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Retirement Tax Diversification, Part II

In my previous post I discussed why you should pay some of your retirement taxes while working. Doing this will increase your tax diversification in retirement providing you with more control over your annual tax bill. Before I leave this subject there is one more important strategy to be aware of to optimize the current federal tax code during the early years of retirement. I believe this strategy is another way to reduce portfolio risk that could occur if we encounter higher tax rates in the future.

Although this strategy may not be suitable for everyone, remember that the IRS requires mandatory withdrawals at age 701/2 for all your tax deferred retirement accounts. So if you have substantial tax deferred retirement accounts at age 701/2, you will incur large taxable income that you cannot avoid. The strategy I am referring to will essentially compel you to pay some taxes earlier in your retirement, but, in doing so, it should reduce your overall lifetime tax bill.

The key to this strategy is to make maximum use of the two lowest federal tax brackets (i.e., the 10% and 15% tax brackets) where possible. In my opinion If (or rather when) the federal tax rates are increased, it is highly likely that these two lower brackets will not be changed. If I am correct, this strategy will provide even greater financial benefits.

Before I finished this post, I happened to read a personal finance article in the Wall Street Journal that touches on the strategy I am talking about. Rather than re-hash the strategy in this post, just click here to read an online version of the Wall Street Journal article and read the entire article carefully. This is the exact strategy I am using to minimize my lifetime taxes so that my nest egg lasts several years longer than it otherwise would.

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