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In Practice June 26, 2026
Tax Diversification: Keep It Simple
Plan participants should know the ‘what’ and ‘why’ behind their tax selections to maximize their contributions.
Reported by
Valentina Baez
Understanding how contributions are taxed can be key for retirement plan participants to maximize their savings. However, teaching participants the difference starts with one key factor: simplification.
Without a clear understanding of tax strategies and the role diversification plays, participants may rely too heavily on a single tax treatment, creating uncertainty once they reach retirement.
“Improving awareness of tax diversification starts with simplifying key concepts and including them within broader financial wellness conversations so participants understand not just the ‘what,’ but also the ‘why’ behind saving across different types of accounts,” wrote Dina Caggiula, head of participant client experience at Vanguard, in an email to PLANADVISER.
Using different tax strategies can mitigate income uncertainties for retirees, such as future tax brackets and withdrawal costs.
“Tax diversification can help investors manage tax brackets, [required minimum distributions] and cash flow needs more efficiently,” says Ben Rizzuto, a wealth strategist at Janus Henderson.
Basics and Buckets
Advisers say many plan participants need to understand tax fundamentals, starting with the importance of participating in a workplace plan and the flexibility to either pay upfront or defer taxes on retirement contributions.
“If you’ve got a 401(k) plan, it’s a real tax advantage,” says Brant Wong, head of retirement solutions at Principal Asset Management. “Make sure that you’re using it to the full extent that you can.”
Wong notes that 22% of eligible employees did not know whether they could participate in a 401(k) plan, according to Principal’s eligible nonparticipating research. More than half of nonparticipating employees mistakenly believed they were already enrolled, and Wong says plan design features such as automatic enrollment and automatic escalation can help participants get started.
As participants figure out their contributions, one common analogy industry experts use to explain the differences is “buckets.”
Rizzuto says pre-tax, Roth and taxable accounts are separate buckets with their own tax treatment and purpose. Pre-tax contributions go into one bucket, in which money grows, but is taxed upon withdrawal. Roth contributions are taxed upfront, but can be withdrawn tax-free in retirement.
Using multiple buckets can give retirees more control over their income strategy. For example, RMDs from pre-tax accounts can increase taxable income later in life, but Roth assets can be tapped strategically to manage tax exposure.
“You can manage your tax brackets a little bit better if you have those different buckets of money,” Rizzuto says. “Having Roth assets in a down market can help meet cash flow needs, without having to sell pre-tax investments at a loss, and still generate taxable income.”
Similarly, Caggiula says imbalanced buckets can make it harder on participants once they retire.
“It’s common to see over-reliance on a single tax bucket, which can limit flexibility and create uncertainty, and even confusion, when participants transition into retirement,” she wrote.
Improving Awareness
Once participants are engaged, advisers can introduce tax diversification concepts through simple, decision-oriented framing.
“It’s a matter of [providing a] pretty simple, immediate explanation,” says Wong. “Questions like, ‘Do you think your taxes are going to go be up or down later in life? Do you think the overall tax rate is going to be up or down?’”
Advisers also need to tailor conversations based on both engagement level and demographics. Wong emphasizes that not every participant is ready for the same level of complexity.
“There’s a set of clients where just the basics are going to be so important,” Wong says. “Then you have more engaged participants who may benefit from understanding Roth options and, beyond that, more complex strategies for higher-net-worth individuals.”
Communication strategies are evolving alongside participant expectations. Younger investors, in particular, are more likely to encounter financial education through digital platforms, social media and even artificial intelligence tools before speaking with an adviser.
To meet participants where they are, experts say advisers can incorporate a mix of communication tools, including digital education platforms and calculators; personalized financial wellness tools; short-form, mobile-friendly content; and interactive planning tools that show how different accounts work together over time.
Caggiula says retirement savings calculators and account hierarchy frameworks are effective ways to show how 401(k)s, health savings accounts and individual retirement accounts fit into a broader tax-efficient strategy.
“Incorporating financial wellness tools into the planning process can help participants understand and act on their tax-advantaged savings hierarchy,” she wrote.
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