. The converted amount is generally taxable in the year of conversion, so timing matters. Lower income years, such as early retirement or a year with business losses, are often reviewed as potential windows. Conversions are not right for everyone and deserve careful analysis.
How do taxable brokerage accounts fit into the plan?
Taxable accounts have no contribution caps and allow access before retirement age. Long-term capital gains may be taxed more favorably than ordinary income, and heirs may receive a step-up in basis. These features can make taxable accounts a useful third bucket alongside pre-tax and Roth savings, especially for early retirees or those planning large purchases.
How often should I review my account mix?
Many families review their account mix annually, often alongside tax preparation and portfolio rebalancing. Major events such as a job change, business sale, inheritance, retirement or new tax legislation are also good times to revisit the plan. Regular reviews can help keep contribution choices, conversions and withdrawal strategies aligned with your broader wealth goals.
Compound is a registered investment adviser. Registration does not imply a certain level of skill or training. This article is for informational and educational purposes only and should not be construed as personalized investment, tax, or legal advice. Tax laws are complex and subject to change. Strategies discussed may not be suitable for everyone, and there is no guarantee that any strategy will achieve its objectives or reduce taxes. Calculator results are hypothetical, are not guarantees of future results, and do not reflect any actual investment. Investing involves risk, including possible loss of principal. Please consult your tax, legal, and financial professionals before acting on any information in this article. For more information, see Compound's Form ADV, available at adviserinfo.sec.gov.
About Compound Wealth
Long-term financial planning often involves balancing tax considerations, investment decisions, business interests, and personal financial goals. Compound Wealth provides an integrated planning approach that brings these disciplines together to provide a coordinated framework for evaluating financial decisions as financial circumstances evolve over time.
