That tax approach has always been recommended for extremely wealthy people and corporations, with high-powered lawyers and accountants at their disposal. But even if you work for a living and have a more modest income and savings, there may be tax planning moves available that could benefit you in the future.
Roths and Other Shelters
Diversification won’t protect you fully all the time, of course. In investing, for example, there have been periods — most recently, the high-inflation, high-interest-rate environment of 2022 — when stocks and bonds fell, domestically and internationally. But for the most part, the strategy has worked, generating reasonably good returns over long periods with far less volatility than if you had put all your money into the stock market — or into one stock that didn’t turn out to be a worldbeater.
Similarly, tax diversification means giving yourself options that will limit the damage, and, maybe, even help you prosper, whatever happens to the tax code. To the extent that you can control your own finances, it’s prudent to consider a variety of simple, widely available tax shelters, without depending totally on just one.
The broad concept is simple. The details, however, can give you a headache.
Mr. Dickson suggests spending some time exploring both traditional and Roth accounts in both 401(k)s and I.R.A.s. The traditional versions allow you to defer paying taxes on the income you put into the accounts — which makes sense if your tax rate will be lower later. The Roth versions require that you pay taxes now, which makes sense if your tax rate will be higher later.
There are some basic rules of thumb for which kind of account to emphasize at different stages of life. Typically, people’s earnings are lower earlier in their career, putting them into a lower tax bracket. So a Roth, which can also be drawn upon as an emergency fund, may be a better choice then. When your earnings are higher and you are taxed more heavily, the traditional version of 401(k)s and I.R.A.s may be more suitable.
