Planning for retirement is a challenge many face when evaluating how to maximize their savings throughout their working lives. While many focus on increasing their contributions to 401(k) or IRA accounts, financial experts point out the importance of diversifying and not relying exclusively on these tools.
Some of the first recommendations on how to save involve maximizing those accounts, but some professionals advise spreading savings across different types of financial vehicles. This can include brokerage accounts and Roth accounts, each offering unique tax advantages and retirement flexibility.
Benefits of Different Savings Instruments for Your Retirement
Having multiple sources of money for retirement not only provides flexibility, but can also result in significant tax savings. You don’t want to have all your money in tax-deferred accounts, explained Daniel Razvi, senior partner and chief operating officer at Higher Ground Financial Group. “IRAs are the abiggest tax scam today.”
IRAs and 401(k) accounts, characterized as tax-deferred investments, are not taxed until withdrawal. However, uncertainty about future tax rates is raising concerns. Rates may be higher in the future, negatively impacting retirement income.
Avoid These Common Retirement Tax Mistakes
The problem is similar to a business contract: Let’s say you start a business and I put in 25%, you put in 75%. Then, imagine discovering that one of the partners can modify the percentages without agreement. With retirement accounts like IRAs, the government determines future tax rates, symbolizing this type of arrangement.
Withdrawals from 401(k) and IRA plans are taxed as income, which generally faces higher rates than long-term capital gains from traditional brokerage accounts. If significant net worth is concentrated in these accounts, the risk of increased tax burdens may be greater.
Impacts of Required Minimum Distributions (RMDs)
Starting at age 73, people must take an annual required minimum distribution (RMD), paying taxes regardless of need for the money. High RMDs increase income, potentially raising Medicare costs and affecting Social Security benefits. “I love tax-deferred growth, but are you deferring your taxes into higher brackets?” asks Nicholas Yeomans, president of Yeomans Consulting Group.
New IRS rules on inherited IRAs further complicate the picture. Non-spousal beneficiaries could face a tax burden of having to pay off accounts within 10 years and meet potential RMD requirements during higher earning years.
Strategies to Minimize Taxes in Retirement and Keep More of Your Money
Roth, traditional brokerage, and health savings accounts (HSAs) offer better opportunities to manage taxes and income. With Roth accounts, the money contributed has already been taxed, allowing tax-free withdrawals under certain conditions. Additionally, they do not require mandatory minimum distributions, providing freedom in retirement planning.
For Roth account beneficiaries, settlement can be deferred until the 10th year, allowing for tax-free growth. Brokerage accounts, on the other hand, also don’t face RMDs, and their long-term capital gains are typically less tax-expensive than other types of income.
Taking Advantage of Brokerage Accounts and HSAs
Inherited brokerage accounts are marked to market value at the time of the owner’s death, which can avoid capital gains taxes if they are liquidated immediately. Yeomans points to this feature as an added advantage when diversifying retirement sources.
Health savings accounts (HSAs) also come into play. They allow you to set aside money on a pre-tax basis for qualified medical expenses and offer triple-tax benefits: qualified contributions and withdrawals are tax-free and investment growth is deferred. According to Lauren Wybar, senior wealth advisor at Vanguard, this option represents powerful retirement savings through the strategic use of savings for future medical expenses.