INDUSTRY INSIGHT
FINANCIAL FOCUS
TAKE ADVANTAGE OF
TAX DIVERSIFICATION
A
s an investor, you will have access to accounts that are
taxed differently from one another. And it’s possible you
could benefit from tax diversification by owning accounts
in these three categories:
• Tax-deferred – Tax-deferred accounts include the traditional
IRA and a 401(k) or similar employer-sponsored retirement
plan. When you invest in tax-deferred vehicles, your money
can grow faster than if it were placed in an account on which
you paid taxes every year. You also may get a tax deduction
for contributions you make today. When you start taking
withdrawals from these tax-deferred accounts, typically
during retirement, the money is usually taxed at your
ordinary income tax rate.
• Taxable – Taxable investments are those held in a standard
brokerage account, outside your IRA or 401(k). While
you can put virtually all types of investments into a taxable
account, you may want to focus on those considered to
be most tax-efficient. So, you could include individual stocks
that you plan to hold, rather than actively trade, because you
will not get taxed on the capital gains until you sell. You also
might consider mutual funds that do little trading and
generate fewer capital gain distributions. This is important
not only in terms of controlling taxes, but also because the
taxes on these distributions can reduce your investments’
real rate of return.
• Tax-free – When you invest in a Roth IRA/Roth 401(k), you
don’t get an immediate tax deduction, but your earnings,
as well as your withdrawals, are tax-free, provided you do not
start taking withdrawals until you’re 59½ and you have had
your account at least five years. (However, income
restrictions do apply to Roth IRAs.)
SPONSORED CONTENT
after-tax in
Tax-Free
after-tax in
Taxable
pre-tax in
Tax
deferred
So, given the difference in how taxes are treated in these
accounts, how can you choose where to put your money? For
example, when would you contribute to a Roth IRA or Roth
401(k), rather than a traditional, tax-deferred IRA or 401(k)?
If you are in a high tax bracket now and expect it to be lower
in retirement, a traditional IRA may make more sense, as you
potentially get a sizable benefit from the tax deduction. But if you
are in a lower tax bracket now, you have most of your retirement
investments in tax-deferred accounts, and/or you can afford to
forego the immediate tax deduction, you might find that the
Roth IRA/Roth 401(k), with its tax-free withdrawals and earnings,
ultimately will make more sense for you. But since no one can
predict where tax rates will go in the future, having money in
different types of accounts – i.e., tax diversification – can be
beneficial. If you only focus on traditional, tax-deferred accounts,
you could end up with larger tax bills than you anticipated when
you retire and start tapping into these accounts, particularly
when you must start taking withdrawals – called “required
minimum distributions” – when you reach 70½. By having money
in accounts with different tax treatments, you may have more
flexibility in structuring your withdrawals during retirement,
based on your year-to-year tax situation. There’s no formula for
achieving an ideal tax diversification. You’ll want to consider
your own needs and circumstances in choosing the right mix
of taxable, tax-deferred and tax-free accounts. Ultimately, taxes
should not drive all your investment decisions.
This article was written by Edward Jones for use by your local Edward
Jones Financial Advisor.
Edward Jones, its financial advisors and employees cannot provide tax
or legal advice.
Matt Dudkowski, AAMS® | Financial Advisor | 1007 Mt Royal Blvd. Pittsburgh, PA 15223 | 412.487.3300
[email protected] | www.edwardjones.com | Member SIPC
Matt Dudkowski has been a financial advisor with Edward Jones since 2002, serving individual investors in
the Pittsburgh area from his Shaler Township office. In January of 2015, Dudkowski accepted an invitation
to become a limited partner with the firm.
Since joining Edward Jones, Dudkowski has obtained the professional designation of AAMS®. Prior to
Edward Jones, Dudkowski, as a CPA, worked at the H.J. Heinz Company, and at Ernst & Young LLP.
He currently serves on the board of directors for Keystone Wellness Programs, a local nonprofit organization.
A native of Butler County and a graduate of the University
of Notre Dame, Dudkowski resides in Gibsonia with his wife,
two sons and daughter.
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