Why you should spread your retirement savings over multiple accounts.  Here's why |  personal finance

Why you should spread your retirement savings over multiple accounts. Here’s why | personal finance

(Adam Levy)

There are a variety of accounts available to most investors to save for retirement. You can opt for a traditional 401(k) or IRA, Roth versions of those accounts, or stick with a regular taxable brokerage account. You could even use a tax-free HSA to save for retirement.

If you’re planning for the long term, which retirement planners necessarily do, it’s better to have the money spread across all of those accounts rather than pooling it in one. Doing so will give you the most flexibility for your savings while giving you the best chance of keeping your taxes low in retirement.

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Control your income

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If you can avoid paying more taxes than you need to in retirement, you can withdraw a smaller portion of your portfolio or spend more of your savings each year. To avoid taxes, you must be able to control your taxable income as much as possible.

All withdrawals from a traditional (before taxes) IRA or 401(k) count toward your income. But withdrawals from a Roth (tax-free) account don’t count at all. Also, withdrawals from an HSA (tax-free) for qualified medical expenses don’t count. Also, only investment earnings in taxable accounts affect your adjusted gross income.

By combining pre-tax and tax-free account withdrawals, you can virtually decide what your taxable income is when you retire. You can keep your taxable income at $0 by making pre-tax withdrawals from your accounts only up to the level of your deductions.

You may also be able to take advantage of capital gains in your taxable account with zero tax liability if you stay below the 0% capital gains tax rate threshold. For 2022, that limit is a taxable income of $41,675 for individuals and $83,350 for couples filing jointly. Remember, those are earnings on top of the main investment, so you could potentially withdraw a large amount from your taxable account without generating any tax bills.

If you have room to take capital gains at a 0% tax rate, it’s a no-brainer to do so. Even if you don’t need the funds for your budget, by selling and buying back shares right away, you can increase the cost basis of your investments, reducing your potential taxable earnings in future years. This is a strategy called tax profit harvesting.

Get the most out of every account

If you have a diversified portfolio of stocks, bonds, and other assets, you can take advantage of your various accounts.

Because a Roth account requires you to pay taxes on your contributions or conversions, but withdrawals are tax-free, it’s best suited for investments with the most growth potential. Stocks, especially growth stocks, will feel right at home in a Roth account.

If you have dividend payers or bonds that pay interest regularly, you can make the most of it by keeping it in a pre-tax retirement account. Since all taxes are deferred on those accounts, you won’t see a tax bill on those interest and dividend payments each year, and you can keep more of your money invested.

And if you have tax-advantaged investments like REITs or MLPs, you can keep them in a taxable account (although they’d be fine in a retirement account, too). Municipal bonds, which may be tax-free, are also great options for a taxable account.

The accounts in which you hold each type of asset can have a significant impact on the after-tax value of your portfolio in retirement.

By having assets in all types of accounts, you can maximize your savings and the amount of those savings you can keep in retirement.

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