Account Types: Key Features
After-Tax (Taxable) Accounts
- Funded with money that’s already been taxed.
- Earnings (dividends, interest, capital gains) are taxed annually or upon sale.
- No withdrawal restrictions or penalties.
Traditional Qualified Accounts (e.g., Traditional IRA, 401(k))
- Funded with pre-tax dollars, reducing your taxable income in the contribution year if eligible.
- Investments grow tax-deferred; taxes are paid at ordinary income rates upon withdrawal.
- Required minimum distributions (RMDs) must begin at age 73 or 75, depending on your birth year.
- Early withdrawals (before 59½) are subject to taxes and a 10% penalty, with some exceptions.
Roth Qualified Accounts (e.g., Roth IRA, Roth 401(k))
- Funded with after-tax dollars; no immediate tax deduction.
- Investments grow tax-free, and qualified withdrawals in retirement are also tax-free.
- No RMDs for Roth IRAs during the account owner’s lifetime.
- Contributions (but not earnings) can be withdrawn at any time without tax or penalty; earnings can be withdrawn tax-free after age 59½ and once the account has been open for five years.
How to Blend Accounts for Maximum After-Tax Returns
- Asset Location: Assigning Investments by Tax Efficiency
- Place tax-inefficient assets (e.g., taxable bonds, REITs, high-turnover funds) in traditional or Roth accounts to shield income from annual taxation.
- Use taxable accounts for tax-efficient assets (e.g., index funds, ETFs, municipal bonds, stocks held for long-term gains) where you can benefit from lower capital gains rates and tax-loss harvesting.
- Allocate high-growth assets to Roth accounts, where all future appreciation can be withdrawn tax-free, maximizing the long-term benefit of tax-free growth.
- Tax Diversification: Building Flexibility for Withdrawals
- Maintain a mix of taxable, traditional, and Roth accounts. This allows you to tailor withdrawals in retirement to your tax situation, minimizing your overall tax bill each year.
- In low-income years, draw from traditional accounts to take advantage of lower tax brackets. In high-income years, supplement with Roth or taxable withdrawals to avoid pushing yourself into a higher bracket.
- This approach can also help manage taxes on Social Security and Medicare premiums.
- Withdrawal Sequencing and RMD Management
- Prioritize withdrawals from taxable accounts first, allowing tax-advantaged accounts to continue growing.
- Once RMDs begin, coordinate withdrawals from traditional accounts to meet requirements and minimize tax impact.
- Use Roth accounts strategically for tax-free withdrawals, especially in years when you want to avoid increasing your taxable income.
- Rebalancing and Tax Efficiency
- Rebalance using new contributions or within tax-advantaged accounts to avoid triggering taxable events in your taxable account.
- Harvest losses in taxable accounts to offset gains and reduce tax liability.
Example Asset Location Strategy by Account Type
When considering where to place different asset types for optimal tax efficiency:
- US Stocks (Index ETF): These are generally tax-efficient and can be placed in taxable accounts. They are also an optional choice for Traditional IRAs/401(k)s, and an excellent choice for Roth IRAs/401(k)s, especially for high-growth potential that can benefit from tax-free withdrawals.
- Taxable Bonds: Given their tax-inefficiency, these are best suited for Traditional IRAs/401(k)s to shield the interest income from annual taxation. They can optionally be placed in Roth accounts as well.
- REITs (Real Estate Investment Trusts): Similar to taxable bonds, REITs often generate income that is taxed at ordinary income rates, making Traditional IRAs/401(k)s an ideal home. They can also be optionally considered for Roth accounts.
- Municipal Bonds: These offer tax-exempt interest income at the federal level (and sometimes state/local), making them highly tax-efficient for taxable accounts. They are not typically held in traditional or Roth accounts as their tax benefits are already inherent.
- High-Growth Stocks: To maximize the benefit of tax-free growth on future appreciation, high-growth stocks are an excellent fit for Roth IRAs/401(k)s. They can also be an optional choice for taxable accounts or Traditional accounts, depending on your overall strategy.
Benefits of Blending Roth and Traditional Qualified Accounts
- Tax Timing Flexibility: Traditional accounts offer immediate tax benefits, while Roth accounts provide future tax-free withdrawals. Blending both hedges against future tax rate uncertainty.
- Withdrawal Control: The mix allows for strategic withdrawal planning, potentially lowering your lifetime tax bill and optimizing cash flow.
- Legacy Planning: Roth IRAs can be powerful tools for wealth transfer, as heirs can inherit funds income-tax-free and are only subject to RMDs after inheritance.
Conclusion
A well-blended investment strategy that incorporates after-tax, Roth, and traditional qualified accounts can significantly improve your total after-tax returns. By aligning asset types with the most tax-advantaged accounts, maintaining tax diversification, and planning withdrawals strategically, you can reduce taxes, enhance compounding, and increase flexibility for both retirement and legacy planning.
For more information and personalized guidance, please feel free to reach out to Vistamark Investments LLC. You can contact us at
312-895-3001, visit our website at
www.vistamarkllc.com, or send us an email to
info@vistamarkllc.com.
