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By Jason Stipp and Christine Benz | 02-25-2013 01:00 PM

Don't Make These Tax Mistakes

Inefficient contributions and withdrawals and poorly timed asset purchases are among the many common tax-related blunders, but Morningstar's Christine Benz offers solutions to avoid such pitfalls.

Jason Stipp: I am Jason Stipp for Morningstar. Although tax considerations shouldn't drive your investment portfolio, getting your tax plan right can certainly save you a lot of money come tax time. And as with anything, a good tax plan can be almost as much about what you don't do, the mistakes you avoid, as all those details you do get right. So here to help us avoid some common tax blunders is Morningstar's Christine Benz, our director of personal finance. Thanks for joining me, Christine.

Christine Benz: Jason, great to be here.

Stipp: The first mistake to avoid is thinking I am saving in my 401(k), I am maxing out that account, and I am doing everything I need to do for retirement, so I am not going to worry about the other sorts of accounts, just 401(K).

Benz: Well, you know, that might be the obvious decision to make, in part because you are able to put pretax contributions into your 401(k) and that helps lower your adjusted gross income. So that's gratifying when you are in accumulation mode, but this concept of tax diversification is a really important one that becomes only apparent when you are retired because if you do have a tax-diversified pool of assets meaning that you've got some traditional accounts like traditional IRAs and traditional 401(k)s, some Roth accounts and some taxable accounts, you are actually able to exert some control over where you go for income on a year-to-year basis.

If you have all your money saved in a traditional type account like a traditional IRA or 401(k), all that money will be taxed upon withdrawal. With the other categories, the Roth category as well as the taxable categories, the tax penalties or the taxes upon withdrawal are much less. And in fact in the case of Roths, there is no tax at all. So it's important to build that well-diversified pool when you're in accumulation mode.

Stipp: And Roths also have the benefit with required minimum distributions, you don't have to take them from a Roth whereas a traditional 401(k) or IRA, you will be required to take the money out. So there is some flexibility [with Roths], as well.

Benz: Exactly. So if you are able to not have to take those withdrawals, you can reduce your tax bill on a year-to-year basis, and obviously if you have taxable accounts, you don't have to take any withdrawals there if you don't want to either. So if you are someone who doesn't expect to need all of the assets from a particular account during retirement, you get a nice level of control.

Stipp: The other reason you may want to look outside of your 401(k) is that even maxing out a 401(k) might not be enough for you for retirement.

Benz: That's exactly right. So people often say, "Well, I am maxing out my 401(k). I am OK." Chances are if you are at a higher-income level, just putting the maximum into your 401(k) may not give you enough of the income that you'll need to replace during retirement. You may need to additionally make that Roth IRA contribution if you can; you may need to put money into taxable accounts, as well.

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