Whether you are working for a great company or you are building one yourself, your retirement should not sit on the sidelines, no matter how volatile the market!

Given tax is one of two certainties in life, you may want a new way to approach the tax obligations surrounding your retirement.  So how do you increase the value of your retirement income? By lowering your tax bite.

The Retirement Tax Conundrum

All money IS NOT created equal in the eyes of the taxman.  Some is fully taxable now, while other money has a future tax bill attached to it.  But the best is money that grows truly tax free!  

The Solution : Three-Bucket Approach

One of the simplest ways is by dividing your savings using a three-bucket approach. 

The three buckets are:

BUCKET #1: Taxable bucket. Savings in this bucket creates earnings that are subject to both federal and state income taxes. Examples include investments and various bank accounts.

Goal: Fill your taxable bucket with enough money to cover 6 to 12 months of living expenses as well as funding unexpected emergencies.

BUCKET #2: Tax-deferred bucket. Funds in this bucket are money you don't have to pay taxes on until a future date. Tax-deferred accounts include 401(k)s, traditional IRAs, SEP IRAs, and SIMPLE plans.

Goal: Make tax-efficient withdrawals that result in very little or no income tax liability. For example, unplanned distributions from tax-deferred retirement accounts could inadvertently push your total taxable income high enough to cause some or nearly all of your Social Security benefits to be taxed!

BUCKET #3: Tax-free bucket. This bucket contains money that will never be taxed. These accounts include Roth IRA and Roth 401(k) accounts, limited types of annuities, and select mutual fund accounts that are state tax exempt.

Goal: Maximize the balance in this bucket to reduce future taxes AND provide funding flexibility to minimize the tax in your other two buckets.

Applying the Three-Bucket Retirement Tax Strategy

Here are some ideas to use this knowledge:

• First, fill up bucket #1 to ensure you have enough money in case of an emergency.

• Always fill bucket #2 when contributions are matched by your employer.

• Look for opportunities to move funds into Roth accounts with lower tax rates by contributing to a Roth IRA or rolling funds into Roth IRAs.

• Review your buckets EACH year for tax-efficient ways to move funds from buckets #1 AND #2 into bucket #3.

• Calculate the tax-efficient income you can withdraw from retirement accounts each year before getting bumped into the next, higher tax bracket.

In conclusion, savvy tax planning includes understanding the three-bucket concept – 

Taxable, Tax-deferred, and Tax-free. 

Knowledge is not power if not used.   Make sure you review each bucket every year and make adjustments as necessary to leverage this knowledge to your benefit.

As always, should you have any questions or concerns regarding your tax situation please consult with us.