Key Takeaways

  • Saving for retirement is difficult, but you can facilitate your progress by diversifying your income sources and leveraging the tax-advantaged vehicles endorsed by the Internal Revenue Service (IRS).
  • The most common tax-advantaged investment vehicles include individual retirement accounts, 401(k) plans, 403(b) plans and annuities.
  • Other key ways to ensure a tax-efficient retirement include optimizing the timing of your Social Security Administration distributions and leveraging health and life insurance products.

Saving for retirement poses challenges across income levels. Thankfully, there are tax-efficient strategies to ease the journey and alleviate stress. While not exhaustive, this guide offers essential insights for all retirement savers to integrate into their plans.

How Much Can You Expect To Be Taxed in Retirement?

Estimating how much you are going to be taxed in retirement is very difficult, largely due to the many complex variables involved. Some are specific to you, such as income level, claimable tax deductions and credits and the types of investment vehicles owned. Others relate to macroeconomic conditions, such as cyclical business trends, geopolitical events and tax legislation.

Effectively grappling with all these variables (alongside numerous unlisted factors) is an unrealistic task. As a result, I advise against spending a lot of time and energy trying to estimate your taxes in retirement. However, if you are intent on establishing a rough estimate, I suggest the following approach for simplicity:

  1. Compute your current effective tax rate (annual income tax incurred ÷ annual taxable income).
  2. Estimate how much taxable income you will have in your first year of retirement. Be sure to include all anticipated sources of income (i.e. Social Security Administration income, pension plan income, retirement account distributions, etc.).
  3. Multiply your current effective tax rate by your estimated taxable income in your first year of retirement.

The result is a conservative estimate of the annual income tax you will incur when you begin your retirement. Over time, the amount is likely to grow, particularly, if you begin taking government-mandated required minimum distributions from certain investment vehicles later in life.

The Tax Impact of Diversifying Your Retirement Income Sources

One of the most effective ways to bolster the resiliency of your retirement plan is to diversify your income sources. Doing so can stabilize your cash flows and improve your ability to preserve wealth, because it gives you the flexibility to withdraw money from different income sources in different economic environments.

A diversified framework can be established by combining income distributions from the Social Security Administration and income distributions from tax-advantaged retirement vehicles. In some cases, the diversification benefit can be enhanced by incorporating other products, such as annuity contracts and life insurance policies.

Tax-Advantaged Retirement Vehicles To Consider

Retirement savers can benefit from owning one or more of the following tax-advantaged investment vehicles: individual retirement accounts (IRAs), 401(k) plans, 403(b) plans and annuities. Individuals open and maintain IRAs, while employers sponsor 401(k) and 403(b) plans. Annuities, financial products, are sold by insurance companies.

There is no limit to the number of retirement vehicles you can own, but there are Internal Revenue Service (IRS) limits on the amount of money you can contribute to each type of vehicle annually.

An overview of the most common IRS-endorsed instruments is provided below.


IRAs are tax-advantaged investment vehicles that can be established via a brokerage firm. Outlined below are two formats: traditional and Roth-style.

  • With a traditional IRA, contributions are generally tax-deductible in the year in which they are made. The funds can be invested and are allowed to grow on a tax-free basis during your working years. However, in retirement, the withdrawals are taxed at your current income tax rate.
  • With a Roth IRA, there is no upfront tax deductions on contributions made. Like a traditional IRA, the funds can be invested and are allowed to grow on a tax-free basis. However, unlike a traditional IRA, all withdrawals from a Roth IRA are tax-exempt.

401(k) Plans 

401(k) plans are retirement savings vehicles sponsored by profit-oriented employers. The money contributed by employees is tax-advantaged and can be invested in a low-cost and diversified manner. Additionally, many sponsors match employee contributions, which provides a meaningful savings boost.

Like IRAs, 401(k) plans come in two formats, traditional and Roth-style, with the same tax advantages. The main difference between 401(k) plans and IRAs relates to contribution limits. 

In 2023, the annual contribution limits distinguish themselves at $7,000 for IRAs and $22,500 for 401(k) plans. Furthermore, individuals aged 50 and older can augment their contributions with an extra $1,000 for IRAs and an additional $7,500 for 401(k) plans, according to IRS guidelines.

