When it comes to preparing for retirement, how your savings are taxed is just as important as how much you’ve saved. At Cardinal Advisors, we often meet clients who have done a great job accumulating assets—but all too often, their money is concentrated in the wrong type of account. That’s where problems begin.

In this blog, we’ll walk through the three types of retirement savings accounts—taxable, tax-deferred, and tax-free—and how understanding these categories can lead to smarter retirement income planning, lower taxes, and greater flexibility.

Taxable Retirement Savings

A taxable account includes any savings or investment account funded with after-tax dollars. This might be a traditional brokerage account, savings account, money market fund, or certificate of deposit (CD). The key characteristic of these accounts is that you have already paid income tax on the money before contributing it.

• Contributions are made with money that’s already been taxed, meaning there’s no upfront tax break.
• Growth in these accounts is subject to annual taxation. Interest, dividends, and capital gains must be reported on your tax return each year.
• Flexibility is a benefit: there are no early withdrawal penalties or required minimum distributions (RMDs). You can access funds at any time without triggering a tax penalty, although you may owe taxes on any realized gains.
• Drawback: Because investment earnings are taxed as they occur or when you sell, these accounts can create an ongoing tax liability during retirement if not managed properly.

While taxable accounts offer liquidity and flexibility, they’re generally less tax-efficient compared to other savings types. However, they are extremely useful for covering emergencies, lifestyle spending, and funding Roth conversions or other tax strategies without increasing taxable income.

2. Tax-Deferred Retirement Savings

This is where most people have the majority of their retirement money. Tax-deferred accounts include traditional IRAs, 401(k)s, 403(b)s, SIMPLE IRAs, and certain annuities. These accounts allow you to postpone paying taxes on both contributions and earnings until you begin withdrawing money in retirement.

• Contributions reduce your taxable income in the year they are made (subject to IRS limits), which can result in significant tax savings during your working years.
• Growth is not taxed year-to-year, allowing for compound growth without annual tax drag.
• Withdrawals are taxed as ordinary income. This includes both your original contributions and the earnings.
• RMDs begin at age 73 under current law. These mandatory withdrawals can create large taxable income spikes, impacting your Medicare premiums and Social Security taxation.

The danger? Many retirees end up with nearly all their savings in tax-deferred accounts, which gives them few options when they need income. This can cause them to pull more money than necessary just to pay taxes, leading to higher tax brackets, Medicare surcharges (IRMAA), and reduced financial flexibility. A balanced withdrawal strategy is essential to prevent over-reliance on these accounts.

3. Tax-Free Retirement Savings

Tax-free retirement savings accounts are powerful tools that allow for tax-free growth and withdrawals under specific conditions. These include Roth IRAs, Roth 401(k)s, and properly structured cash value life insurance policies.

• Contributions are made with after-tax dollars, meaning there is no upfront deduction.
• Growth is completely tax-free as long as certain conditions are met (e.g., the Roth account is at least five years old and the account holder is over age 59½).
• Withdrawals do not count as income, so they don’t affect your tax bracket, your Medicare IRMAA charges, or the taxation of your Social Security.
• No RMDs apply to Roth IRAs for the original account holder, giving you full control over when or whether to withdraw funds.

These accounts are especially valuable in retirement because they provide a source of income that won’t increase your tax burden. Starting early, as in the case of Hans’s son contributing to a Roth IRA in his twenties, allows decades of tax-free compounding. For those nearing or in retirement, Roth conversions can be an effective way to shift some assets out of the tax-deferred bucket. Though taxes are paid upfront, the long-term benefits can be significant.

Additionally, cash value life insurance and municipal bonds can offer tax-free benefits under specific circumstances. When structured properly, life insurance can be used for tax-free income in retirement through policy loans, and municipal bonds offer federally (and sometimes state) tax-free interest income.

Why This Matters: Retirement Income Is Not Just About the Numbers

At Cardinal Advisors, we frequently meet clients who tell us they need, for example, “$10,000 a month” in retirement income. But few have thought about whether that number is before or after taxes. That distinction is critical.

If your income is coming primarily from tax-deferred accounts, you may need to withdraw $14,000 or $15,000 just to net $10,000 after taxes. That additional withdrawal can push you into a higher tax bracket, make more of your Social Security taxable, and increase your Medicare premiums through IRMAA.

Without proper planning, retirees risk depleting their accounts faster, reducing the longevity of their savings, and increasing the overall tax burden unnecessarily. That’s why understanding your buckets and balancing withdrawals strategically is essential.

Building Your Retirement Strategy with the Three Buckets

When you come to Cardinal Advisors for a financial plan, the first step we take is to categorize your assets into the three tax buckets: taxable, tax-deferred, and tax-free.

From there, we:

• Analyze how much monthly income you need.
• Determine the optimal accounts to draw from to meet that need.
• Evaluate your future tax exposure, especially with RMDs starting at age 73.
• Create a year-by-year distribution plan that balances tax efficiency with your financial goals.

We also explore whether it makes sense to begin Roth conversions, how to fund those conversions tax-efficiently (perhaps from a taxable account), and whether insurance or investment repositioning might help improve long-term results. The objective is to make your plan sustainable, tax-smart, and aligned with your goals.

Conclusion: Taxes Matter in Retirement

Tax planning is an essential piece of retirement planning. It’s not just about growing your money; it’s about keeping more of it when you need it most.

Understanding the differences between taxable, tax-deferred, and tax-free accounts can empower you to make informed decisions about how to fund your retirement lifestyle. And while you can’t control everything—like tax law changes or market volatility—you can control how your money is structured and how it’s withdrawn.

If you’re unsure about how your retirement savings are divided across the three buckets, or if you want to know whether a Roth conversion or other tax strategy makes sense for you, we’re here to help.