Breakdown Between Types of Investment Accounts

Since we are approaching tax time I wanted to spend a few minutes talking about good balances between the trifecta of investment accounts. At the bottom is a video summary. In case that is easier:-)

Those are Tax-Deferred, Taxable and Never-To-Be-Taxed-Again. 

As a reminder, Tax-Deferred accounts are things like IRAs and 401ks. Contributions to these accounts traditionally go in before taxes are taken out. This means when you take the money out they are taxed like ordinary income. So, like you earned the money. 

Taxable accounts are funded with money you have already paid income taxes on. However, they are still subject to taxes such as capital gains. Taxation of these accounts is typically lower than Tax-Deferred accounts, but this is NOT a guarantee. 

Finally, we have the Never-To-Be-Taxed-Again accounts, like Roths and Health Savings Accounts. Money may or may not have already been taxed, but the distributions are tax-free, assuming you follow the rules. 

This recommendation is based on what I have seen with clients over the years, with a focus on physicians who typically have higher incomes and the ability to not only max out 401ks but also put money away into Roths (via backdoor) and Taxable accounts. 

The breakdown I like to see is basically 50% in Tax-Deferred, 25% into Taxable and the balance into Never-To-Be-Taxed-Again accounts. 60/20/20 is also a good mix. 

Ultimately, the goal is not to have EVERYTHING in your Tax-Deferred accounts. It isn’t unusual to see this with new clients. Mostly because the traditional advice is to reduce your tax bill right now as much as possible. 

The problem then becomes you may have a massive tax bill in retirement when Required Minimum Distributions (RMDs) come into play. Unfortunately, the timing of RMDs usually corresponds to limited tax reduction strategies, like student loan interest. 

I frequently see this with new clients coming my way. Most of their investable assets for retirement are in Tax-Deferred accounts. It is not uncommon in these situations to see projected RMDs higher than their best earning years as a doctor. 

I get that trying to lower your current tax bill is important. We are in a relatively low tax environment currently, so maybe some time can be spent on looking at future tax bills. Why? Well, because my clients and I work under the scenario that Lowest Lifetime Tax Bill Wins!

If you take one thing away from this, please let it be to think about adding more savings into accounts other than Tax-Deferred. This is where having a CFP who is also proficient in tax-planning is paramount to your retirement success.