How Smart Tax Strategies Can Save You Money, Now, and in the Future

By Katherine Vessenes, JD, CFP®, RFC
President, MD Financial


When I first started financial planning, we all had one basic assumption - push taxes into the future. The general thought was our clients would be in a much lower tax bracket for taking distributions from their retirement plans. About 13 years ago, I had an “aha moment”. What if that assumption was false?


If it were untrue, then we had done our clients a great disservice. Instead of paying their taxes now, when the rates are historically low, we would have pushed them into the future, when they could be in a higher tax bracket.


In fact, in order for your tax rate to be lower in retirement, two things must happen:

1.    You must need less income. However, most people want exactly the same lifestyle in retirement that they are living now.

2.    The other alternative is Congress will reduce the tax rates. The recent elections have shown that this is highly unlikely for the foreseeable future.


Given these options, we believe a lot of people (not all) will be in a higher tax bracket in retirement than they expect.


This is where the tax control triangle can give you a framework to make good decisions about your investments.


Here is how it works:

There are mainly three ways your income in retirement can be taxed:

1.    Taxed now in taxable accounts. We think of this as a tax forever account because the earnings are subject to income tax every year.  Some assets that would fit in this bucket include:

  • Savings accounts

  • Mutual funds and investments held in your name

  • Income from real estate

  • CDs and money market accounts

  • Investment real estate


2.    Taxed later in a tax-deferred account. Here are a few types of accounts that allow for a tax reduction in the current year by deferring taxes until retirement:

  • 401k

  • 403b

  • 457

  • IRA

  • SEP



3.    Tax-free. There are only a few ways to get tax-free income:

  • 529 plans if used for college costs within the USA

  • Health Savings Accounts

  • Municipal Bonds

  • Roth IRAs

  • Certain kinds of cash value life insurance



We make sure our clients know there are pros/cons with each of these buckets:

1.    For the non-qualified, taxable accounts:

a.    Pros:

  • The funds are liquid and available on a few days notice.

  • There are no penalties for withdrawing the funds.

  • It is very important to have emergency funds in this bucket.

b.    Con:

  • With these accounts being taxed forever, the tax burden reduces the rates of returns.


2.    For the qualified/tax deferred accounts:

a.    Pros:

  • You can reduce your taxable income for the current year when you contribute to this type of account. For example, an investor who maximizes their 401k, could invest $18,000 and not have to pay any taxes on that money. For those in the highest tax brackets, it might save them as much as $7,000 or more in taxes this year - money in their pocket.

  • This analysis has become more important under the new tax regulations. It might make sense to put enough money in this bucket to reduce income so it is below certain thresholds where deductions are lost or additional taxes kick in.

                            b.    Cons:

  • Unfortunately there will come a time in the future, where you will have to pay the piper—the taxman. In retirement, all the funds in this bucket will be taxed as ordinary income.

  • Investors with a lot of money here face two big unknowns: they don’t know how much their funds will grow between now and retirement, and they don’t know what the tax rates will be.

  • There are also steep penalties for pulling the money out of the accounts before age 59 1/2.


3.    The tax-free/tax advantaged accounts:

First a little background. For retirement purposes, there are only Four main choices: Municipal Bonds, Health Savings Accounts, Roths or certain types of life insurance. We don’t usually recommend Muni’s to our clients due to poor returns, and in some states the real risk of defaults. That leaves Health Savings Accounts, Roths, and life insurance. For married couples, whose joint income is over $184,000 in 2016, regular Roths are not usually an option.  They may qualify to do what’s called a back-door Roth IRA as a work around. Another option for many clients so they can get tax-free income in retirement is through cash value life insurance.

a.    Pros:

For either Roths or cash value life insurance, the client invests in the funds with after tax dollars. The accounts grow tax-free and can be withdrawn free of taxes if done correctly. For Roths this would be a direct withdrawal after age 59½. For life insurance it is usually done in the form of a loan.
Certain types of life insurance have some guarantees that are appealing to many investors.

b.    Cons:

For Roths there are steep penalties for withdrawing the funds prior to age 59½  (except for the cost basis).
Depending on the type of life insurance used, there may be surrender charges if the client decides to cancel the policy early. These charges would reduce the amount of funds the investor could access.


Here is what we tell every client:

It is important to have some money in each bucket, because that gives you more flexibility in retirement. If tax rates are high when you retire, then you can take the money out of the tax-free bucket. If they are low, you will want to take them out of the tax-deferred bucket. This strategy allows you options. Unfortunately, those investors who just blindly invested all their money in the tax-deferred bucket could wake up to some very unpleasant tax bills in retirement.


A common strategy we use:

1.    First, we fund the taxable bucket to a level that our clients feel comfortable with for emergency funds or liquid savings.

2.    Next, we look at their tax-deferred options.

3.    We then look at the tax-free bucket and use Roths, if available, or cash value life insurance. Sometimes we use a combination of both.

4.    Ongoing savings are used to fund the taxable bucket and the tax-free bucket in a ratio that our client feels meets their budget.


It is our belief that the mix of how much money you have in each tax bucket is just as important as the investment returns.


Katherine Vessenes, is the founder and CEO of MD Financial Advisors who serve 500 doctors from Hawaii to Cape Cod. An award-winning Financial Advisor, Attorney, Certified Financial Planner®, Registered Financial Consultant, author and speaker, she is devoted to bringing ethical, fiduciary advice to physicians and dentists. She can be reached at