One of the most common retirement planning questions isn’t about how much to save. It’s about where that money should live.
By the time you reach retirement, the balance between taxable and tax-deferred accounts can have a greater impact on your financial flexibility than your overall portfolio size. The mix determines how much control you have over your taxable income, how you respond to market downturns, and how efficiently you fund spending later in life.
There is no universal “right” ratio. But knowing how these accounts function and how they interact with the tax system is important for building a resilient retirement strategy.
Understanding the Two Buckets: Taxable vs. Tax-Deferred Accounts
At a high level, retirement assets fall into two broad categories: tax-deferred and taxable. Each plays a distinct role.
Tax-deferred accounts
Tax-deferred accounts allow you to postpone taxes until money is withdrawn. Contributions are often made with pre-tax dollars, which can reduce taxable income during working years. In exchange, withdrawals in retirement are generally taxed as ordinary income.
Common examples include:
- Traditional IRAs, where contributions may be deductible, and withdrawals are fully taxable
- Traditional 401(k) plans, funded with pre-tax payroll contributions
- 403(b) plans, used by certain nonprofit and public-sector employees
These accounts are powerful accumulation tools, especially during peak earning years. However, they come with restrictions, like annual contribution limits, penalties for early withdrawals, and mandatory distributions later in life.
Taxable accounts
Taxable accounts are funded with after-tax dollars. Interest, dividends, and realized gains are taxed in the year they occur, but the account itself carries no restrictions on contributions or withdrawals.
Examples include:
- Brokerage accounts
- Savings accounts
- Money market accounts
While taxable accounts lack the upfront tax benefits of retirement plans, they offer something equally important: control. Withdrawals can be timed strategically, capital gains can be managed, and assets can be accessed without age-based penalties.
In retirement, flexibility often matters more than deferral.
How Taxes Work in Retirement (and Why It’s Complicated)
Many people assume they’ll automatically pay less tax in retirement. That’s not always true.
Retirement income is taxed differently depending on its source. Withdrawals from traditional retirement accounts are taxed as ordinary income. Investment gains in taxable accounts may be taxed at preferential capital gains rates. Social Security benefits may be partially taxable depending on overall income levels.
The interaction between these income sources is where complexity arises. Adding withdrawals from tax-deferred accounts can push income into higher brackets, increase the portion of Social Security subject to tax, or affect other income-based thresholds.
In other words, which account you draw from matters just as much as how much you withdraw.
Why Having Only Tax-Deferred Savings Can Be Risky
Tax-deferred accounts feel efficient during accumulation years. But an overreliance on them can create challenges later.
At age 73, Required Minimum Distributions (RMDs) begin for most tax-deferred retirement accounts. These mandatory withdrawals are taxed as ordinary income, regardless of whether the money is needed for spending.
This creates two problems:
- Loss of income control. Even if you prefer to delay withdrawals, RMDs force taxable income into your return.
- Bracket risk. RMDs layered on top of Social Security and other income sources can push retirees into higher tax brackets later in life than expected.
Over time, this can reduce flexibility and increase exposure to future tax law changes. Tax deferral solves a short-term problem (current taxes) but can create a long-term one if not balanced intentionally.
Benefits of Maintaining Taxable Assets in Retirement
Holding assets in taxable accounts isn’t a failure of tax planning. It’s often a sign of it.
Taxable accounts provide strategic advantages that become increasingly valuable in retirement.
Flexibility and Liquidity
Taxable accounts have no age restrictions or mandatory withdrawals. Funds can be accessed at any time, making them useful for early retirement spending, unexpected expenses, or bridging income gaps.
This flexibility can reduce pressure on tax-deferred accounts and allow withdrawals to be timed more efficiently.
Better Control Over Taxable Income
With taxable assets, taxes are typically paid as gains are realized, not when funds are withdrawn. This allows retirees to manage income levels year by year, smoothing tax exposure and avoiding unnecessary spikes.
When used properly, taxable accounts can help keep income within favorable tax brackets.
Support for Large, One-Time Expenses
Major expenses like travel, home repairs, and vehicle purchases are often easier to fund from taxable assets without triggering additional ordinary income. This preserves tax-deferred accounts for their intended purpose: long-term income generation.
Tax Diversification
Just as investment diversification reduces market risk, tax diversification reduces policy and income risk. Holding a mix of taxable and tax-deferred assets creates optionality, which is one of the most underappreciated advantages in retirement planning.
It’s Not About a Perfect Ratio
There is no ideal percentage of assets that should be taxable or tax-deferred. The right mix depends on:
- Expected spending needs
- Other income sources
- Health care costs
- Longevity considerations
- Anticipated tax environment
What matters most is having choices. A portfolio that forces withdrawals from only one type of account limits planning flexibility when it’s needed most.
The Role of a Financial Advisor in Managing Retirement Withdrawals
Managing retirement income is an ongoing process.
A financial advisor helps coordinate withdrawals across account types to manage tax exposure over time. This includes monitoring tax brackets, adjusting strategies as laws change, and stress-testing plans against market volatility or rising expenses.
Just as importantly, an advisor helps retirees avoid reactive decisions. Pulling funds from the wrong account in a high-income year can have ripple effects that last far longer than the withdrawal itself.
Regular review turns retirement income planning from a static plan into an adaptable strategy.
Final Thoughts
A thoughtful balance between taxable and tax-deferred accounts creates flexibility, reduces forced decisions, and improves after-tax outcomes over time. While tax deferral is valuable, control is just as valuable.
The most resilient retirement plans aren’t optimized for a single scenario. They’re built to adapt. And that adaptability often starts with how, and where, your assets are held.
Disclaimer: There is no guarantee that a diversified portfolio will enhance overall returns or outperform a non-diversified portfolio. Diversification does not protect against market risk. Content in this material is for general information only and is not intended to provide specific advice or recommendations for any individual. All investing involves risk, including loss of principal. No strategy ensures success or protects against loss.
Securities and advisory services offered through LPL Financial, a Registered Investment Advisor, Member FINRA/SIPC This information is not intended to be a substitute for specific individualized tax advice. We suggest that you discuss your specific tax issues with a qualified tax advisor.