High Savers Overlook Tax Diversification in Retirement Plans

Savers who build large balances in employer retirement plans are still making one planning mistake, according to a report from Fox 28 Columbus: treating a big account balance as the finish line instead of planning for how that money will be taxed when it comes out.

The station's report describes a pattern financial planners see among disciplined savers who contribute steadily for years but never diversify where that money sits. Most of it lands in tax-deferred accounts, such as a traditional employer plan or IRA, where every withdrawal in retirement counts as ordinary income. That can push a retiree into a higher tax bracket than expected, even if their spending needs are modest, the report notes.

Why does this catch high savers off guard?

The focus during working years is almost always on growing the balance, not on what happens to it later. A saver who maxes out contributions for decades builds a sizable nest egg, but if nearly all of it sits in pre-tax accounts, the tax bill arrives all at once in retirement rather than being spread out, according to the report.

What is the fix financial planners recommend?

The report points to tax diversification as the common remedy: spreading money across pre-tax accounts, Roth accounts, and ordinary taxable brokerage accounts. That mix gives a retiree flexibility to choose which account to draw from in a given year based on their tax situation, rather than being forced to pull only from one taxable pot.

"The mistake isn't saving too little — it's not thinking about the tax bill until it's too late," the report states, describing the pattern among high savers who rarely contribute to Roth accounts during their working years.

What should savers do differently now?

• Ask a tax professional or financial planner whether some new contributions should go into a Roth account instead of a traditional one.
• Consider whether a partial Roth conversion makes sense in a lower-income year.
• Keep some savings in a standard taxable brokerage account for flexibility outside retirement-account rules.

Savers looking to diversify holdings beyond account type can also look at how they're invested within those accounts. The Vanguard Utilities Index Fund ETF (VPU), for example, is one sector fund some investors use to balance a portfolio, as The Wealthy Will detailed in a separate report.

What should retirees watch for next?

• Required minimum distribution rules that force withdrawals from pre-tax accounts starting at a set age.
• Medicare premium surcharges that can kick in when taxable income rises in a given year.
• State-level tax treatment of retirement withdrawals, which varies by where a retiree lives.

The report frames tax diversification as a planning step that costs little to start early but becomes harder to fix once a saver is already in retirement and drawing down accounts. Read the full report from Fox 28 Columbus for the full discussion.

Artiglio is A coming-soon iPhone chief of staff for briefings and drafts. Not on the App Store yet.