How to control your tax rate in retirement (starting now)

THE TAX DIVERSIFICATION STRATEGY NOBODY TALKS ABOUT

Everyone agrees you should have a diversified portfolio. You’d be crazy to go all in on a single stock.

But nobody talks about tax diversification.

Business owners spend hours researching whether to invest in SPY or VOO, then dump everything into one tax bucket without a second thought. They wonder why their retirement savings are completely underoptimized when they need them most.

The result? People who did “everything right” for 30 years end up paying hundreds of thousands in unnecessary taxes because they optimized for contribution limits instead of tax efficiency.

Here’s what most people miss: the account you choose matters as much as the investments inside it.

The Three-Bucket System

Smart tax planning requires three types of accounts working together:

Taxable Brokerage: Your normal Vanguard, Schwab, or Robinhood account. After-tax money goes in. You pay tax on dividends and distributions annually, and capital gains when you sell. But there are no age restrictions, no required distributions, and full flexibility. Access your money anytime without penalty.

These accounts are underappreciated. No complex rules. No forced timelines. Just straightforward investing.

Tax-Free (Roth IRA/Roth 401k): Available to anyone with earned income up to $7,000 a year via direct contribution or Backdoor Roth. Pay tax now at today’s rate, never again. Your money compounds tax-free forever. Tax-free withdrawals in retirement.

Tax-Deferred (Traditional 401k/IRA/Defined Benefit Plans): Available through employers, to self-employed folks, and to business owners. Defer tax now, pay later. You’re betting on lower future rates because of lower income in retirement. But your money is locked until 59½. Forced distributions starting at 73 (or 75 if born 1960 or later). Your heirs pay tax within 10 years.

Most people max out their traditional 401k every year because it feels like winning. Defer $23,500, save $8,000+ in taxes today.

But that’s only half the story.

The Duration Problem

Every retirement account has an end date.

When I was starting out, I asked an old CPA mentor about setting up a retirement plan for a wealthy client.

“I don’t,” he said.

My face must have said it all.

“Anytime the government gives you a deal, it’s not a deal.”

Charlie Munger famously said, “Never interrupt the compounding.”

But when you invest in a tax-deferred retirement plan, you will by definition interrupt the compounding. You’ll pay taxes at some point during your life, or no later than 10 years after your death when your heirs must liquidate the plan.

While counterintuitive, this idea has come more into vogue as the rules have become more restrictive.

Think about the timelines:

529s for college? These have no expiration date. You can change beneficiaries or even roll to a Roth IRA now under SECURE 2.0. But the practical reality is you’re investing with a target date in mind. By the time your kid turns 8-11, you need to get conservative or risk a market crash right when tuition bills hit. The timeline constrains your strategy.

Traditional IRAs? You must start taking Required Minimum Distributions at 73 whether you need the money or not. (If you were born 1960 or later, that pushes to 75.) Those RMDs can push you into higher brackets and trigger IRMAA surcharges on Medicare premiums.

Your heirs? The SECURE Act killed the stretch IRA. They pay tax on your entire deferred balance within 10 years of inheriting it. If they’re in their peak earning years, they could pay 37% federal on money you deferred at 24%.

The math gets brutal when you stack these timelines together.

The Wrong Way (Most People)

Client making $120k at 28 years old. Marginal rate of 22%, effective rate around 14%.

Maxes traditional 401k for 30 years. Saves roughly $5,000 per year in taxes. Feels smart.

Fast forward to age 73. Portfolio worth $3.2M. RMDs force him to pull $120,000+ annually. Combined with Social Security, his marginal rate hits 32% federal plus state taxes on every dollar above the threshold.

He deferred at 22% and pays back at 32%+.

Over his lifetime? Paid $400,000+ more than he needed to.

The Right Way (Tax Diversification)

Under 32% marginal rate: Use Roth. Lock in today’s rate. Your 20s and 30s are gold for Roth contributions. Pay 12-24% now instead of 32%+ later.

Over 32% marginal rate: Consider traditional deferrals. But split it. Don’t put everything in one bucket.

