Why You Should Diversify Your Savings by Tax Status

Mark Stern |
Categories
Financial Planning
Tax Planning
If you’re a creative or self-employed person, managing your money isn’t just about how much you save — it’s also about where you save it to keep your tax bills in check and your financial freedom intact. That’s where tax diversification comes in. It’s simply the idea of spreading your savings across different types of accounts that the tax rules treat differently, so you have more control and flexibility with your money now and later[1][3].
 
Here are the three main types of accounts you can use:
 
  • Taxable accounts: These include your everyday checking and savings accounts, plus any individual or joint brokerage accounts. You pay taxes every year on any interest, dividends, or investment profits. These accounts are the most flexible — no limits or penalties on when or how you take money out.
  • Tax-deferred accounts: Think traditional IRAs, 401(k)s, 403(b)s, and tax-deferred annuities. You usually put in pre-tax dollars, which lowers your taxable income now. But you pay income taxes later when you withdraw in retirement. Plus, these accounts often require you to start taking money out once you reach a certain age[1][3].
  • Tax-free accounts: Roth IRAs, Roth 401(k)s, Roth 403(b)s, and Health Savings Accounts (HSAs) fall here. You fund these with after-tax money, but your earnings and qualified withdrawals are tax-free, giving your money a chance to grow without the taxman taking a cut later[1][3].
 

Key Benefits of Tax Diversification

Enhanced Retirement Flexibility

Having money in all three account types gives you maximum control over your retirement income. You can strategically choose which accounts to withdraw from based on your tax situation each year, potentially keeping yourself in lower tax brackets and reducing your overall tax burden.
 

Protection Against Tax Uncertainty

Nobody knows what tax rates will look like in 20 or even 5 years, but some economists are warning that tax rates will need to rise in the U.S. because the mounting Federal budget deficits are unsustainable[2]. Tax diversification acts as insurance against future policy changes [3]. Whether tax rates go up, down, or stay the same, you'll have options to optimize your tax situation.
 

Improved Estate Planning

Tax diversification provides more flexibility when transferring assets to beneficiaries. Different account types have varying inheritance rules and tax implications, allowing for more sophisticated estate planning strategies [1].
 

Maximized Lifetime Savings

By managing when you pay taxes on your savings, tax diversification can help you keep more money over your lifetime. This is especially valuable for creative professionals who may have irregular income patterns throughout their careers [1][3].
 

One Size Does Not Fit All

Getting tax diversification right isn’t one-size-fits-all — it depends on your income, how long you’re saving, and your unique goals. But some tips to start include:
  • Max out tax-deferred accounts like a solo 401(k) or SEP IRA if you have one — this reduces taxable income while building retirement savings.
  • Use HSAs if you qualify — they offer a double tax benefit and can be a secret weapon for health and retirement expenses[1][3].
  • Keep a taxable account for easy access and additional investment options without withdrawal taxes or limits.

Special Note for Couples

Many couples keep their emergency savings in a joint account but some will keep this stash in an individual account in just one of their names. This can lead to a feeling of a lack of autonomy when an unplanned expense hits the person without direct access. Ideally everyone should have ready access to their own savings account. Regardless, it's essential to make sure that you're on the same page with the family budget and tapping emergency savings. A neutral advisor can help facilitate this discussion.

Final Thoughts

For creatives and self-employed individuals, partnering with a tax professional or financial advisor who understands your world can help tailor a tax diversification plan that works for the unpredictable nature of your income and lifestyle. In short, tax diversification is about creating a flexible financial toolkit that helps your money work smarter — so you can focus on your craft without worrying about tax surprises along the way.

Resources

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References