Tax Diversification is Important

While tax deferred savings in employer sponsored plans and IRAs benefits nearly everyone, having some savings and investments outside of qualified plans can provide flexibility in a retirement income plan. Qualified dividends and long-term capital gains are taxed more favorably than qualified plan distributions. And due to the Social Security Effective Marginal Bracket™ can be a better place to access funds for unexpected expenses. Having funds in Roth IRAs, which are only taxed ins special situations, can also be beneficial.

Income May Be Out of Your Control

There is a tax downside to having funds in non-qualified accounts. If you are the holder of open-end mutual funds, and to a lessor extent exchange traded funds, you have little control over what qualified dividends and capital gains will be distributed. This can be a hard pill to swallow, especially in a down year. According to Russell Investments, the average capital gain distribution from equity funds in the terrible year of 2008 was 8%. Put in dollar terms, a $100,000 investment at the beginning of that year would have been worth about $53,000 at year end, but you would have been taxed (in retirement with Social Security turned on) on about $8,000 in capital gain income.

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Tax-exempt Income

In general, interest paid by state and local government entities is exempt from federal taxation. Tax-exempt income, however, is added into the calculation to determine how much of your Social Security is taxed. People in the 12% bracket can effectively pay taxes of 10.2% on tax-exempt income due to the increased taxation of Social Security.

Sheltering Income from Non-qualified Accounts

If it is anticipated that distributions from qualified accounts will not be needed, except in emergencies, there are various vehicles that can be utilized to reduce, or eliminate, the adverse consequences of the income generated by these account types. To explore how this could be done you can meet with a Tax Acuity Approved Advisor™ by visiting our contact page.