Each category comes with its own rules and potential benefits. When balanced thoughtfully, they can not only help with long-term growth but also give retirees more control over taxes in retirement.
Taxable Accounts
Taxable brokerage accounts don’t come with tax breaks. You are taxed on any dividends/interest the account accrues when you file taxes annually and any capital gains that are realized when trades are placed to raise cash when you withdraw funds. However, they offer significant advantages due to their flexibility. These accounts include standard individual, joint, or living trust investment accounts.
These account types do not have contribution limits or withdrawal penalties. This makes them a great savings vehicle as you can put an unlimited amount of funds in and take them out whenever you need.
We often refer to these accounts as your “Emergencies and Opportunities” fund. These accounts are essential for building financial independence before retirement age and for flexibility in tax strategy during retirement. Additionally, if you are considering retiring early, this account does not have an age limit you have to obtain to access the funds.
Tax-Deferred Accounts
Tax-deferred accounts include traditional IRAs, 401(k)s, 403(b)s, SEP-IRAs, and similar retirement vehicles. Contributions to these accounts are often tax-deductible, meaning you receive a tax benefit today in exchange for paying taxes on withdrawals during retirement.
This is the most common savings vehicle that investors use. The immediate tax deduction can lower your current taxable income, and you do not pay taxes on dividends/interest or capital gains. Specifically, with 401(k)s and 403(b)s, you may also get a company match when you contribute which can dramatically increase the long-term value of the account.
The trade-off for this tax-deferred treatment is that the funds are taxed as ordinary income when you make a withdrawal, with the added caveat that when you turn 73 you must take a Required Minimum Distribution (RMD). This means that even if you do not need the funds, you will have to realize taxable income in the future.
These accounts are often the foundation of investors wealth as they are often the easiest account to contribute to during your working years. However, only using them can create a “tax time bomb” in retirement as future tax rates are unknown. Many high-income professionals maximize their pre-tax contributions during their peak earning years, only to later discover that RMDs force them into high tax brackets even after they’ve stopped working.
Tax-Free Accounts
Tax-free accounts include Roth IRAs and Roth 401(k)s Contributions to these accounts are from funds that have already been taxed. These accounts provide tax-free growth and tax-free withdrawals in retirement - providing the appropriate conditions are met; we encourage you to connect with your CWM advisor if you have any questions on ensuring tax-free withdrawals from these specific accounts. Health Savings Accounts (HSAs) are another form of tax-free accounts with its own set of rules and tax treatment. For more on the intricacies of HSA accounts read our article Health Savings Account: A powerful tool in your financial toolkit.
These tax-free withdrawals are a powerful tool for managing taxes in the future. You also will not have RMDs from Roth IRAs. Because of the uncertainty of tax rates in the future, paying the taxes now might be more beneficial. Since these accounts are tax-free after contributions, there are often contribution limits or eligibility rules that must be met to use them. Check out our tax time reminder article for a current chart of contributions limits.
From a planning standpoint, Roth accounts are tremendously flexible, however not every employer offers them. IRA conversions to Roth accounts are possible, and we recommend you speak to your CWM advisor to see if this is a viable option for you. They give retirees control over how much taxable income they generate each year, and they serve as an excellent buffer against unexpected tax law changes.
Using the Tax Control Triangle to Maximize Retirement Flexibility
The true power of the Tax Control Triangle lies not in each individual account, but in how they can be used to work together. A retiree with only tax-deferred savings has little control over taxes. A retiree with savings evenly spread across all three tax pools has numerous levers to pull.
By mixing withdrawals from taxable, tax-deferred, and tax-free accounts, we can intentionally fill lower tax brackets while avoiding higher ones. Controlling taxable income can also prevent costly Medicare premium surcharges. A diversified tax structure allows retirees to adapt year by year depending on markets, healthcare costs, and lifestyle needs.
The Tax Control Triangle is a tool that shapes real-world financial outcomes. By diversifying the accounts you fund, you give yourself control over when taxes are paid, how much you pay, and what strategies you can use to pursue financial independence in retirement.
At CWM, we help our clients create a well-balanced Tax Control Triangle that gives them the ability to retire with confidence, flexibility, and lasting financial security. Contact us or call the office at (425) 778-6160 to schedule an appointment with a CWM advisor for a complimentary look at your account mix to determine how the Tax-Control Triangle may best work for you.