Fast-forwarding to 2024, notable adjustments mark the annual contribution limits at $8,000 for IRAs and $23,000 for 401(k) plans. For those aged 50 and above, the IRS allows supplementary contributions of $1,000 for IRAs and an added $7,500 for 401(k) plans.

403(b) Plans

403(b) plans are very similar to 401(k) plans, but they are sponsored by certain tax-exempt organizations, such as public schools, hospitals and nonprofit organizations – as opposed to profit-oriented entities. Like 401(k) plans, they enable eligible employees to contribute a portion of their income to retirement investment accounts and allow the contributions to grow in a tax-advantaged manner. 

Traditional accounts offer tax deductions and tax-deferred growth, while Roth-style accounts offer tax-exempt growth. Both types of accounts allow for employer matches and contributions.

Did You KNow?

All of the IRS-endorsed vehicles mentioned assume no withdrawals will be made before reaching the age of 59 ½. In the case of early withdrawal, a 10% penalty is typically imposed, along with any tax liabilities.


Purchasing an annuity is another way to enhance your retirement plan in a tax-efficient manner. Buying one is not as clear-cut a decision as saving for retirement via an IRA, 401(k) or 403(b). Determining whether to buy an annuity depends on your tolerance for risk. 

For a conservative, hands-off investor, an annuity can be an efficient, low-risk way to save for retirement. In some cases, it can be a nice complement to a portfolio of traditional investments. Depending on your time horizon, one of the following types of annuities could make sense:

If you are on the verge of retirement, a single premium immediate annuity (SPIA) could be ideal. In exchange for a lump-sum premium, it kicks off a guaranteed stream of periodic payments, beginning within one year of purchase. The payments consist of interest earned and a partial return of premium.

If you have ten or more years until retirement, a  deferred annuity is more appropriate than an SPIA. This type of contract allows your funds to grow as you continue working toward retirement. The longer you wait to receive your annuity’s contractually-stipulated payments, the more your funds can grow and work for you.

Will You Be Able To Maintain Your Retirement Lifestyle?

Learn how annuities can:

  • Help protect your savings from market volatility
  • Guarantee income for life
  • Safeguard your family
  • Help you plan for long-term care

Speak with a licensed agent about top providers and how much you need to invest.

Strategies for Withdrawals

In general, having two tax-advantaged retirement vehicles—a traditional one and a Roth-style one—makes sense. This approach provides flexibility in taking income distributions in a tax-efficient manner.

For example, in low-income years, withdrawing money from your traditional vehicle is smart, because these funds have never been taxed. Conversely, in high income years, withdrawing money from your Roth-style vehicle is smart, because the funds are exempt from tax.

Unfortunately, optimizing your retirement income withdrawals entails more complexity than suggested above. 

Be Aware of RMDs

A required minimum distribution (RMD) is an IRS-mandated minimum annual withdrawal for certain tax-advantaged retirement accounts, such as 401(k) plans, 403(b) plans and traditional IRAs. RMDs exist to prevent people from indefinitely growing their retirement savings on a tax-advantaged basis. Essentially, they ensure untaxed retirement contributions and accumulated earnings are taxed at a predictable point in time.

Beginning at age 73 (or age 72 if you reach 72 before January 1, 2023), you must take RMDs each year. Failure to do so will usually result in a penalty of 25% of the required distribution.

This is a severe penalty that all retirees should strive to avoid. However, it’s important to note that this does not necessarily mean adhering strictly to the IRS’s rigid schedule for RMDs. There are some strategies for postponing or minimizing RMDs, including working longer, donating to charity, buying a qualified longevity annuity contract (QLAC) and executing a Roth IRA conversion. 

Regardless of your individual circumstances, make sure to tackle the challenge of RMDs. If needed, seek guidance from a trusted financial advisor.

Rollovers and Conversions

In addition to being cognizant of RMD rules, it is important to be aware of the various retirement account rollover and conversion options at your disposal. Generally, an IRS-endorsed retirement account can be rolled into a similar account (i.e. traditional 401(k) plan to traditional IRA or Roth 401(k) plan to Roth IRA) without triggering any tax implications. However, tax implications arise when executing a conversion, which means moving money between a traditional account and a Roth-style account.

