Most investors know about diversifying their portfolio, but do you know how to diversify your tax strategies? Understanding the three different ways that your savings are taxed can help you make better long-term choices now about investments that will provide income later.
When it comes to your taxes at distribution, there are three kinds of money:
- Taxable: you pay taxes on this money now.
- Tax deferred: you pay taxes on this money later.
- Tax free: you never pay taxes. Woo-hoo!
If all the money you are saving for retirement goes into your 401(k), it grows tax deferred. While this is a great way to save, when it comes time to take the money out for income, what you have is essentially a big pot of taxable money. Your tax rate might be 35 percent today, but there is a very real possibility that rate could be much higher tomorrow. During retirement, will you be able to pay the bills if say 45, 50, 0r 60 percent of your retirement income is taxed?
Diversifying your tax strategies gives you options during the often neglected distribution phase of your financial plan. Other investment vehicles such as a Roth IRA or properly structured life insurance used in vehicles in combination with your 401(k) can create a properly diversified distribution plan that allows for more flexibility in a broad range of economic scenarios. Contact us for more information about tax diversification strategies for your savings.