A fundamental principle of saving for retirement is to maximize contributions to your 401(k) or individual retirement account (IRA). However, some financial experts caution against putting all your resources into these accounts.

When saving for retirement, diversifying your investments across different savings options, such as brokerage accounts and Roth accounts, may be more advantageous, they suggest.

Having various sources of funds in retirement not only provides more flexibility but also brings considerable tax advantages.

“You don’t want all your funds tied up in tax-deferred accounts,” stated Daniel Razvi, senior partner and COO at Higher Ground Financial Group. “IRAs are one of the biggest traps in terms of taxes these days.”

Why Are 401(k)s and IRAs Potentially Tax-Disadvantageous?

• Investments in IRAs and 401(k)s are tax-deferred, meaning you don’t pay taxes until you withdraw the money, typically during retirement. The concern is that future tax rates are unpredictable but are expected to rise, according to advisers.

“Imagine starting a business where I invest 25%, and you invest 75% while doing most of the work,” Razvi explained. “After 20 years, I find out that I can change our agreement without any consent from you. Would you agree to such a setup? That’s how it works with IRAs; the government will determine future taxes without any say from you.”

• Withdrawals from 401(k)s and IRAs are taxed as regular income. Income tax rates tend to be higher than the long-term capital gains tax associated with traditional brokerage accounts, according to advisors.

“If you have a net worth of $2 million but $1.7 million is tied up in IRAs, consider how vulnerable you could be if taxes increase,” noted Joseph Patrick Roop of Belmont Capital Advisors. “With only IRAs and 401(k)s, you face unavoidable taxes.”

• Once you reach age 73, you must withdraw a certain amount annually (required minimum distribution or RMD) and pay taxes, regardless of whether you need the funds. These withdrawals could elevate your income to a level that increases your Medicare premiums and taxes on your Social Security benefits.

“I appreciate tax-deferred growth, but are you pushing yourself into higher tax brackets?” asked Nicholas Yeomans, president and chief compliance officer at Yeomans Consulting Group.

• When it comes to inherited IRAs, the IRS mandates that most heirs must liquidate the IRA within 10 years of the original owner’s death, and in some scenarios, require annual RMDs that may coincide with the beneficiary’s peak income years.

How Can Various Account Types Help Minimize Taxes?

By using Roth, traditional brokerage, and health savings accounts, you can have enhanced control over your income and tax situation, experts explain.

• Roth accounts utilize after-tax dollars, allowing for tax-free withdrawals if you’re 59-1/2 or older and have contributed for at least five years. Additionally, there are no RMDs for Roth accounts, which means you won’t be forced to withdraw funds.

Most non-spouse beneficiaries of Roth accounts will need to withdraw the entire amount within 10 years of the original owner’s passing but can defer the liquidation until the final year, enabling the investment to grow during that time without any tax implications.

• Brokerage accounts have no RMDs, and if you hold your investments for over a year, withdrawals are taxed as long-term capital gains. These tax rates, ranging from 0% to 20% based on income, are generally lower than the income tax rates, which can go up to 37%.

Inherited brokerage accounts benefit from a step-up in basis — the account is adjusted to its market value at the previous owner’s death, meaning immediate liquidation incurs no capital gains tax, according to Yeomans.

• Health savings accounts (HSAs) allow you to set aside pre-tax money if you have a high-deductible health plan to cover qualified medical expenses, also serving as a retirement savings tool. “You have the option to pay for medical expenses now or invest and let your contributions grow for future costs in retirement,” stated Lauren Wybar, senior wealth adviser at Vanguard. If you save receipts for healthcare expenses, you can withdraw HSA funds tax-free for those qualified costs in retirement. HSAs offer triple tax advantages: tax-free contributions and withdrawals and tax-deferred growth,” she added.

A non-spouse beneficiary of an HSA must liquidate the account and pay income tax in the year the account owner passes away, however.

What is the best way to distribute your funds across different accounts?

To start, if your employer offers matching contributions, be sure to contribute enough to take full advantage of those accounts. “Don’t pass up free money,” Yeomans advised. “That’s essentially a 100% return on your investment. Secure the full match.”

Once that’s covered, financial advisors have slightly varying opinions on the next steps. For instance,

• Wybar suggests maintaining a savings rate of 12-15% of your income (including matched contributions) in your 401(k), or if possible, aim to max out this account to benefit from its tax-deferred advantages before considering Health Savings Accounts (HSAs). If you still have surplus funds, traditional and Roth IRAs offer the flexibility to invest in a wide range of options such as mutual funds, ETFs (exchange-traded funds), stocks, and bonds—many of which may be more affordable than those offered through your employer’s plan.
• Yeomans recommends a rough guideline of saving about half of your funds in tax-deferred accounts, a quarter in Roth accounts, and the remaining quarter in brokerage accounts.

“While many people emphasize asset diversification, it’s equally important to consider tax diversification, as we cannot predict future tax rates,” Yeomans emphasized.

Medora Lee is a reporter covering money, markets, and personal finance for YSL News.