This question addresses how your money is spread across the three tax buckets: 

• Tax-Deferred 

• Tax-Free 

• Taxable 

Understanding how these buckets work, and how to diversify your assets across them, may significantly impact your long-term wealth, flexibility, and lifetime taxes. 

Understanding the Three Tax Buckets 

Every investment account you own fits into one of these categories. Each bucket has different tax rules, advantages, and trade-offs. 

1. Tax-Deferred Bucket  

A tax-deferred account typically allows contributions to be made on a pre-tax basis, meaning you receive a tax deduction in the year you contribute. The investments in the account have the potential to grow tax-deferred, so you generally do not pay taxes on earnings each year. However, withdrawals are taxed as ordinary income. Additionally, the IRS requires that annual minimum distributions (RMDs) be taken from your tax-deferred retirement account when you reach a certain age. RMD age is dependent on your birth year and currently ranges from 72-75 years old. The dollar amount of the RMD is calculated using an IRS-published life expectancy factor (based on age) and your account value at the previous year-end (IRS). Some common examples of tax-deferred accounts are traditional 401(k)s, traditional 403(b)s, and traditional IRAs. 

Tax-deferred retirement accounts offer several key advantages, including immediate tax savings and reduced taxable income during your working years. Your investments may also benefit from long-term tax-deferred growth, and in some cases, you may receive employer matching contributions. However, it’s important to remember that taxes are postponed, not eliminated. Additionally, accumulating large balances can result in significant taxable withdrawals later in retirement.  

While tax-deferred accounts can serve as powerful savings tools—particularly during high-income years—relying on them exclusively may limit your financial flexibility in retirement. 

2. Tax-Free Bucket  

Contributions to tax-free accounts are made with after-tax dollars, meaning there is no immediate tax deduction. However, investments have the potential to grow tax-free, and qualified withdrawals are also tax-free. Additionally, Roth IRAs do not require RMDs for the original owner, providing added flexibility in retirement planning. Some common examples of tax-deferred accounts are traditional Roth 401(k)s, Roth 403(b)s, Roth IRAs, and Health Savings account (when used for qualified expenses). Depending on the type of Roth account, contributions may be subject to income limits. 

The advantages of Roth accounts include tax-free income in retirement, protection against potentially rising future tax rates, and greater control over your taxable income. They can also be valuable tools for legacy planning. Due to the enactment of the SECURE Act, retirement assets including both traditional and Roth IRAs are subject to the new rule stating that the entire balance of the inherited asset must be distributed within 10 years. For traditional IRA assets, this potentially creates a significant tax burden for beneficiaries if they receive these assets in their peak earning years. Roth IRAs, however, are tax free in nature and would not cause their beneficiaries to incur any tax liability.  

Overall, Roth accounts offer long-term tax certainty and flexibility—features that may help support a thoughtful retirement income strategy.  

3. Taxable Bucket  

Taxable investment accounts are funded with after-tax dollars and do not have contribution or withdrawal limits, offering significant flexibility. Unlike retirement accounts, interest and dividends are taxed annually, and capital gains taxes are triggered when assets are sold. This means taxes on investment income are paid along the way rather than deferred until money is withdrawn from the account. Some common examples of taxable accounts are brokerage accounts, joint investment accounts, and trust accounts.  

These accounts provide several advantages, including no age restrictions on withdrawals and flexibility in accessing funds at any time. They also benefit from favorable long-term capital gains tax rates and may receive a step-up in basis for heirs. However, taxable accounts can experience an annual tax drag from interest and dividends and require thoughtful tax management to maximize efficiency. 

Why Having Money in All Three Buckets Matters 

Many investors unintentionally concentrate most of their savings in one bucket — commonly tax-deferred accounts through employer plans. While that may seem efficient, it can create challenges later. Having money spread across all three tax buckets—tax-deferred, tax-free, and taxable—creates flexibility in retirement. If all your savings are tax-deferred, every withdrawal increases your taxable income, potentially pushing you into higher tax brackets and increasing Medicare premiums or the taxation of Social Security benefits. By contrast, having assets in Roth and taxable accounts allows you to strategically choose where income comes from each year, manage your tax bracket, and better control your overall income profile. This flexibility isn’t just about reducing taxes in a single year—it may lower your total lifetime tax burden. 

Diversifying across tax buckets may also provide protection against uncertainty. Tax laws and rates change over time, and concentrating all your savings in one type of account exposes you to unnecessary risk—whether that’s future tax increases on pre-tax savings or overpaying taxes upfront with only Roth assets. It may also enhance estate planning outcomes, as different account types pass to heirs in different ways. Together, this diversified tax structure may provide flexibility and control and may help support long-term tax efficiency for retirement income and legacy planning.” 

What Is Asset Location Diversification? 

Most investors understand asset allocation: spreading investments among stocks, bonds, and other assets. Asset location is different, focusing on which type of investment should go in which tax bucket. While asset location strategies should be personalized, common guidelines include the following: 

• Tax-deferred accounts are well suited for investments such as bonds, REITs, and actively managed funds with higher turnover because periodic interest payments  and frequent trading may yield investment gains taxed as ordinary income. Placing these investments in tax-deferred accounts helps reduce annual tax drag by sheltering this income from immediate taxation. 

• Tax-free (Roth) accounts may be appropriate for high-growth stocks, small-cap equities, and other aggressive investments, since qualified investment gains may be withdrawn tax-free. By placing higher-growth assets in these accounts, investors may allow for the possibility of tax-free compounding over time. 

• Taxable accounts are often used for broad index funds, low-turnover ETFs, and other tax-efficient investments because they tend to generate fewer taxable events. In addition, these investments typically benefit from favorable long-term capital gains tax rates, helping to minimize the overall tax impact. 

Final Thoughts 

When considering the different tax buckets and asset location, the question is not simply: “Am I saving enough?”, but also: “Am I saving in the right places?” 

A balanced approach across tax-deferred, tax-free, and taxable accounts may increase flexibility, manage risk, and potentially reduce lifetime taxes. Strategic asset location and tax diversification are not advanced tactics reserved for the ultra-wealthy. They are foundational planning tools available to anyone willing to be intentional. Our team at Howe & Rusling can help ensure that your savings and investment decisions will be well suited for your circumstances. Reach out to start the conversation today! 

Disclosures: This material is provided for informational and educational purposes only and is not intended as investment, legal, or tax advice. Any discussions of tax concepts are general in nature. You should consult your own qualified professional regarding your specific situation. Howe & Rusling is an investment adviser registered with the U.S. Securities and Exchange Commission (SEC). Registration does not imply any level of skill or training. All investing involves risk, including possible loss of principal. Market conditions and economic factors can materially affect results. Past performance is not indicative of future results. No guarantee is made that any investment strategy or planning approach will be successful. This material does not take into account the investment objectives, financial situation, or particular needs of any specific person. Recommendations, if any, are general in nature and may not be suitable for all investors. Examples and hypothetical illustrations (if any) are for educational purposes only, are not representative of any specific client, and do not reflect the deduction of advisory fees or other expenses unless expressly stated. Tax laws and regulations are complex and subject to change. The impact of taxes (including RMD rules and beneficiary distribution rules) depends on individual circumstances and current law. References to third-party information, links, or content are provided for convenience and informational purposes only. Howe & Rusling does not control, endorse, and is not responsible for the accuracy or completeness of third-party information. Asset allocation and asset location strategies do not ensure a profit or protect against loss and may involve additional risks, trading costs, and tax considerations.