Re-examine and Re-balance: Retirement Investing and Your Taxes

No one likes taxes, but everyone has to pay them at some point. Income and investment tax is the most burdensome because it takes away money you’ve rightfully earned. About the only way to mitigate the damage is to do some kind of tax planning. Even if you live off of investment income, you can still manage your tax bill. The trick is to start early, re-examine your financial situation every year, and re-balance investments as needed. 


Diversification is usually something you hear when it comes to investments, but tax diversification can also be a decent idea. If you have all of your money wrapped up into a traditional IRA or 401(k), you’re going to pay income tax on all of the money inside of the account eventually. 

With traditional accounts, you must start taking money at age 70 1/2. If you don’t, there’s a hefty 50 percent penalty on money you should have taken but did not. The IRS requires you to take a minimum withdrawal amount (called a “required minimum distribution”) based on your life expectancy. 

Converting some or all of your pretax money to other accounts might make sense. If you have the option to convert to a Roth IRA, for example, consider doing so – especially if you think that tax rates will climb in the future. 

Even if tax rates remain the same, it could still make sense to convert. You’ll pay the same amount in tax if rates remain flat regardless of which account you’re invested in, though an after-tax account allows you to hedge against higher taxes in the future. 

Finally, a fully taxable account removes you from the game of tax hedging altogether. It’s risky, but only if you don’t plan on using common stocks or long-term investments not subject to income tax. 

Allocate Assets Wisely 

Sometimes, the best move is to simply buy basic common stocks. Why? Common stocks are subject to long-term capital gains rates which are relatively low compared to income tax rates. While you do still pay tax on the money, you have more control over when you pay the tax and the future is a little more certain since you’re not relying on the government to give you a perpetual pass on taxes with a Roth IRA. 

Additionally, you don’t have to follow complicated retirement plan rules. All you have to do is hire someone to help you pick a good investment. 

Re-balance The Taxation of Accounts 

This can get tricky. if you’ve kept all of your money in a traditional IRA, there’s only one way out – pay tax. However, if you’ve remained relatively diversified, there’s a lot you can do to slosh funds around and keep a defensive tax position. 

For example, you can shift taxable gains from stocks into your Roth IRA indirectly. A simple way to do this would be to contribute more money from your paycheck than usual to your Roth. Then, offset the decrease in income by taking profits from your taxable stock. Over time, you have the opportunity to recover the capital gains tax and possibly the additional income tax paid for the contribution. Of course, this can get a little messy at tax time, so it’s probably best to hire a tax professional and file taxes online so that you minimize the paperwork involved. 

Use Tax-Free Investments 

Using tax-free municipal bonds is one way to get around paying tax on investment gains, and you don’t even need a tax-deferred investment account. You can use a regular taxable account. Most muni bonds pay reliably and are a simple way to hedge against rising taxes without adopting fancy or complicated tax planning schemes. 

Jeremy S is a personal finance consultant. He likes to keep his clients up to speed with the latest money saving developments.

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