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By Jason Stipp and Christine Benz | 02-26-2014 04:00 PM

6 Ways to Curb Taxes in Retirement

Investors who build tax diversification, get savvy with RMDs, mind state taxes, and avoid the 'tax torpedo' can lighten their tax loads considerably in retirement, says Morningstar's Christine Benz.

Jason Stipp: I'm Jason Stipp for Morningstar.

It's Tax Relief Week on, and today we're talking about taxes in retirement. Joining us with a few tips is Morningstar's Christine Benz, our Director of Personal Finance.

Christine, thanks for being here.

Christine Benz: Jason, great to be here.

Stipp: Taxes, and a lot of other things actually, can change in retirement. You brought six tips to help reduce tax bills in retirement. The first one has to do with something you should start before retirement that can be a big help in retirement, and that's build tax diversification. What does that mean?

Benz: That simply means that you want to hold assets in different types of accounts that will receive different tax treatment upon withdrawal. Many people come into retirement with a lot of their nest eggs in traditional IRAs & 401(k)s. Unfortunately when it comes time to take that money out, all of that money is taxed at your ordinary income tax rate. What felt good going in, may not feel so good coming out.

I think for a lot of people it makes sense to have all three types of accounts represented in your portfolio when you come into retirement. That means Roth accounts, which will be tax-free up on withdrawal; the tax-deferred accounts (traditional IRAs and 401(k)s), which are pretty inevitable for most of us who are saving for retirement; and finally, some taxable accounts, where if you buy and hold securities you will be able to get ordinary capital gains treatment on those withdrawals.

Stipp: And how might an advisor help you figure out and when might you use these different accounts? What kind of situations are they valuable for you?

Benz: I've learned a lot about this from our users, who spend a lot of time strategizing about where they go for income on a year-to-year basis. And what they say is, really they can manage their tax brackets by pulling just enough from this account and that account to keep themselves in the lowest possible tax bracket.

I know that some of the tax-prep software will help you with this, but you can also use a tax advisor to give you some guidance if you are not familiar with this area on where to pull money for living expenses in order to manage your tax bracket.

Stipp: The key is of course, having those different pools available when you do reach retirement, so it is important to plan for that.

The second tip also involves the Roth account. Some folks in retirement might think, it's too late, I'm too old, and I shouldn't have a Roth account, but that's not necessarily true.

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