One of the best ways to gain wealth and financial independence is to build a diversified portfolio from both an investment and tax perspective. While there are many different account types and holdings, we’re going to walk you through the three primary tax buckets: taxable accounts, tax-deferred accounts, and tax-free accounts.

By understanding the different tax buckets, you can make informed decisions about your savings and investment strategies, save money on taxes, and help secure your financial future.

Building a Diversified Portfolio

The first bucket is the taxable bucket. This includes any income on investments that are subject to taxes each year. Examples for taxable income include salary, wages and interest earned on savings accounts. Any gains from selling assets, such as stocks or real estate are also subject to taxes but oftentimes are at the lower capital gains rate. Taxable accounts typically have no restrictions on when you can withdraw funds and how much you can withdraw.

The second bucket is the tax-deferred bucket. This includes accounts like traditional 401ks and IRAs. The contributions you make to these accounts are not taxed in the year you make them but they are taxed when you withdraw the money. This can be a great way to save on taxes in the short term but you will pay taxes on the money when you take it out. This bucket is ideal for those who believe they will be in a lower tax bracket in retirement than they are now.

The third bucket is the tax-free bucket, and yes, there is a tax-free bucket. This includes accounts like Roth 401ks and Roth IRAs. Contributions to these accounts are made with after-tax dollars, but the money grows tax-free and is not taxed when you withdraw it as long as you meet IRS guidelines. This bucket is ideal for those who believe they will be in a higher tax bracket in retirement than they are now.

Which Savings Bucket Is Right For You?

You may be asking yourself, which bucket is right for me? It really depends on your financial goals and circumstances. Ultimately, the goal of saving is to provide flexibility in the future as it relates to retirement and who you would like to impact with your money. If you have these three buckets well established, you can largely control the taxes you pay in retirement by optimizing your distribution strategy and taking advantage of advanced planning techniques like Roth conversions, the state and gifting strategies, and many more.

Understanding these tax buckets is essential for effective financial planning. There are contribution limits tied to the pre-tax and Roth buckets each year so it is important to craft a plan for current and future saving strategies.

Please reach out to any of our advisors if you would like help determining the best mix for your specific financial situation to minimize the impact of taxes on your wealth over time.

For informational purposes only. Not intended as investment advice or a recommendation of any particular security or strategy. Past performance is not indicative of future results. Information prepared from third-party sources is believed to be reliable though its accuracy is not guaranteed. Opinions expressed in this commentary reflect subjective judgments of the author based on conditions at the time of writing and are subject to change without notice. For more information about Wealth Dimensions, including our Form ADV Part 2A Brochure, please visit https://adviserinfo.sec.gov or contact us at 513-554-6000. Please be advised that this material is not intended as legal or tax advice. Accordingly, any tax information provided in this material is not intended and cannot be used by any taxpayer for the purpose of avoiding penalties that may be imposed on the taxpayer.