Business owners with QBI: Solo 401k lets you defer $23,500 as an employee deferral (which comes from salary that doesn’t get QBI anyway) while your profit distributions stay eligible for the 20% QBI deduction.

Self-employed crushing it: Mega Backdoor Roth can get you up to $70,000 total into your Solo 401(k) if you’re in the 24% bracket and your plan allows after-tax contributions. That money converts to Roth and never gets taxed again.

Year-End Deadlines (Why This Email Matters NOW)

Solo 401k plans must be ESTABLISHED by December 31st. Not funded. Established.

Here’s the nuance that trips people up: Employee elective deferrals (the $23,500) must also be made by December 31st. Only employer profit-sharing contributions can wait until your tax filing deadline, including extensions.

Client making $400k wanted to max out contributions in January. Too late. The plan didn’t exist on 12/31.

He missed the chance to defer $70,000 and save over $20,000 in taxes.

Roth conversions must happen by December 31st. If you’re in a low income year (business had a down year, took time off, whatever), convert traditional IRA dollars to Roth at today’s lower rate.

You have three weeks to get this right for 2025.

Common Mistakes That Cost Thousands

Putting real estate in self-directed IRAs: Real estate already gets depreciation and 1031 exchanges. Wrap it in an IRA and you create UBTI (Unrelated Business Taxable Income) problems if you use leverage, distribution nightmares, and you’ll never get traditional financing.

Using ROBS for franchise purchases: If your capital is locked in your IRA, you can’t afford the deal. Plus you lose the tax shield of business deductions.

Converting too much in one year: Roth conversions are taxable income. Converting $200k in one year could push you through the 32% and 35% brackets. Spread it across multiple low-income years.

Ignoring state tax: Some states don’t follow federal Roth rules. Know your state’s treatment before making moves.

The $0 tax year in retirement: Living off savings and paying zero tax wastes your standard deduction and lowest brackets. Strategic Roth conversions at 10-12% beat forced RMDs at 32% later.

Hiring kids without proper documentation: If you want to set up Roth IRAs for your kids working in the business, the work must be legitimate and the compensation reasonable. Don’t create an audit problem trying to save on taxes.

Three Weeks to Get This Right

If you’re under 32% marginal rate: Open Roth 401k or Roth IRA. Lock in today’s rate. Max it out. Your future self will thank you.

If you’re self-employed with no retirement plan: Establish a Solo 401k by 12/31. Remember - employee deferrals must be made by year-end too. Only employer contributions can wait. This is non-negotiable.

If you’re over 32% and maxing traditional: Keep doing it, but allocate 20-30% to Roth as well. Build all three buckets.

If you had a low-income year: Consider Roth conversions now while you’re in lower brackets. Pay 12% or 24% today instead of 32%+ when RMDs hit.

If you have kids working in your business: Set up Roth IRAs for them if the work is legitimate and the pay is reasonable. They’re in the lowest brackets. They get 40+ years of tax-free compounding.

The Math That Millionaires Understand

Every dollar in a Roth account at age 30 becomes $10+ tax-free by retirement.

Every dollar deferred in a traditional account creates a future tax liability at an unknown rate.

Given $35 trillion in federal debt and Social Security obligations, I believe tax rates are unlikely to be lower in 30 years. You may disagree. But building tax diversification lets you control your rate in retirement instead of letting the IRS control it through RMDs.

That optionality has value regardless of which way rates move.

What To Do Next

At Better Bookkeeping, we build complete tax strategies that work for decades, not just December. We map your lifetime effective tax rate, identify where you are in your earnings curve, and structure retirement savings that minimize taxes over 30+ years.

We have three weeks before December 31st to optimize your 2025 retirement strategy.

Want to see your complete retirement tax picture? Schedule a consultation or hit reply.

For wealth management and comprehensive financial planning, work with Baldridge Financial to build your multi-decade tax strategy. We’ll calculate how much you should contribute, to which accounts, and why.

The difference between smart retirement planning and conventional retirement planning is hundreds of thousands of dollars over your lifetime.

Let’s stop optimizing for this year and start optimizing for the next 30.