Retirement planning can be overwhelming, but David McKnight’s “three buckets” framework simplifies it by categorizing retirement savings into three types: taxable, tax-deferred, and tax-free. Understanding these buckets helps retirees optimize their savings and reduce their tax burdens.

Taxable Bucket:
This includes assets like brokerage accounts, CDs, and money market funds. These investments are taxed annually, making them less tax-efficient. McKnight advises keeping only enough in this bucket to cover about six months of living expenses to avoid the “tax drag” on returns.

Tax-Deferred Bucket:
Accounts like 401(k)s and traditional IRAs fall into this category. Contributions are made pre-tax, and taxes are deferred until withdrawals begin in retirement. However, future tax rates are uncertain, and any distributions are taxed as ordinary income. This means that if tax rates rise, retirees could end up paying more in taxes than they saved during their working years (Congressional Budget Office).

Tax-Free Bucket:
This includes Roth IRAs, Roth 401(k)s, and Life Insurance Retirement Plans (LIRPs). These accounts are the most tax-efficient, offering tax-free growth and withdrawals. McKnight emphasizes the importance of maximizing savings in this bucket as a hedge against potential tax increases. Financial experts, including those at Vanguard, support diversifying savings across these three buckets to balance flexibility and tax efficiency.

Key Takeaway: Balance is key. Diversifying across these buckets, with an emphasis on growing your tax-free savings, provides flexibility and reduces your tax burden in retirement.

With a solid understanding of how to diversify your savings, it’s time to focus on the ultimate goal: tax-free income in retirement. In our next post, we’ll explore McKnight’s strategies for building a tax-free future—think Roth conversions, life insurance plans, and more—to help secure a 0% tax bracket in retirement. Zero taxes, zero worries!