The Importance of Tax Diversification in Your Portfolio

By LouAnn Schulfer, AWMA®, AIF®
Accredited Wealth Management AdvisorSM
Accredited Investment Fiduciary® , Published Author | July 15, 2025

A common discussion I have with my clients is building tax diversification within their portfolio.  I started working with a client nearly ten years ago who had retirement accounts that were funded with pre-tax dollars which would be fully subject to ordinary income taxation upon withdrawal, as well as non-retirement investments and savings accounts which conversely, are taxed upon their respective realized growth.

We started her Roth IRA while she was still allowed to contribute.  She remained disciplined, maximizing annual contributions to the very last dollar.  Our goal was to allow her Roth to grow as long as possible, planning to defer taking any distributions from her most tax-favored account for many years. 

With highly calculated financial planning she retired at an early age, prior to Medicare eligibility, beating her goal by over a year!   We monitored her taxable income through the years and took advantage of low tax brackets when we could, converting dollars from her IRA to her Roth IRA continuing to build her tax-free bucket of money.

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Life is good and her plan is working well.

Then, I received an e-mail just the other day stating she was very stressed, as her car was having significant mechanical problems and she needed to replace it.  We hadn’t planned on a withdrawal for a new vehicle for a few years.  What she was most stressed about was that the distribution, if taken from her IRA, would cause a large increase in her health insurance costs, to the tune of about $7,200 as she purchases health insurance from the exchange. 

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After review of her financial plan, investments and taxation, I recommended she make the unplanned withdrawal from her Roth IRA.  Knowing our original goal of deferring Roth distributions for as long as possible, she raised concern that using this much money from her Roth would derail our original plans.  I explained that we could “put the money back” into the Roth gradually, through future conversions in coming years, with special attention to not exceed certain Modified Adjusted Gross Income thresholds which would have negative consequences to her premium tax credits.  Thus, she could avoid paying the $7,200 this year and all together.  That is a great success!

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Life is unpredictable, but you can plan to be prepared when a financial curve ball is thrown your way. In this case, we had options and were able to significantly mitigate taxation because 10 years ago, we understood the importance of tax diversification to her portfolio.