Optimizing Social Security Benefits

Saving and investing in a tax-advantaged manner is critical, but you also need to optimize your Social Security benefit election. While you can claim Social Security benefits as early as 62 years of age, this is not always the best course of action. Opting for the benefit before reaching full retirement age, currently set between 66 and 67, will lead to a reduced monthly payment.

When it comes to claiming Social Security, there is no universally correct decision. The optimal election age depends on your financial needs, life expectancy and confidence level in the federal government’s ability to manage this welfare program. 

Regardless of your situation, you should begin thinking about your Social Security election well before age 62. Foundational planning can help you avoid making the costly mistake of claiming benefits too early or too late.

Understanding the Tax Implications of Your Insurance

Another important way to plan for a tax-efficient retirement is to thoughtfully leverage health and life insurance policies, assuming these products add value to your household unit. Each type of insurance offers meaningful tax advantages. 

With health insurance, premiums paid are generally tax-deductible, which reduces your taxable income and lowers your tax liability. Additionally, certain medical expenses not covered by insurance are tax-deductible – if they collectively exceed the IRS’ specified threshold.

With term life insurance, which is in-force for a finite period, death benefits paid to beneficiaries are generally tax-exempt. Permanent life insurance extends the tax benefits. With this type of coverage, which is in-force for your entire life, premium payments fund two components – a death benefit and a cash value reserve. 

The death benefit provides financial protection to named beneficiaries (just like a term policy), while the cash value reserve gives you an equity interest in the policy. The money allocated to the cash value reserve component can be invested and is allowed to grow on a tax-deferred basis (just like a traditional retirement account).

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Estate Planning With Taxes in Mind

A final way to plan for a tax-efficient retirement is through formal estate planning. Generally, this is best suited for high-net-worth individuals. A holistic plan typically reflects a robust investment program, an annual gifting strategy, the establishment of trusts and thoughtful determination of the beneficiaries of tax-advantaged retirement accounts. 

Collectively, these maneuvers can enable you to safeguard your wealth, reduce estate taxes and transfer assets to designated beneficiaries in a tax-efficient manner. Ultimately, this helps you and your loved ones enjoy a more financially secure retirement.

Establishing a plan to save for retirement in a tax-efficient manner is difficult, especially, if you lack awareness of the various tools and approaches at your disposal. As a result, working with a fiduciary financial advisor is strongly advised. He or she can help you assess your current financial position and implement strategies to optimize your long-term wealth-accumulation and preservation potential.

Can I save for retirement via a 401(k) plan and an IRA?

Yes, you can save for retirement through the simultaneous funding of a 401(k) plan and an IRA. Most financial advisors recommend doing so to maximize your retirement savings contributions and capitalize on the tax benefits, savings incentives and investment optionality offered by each type of vehicle.

However, there are annual contribution limits for both 401(k) plans and IRAs. Moreover, there are special considerations when simultaneously contributing to these types of vehicles. Make sure you familiarize yourself with the rules, while planning your contributions accordingly.

Is a traditional retirement vehicle better than a Roth-style retirement vehicle?

When deciding whether it makes more sense to invest in a traditional retirement account or a Roth-style account, the most important consideration is whether you expect to be in a higher tax bracket during your working years or retirement years. A traditional account is the optimal choice if you expect to be in a higher bracket during your working years. Conversely, a Roth-style account is the optimal choice if you expect to be in a higher bracket during your retirement years.

Unfortunately, accurately projecting your future tax rate is not easy. As a result, it is sensible to assign a portion of your retirement savings to a traditional account and a portion to a Roth-style account.

What is an employer match?

An employer match is a form of compensation that also serves as an incentive for an employee to save for retirement via an employer-sponsored retirement plan, such as a 401(k) plan or a 403(b) plan. An employer match complements an employee’s retirement contribution, which strengthens his or her ability to save. For this reason, a match is often referred to as “free money.”

Please seek the advice of a qualified professional before making financial decisions.
Last Modified: April 23, 2024
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