When people begin thinking about retirement — whether they’re a few years away or already retired — one of the first questions that usually comes up is:

“How much do I need to retire?”

While that’s certainly an important part of the conversation, another factor can play an equally meaningful role in shaping retirement income over time — how those savings may be taxed once retirement begins.

Many retirees and those approaching retirement have accumulated savings in several different types of accounts throughout their working years. Some savings may be held in employer retirement plans, others in personal investment accounts, and some in accounts designed to offer tax advantages later in life.

Because each of these accounts can be taxed differently, planners often describe retirement savings using a concept known as the three tax buckets.

Understanding how these buckets work can help bring more clarity to how retirement income may be structured and how different financial decisions can interact over time. For many pre-retirees, understanding these tax buckets before retirement begins can also help shape how they prepare for generating income later.

What Are the Three Tax Buckets in Retirement?

The three tax buckets refer to the different ways retirement savings may be taxed when money is withdrawn. Retirement assets are often grouped into three categories based on how distributions are typically treated for tax purposes.

These buckets generally include:

• Taxable accounts, such as brokerage accounts, where investment gains may be subject to capital gains taxes depending on how long the investment was held.

• Tax-deferred accounts, such as traditional IRAs or employer retirement plans like 401(k)s, where contributions may reduce taxable income during working years but withdrawals are generally taxed as ordinary income.

• Tax-free accounts, such as Roth IRAs or Roth 401(k)s, where qualified withdrawals may potentially be taken without federal income tax once certain conditions are met.

Understanding how these three tax buckets work can help illustrate how retirement income may be coordinated across different accounts over time.

A Simple Example of the Three Tax Buckets

To make this concept a little more tangible, imagine a couple approaching retirement who has built savings in several different places over the years:

• $700,000 in a traditional 401(k)
• $200,000 in a brokerage account
• $300,000 in a Roth IRA

All of these accounts contribute to their retirement savings, but they may be taxed very differently when income is withdrawn.

For example:

• Withdrawals from a traditional 401(k) are generally taxed as ordinary income.
• Withdrawals from a brokerage account may involve capital gains depending on how investments were held.
• Qualified withdrawals from a Roth IRA may potentially be taken without federal income tax.

If this couple needs $80,000 of income in retirement, where that income comes from could influence their overall tax situation. Taking the entire amount from the 401(k) may create a very different tax outcome than combining withdrawals from several accounts.

For instance, they might take:

• $50,000 from the 401(k)
• $20,000 from the brokerage account
• $10,000 from the Roth IRA

Looking at retirement savings through the lens of different tax buckets can help illustrate how retirement income might be coordinated over time rather than relying heavily on just one type of account.

The Three Tax Buckets

The idea behind the three tax buckets is fairly simple. Retirement assets are grouped into categories based on how withdrawals from those accounts are generally taxed.

Taxable Accounts

The first category is often referred to as the taxable bucket.

These accounts typically include brokerage accounts or investments held outside of retirement plans.

Because these assets are not held within a tax-deferred retirement account, certain investment gains or income may be subject to taxation depending on the type of investment and how funds are withdrawn. Many households build these accounts gradually over time through personal savings and investing.

Tax-Deferred Accounts

The second bucket includes tax-deferred accounts, which is where many people accumulate a significant portion of their retirement savings during their working years.

Accounts such as traditional IRAs and employer-sponsored 401(k) plans generally fall into this category.

Contributions to these accounts may have reduced taxable income when they were made, but withdrawals later in retirement are typically taxed as ordinary income. Because of the tax benefits during the accumulation phase, tax-deferred accounts often represent a meaningful portion of retirement assets for many households.

Tax-Free Accounts

The third category is often referred to as the tax-free bucket.

Accounts such as Roth IRAs or Roth 401(k)s may fall into this category, where qualified withdrawals can potentially be taken without federal income tax once certain conditions are met. For some retirees, these accounts can provide an additional layer of flexibility when coordinating retirement income.

A Common Retirement Planning Challenge

One challenge many retirees face is that a large portion of their savings may end up concentrated in just one tax bucket.

This often happens naturally over time. During working years, employer retirement plans such as 401(k)s can make it easy to contribute consistently while receiving potential tax deductions along the way. As a result, many households reach retirement with most of their savings sitting in tax-deferred accounts.

While these accounts can provide valuable tax benefits during the accumulation years, withdrawals later in retirement are generally taxed as ordinary income.

In some situations, relying heavily on tax-deferred withdrawals can increase taxable income in retirement, which may influence other aspects of retirement planning such as:

• How much of Social Security benefits become taxable
• Potential Medicare premium adjustments (IRMAA)
• Required minimum distributions (RMDs) later in retirement

This doesn’t mean tax-deferred savings are problematic — they can be a powerful tool for building retirement assets. But understanding how these accounts interact with other types of savings can help retirees think more clearly about how income may be structured over time.

Why Tax Diversification Matters

Because different types of accounts are taxed in different ways, many retirement planning conversations naturally turn toward the idea of tax diversification.

Tax diversification simply means having retirement savings spread across multiple tax buckets rather than concentrated in only one type of account. For example, imagine a retiree who needs $70,000 of income in a given year.

If that income comes entirely from a tax-deferred account like a traditional IRA, it could increase their taxable income enough that a larger portion of their Social Security benefits becomes taxable. In some situations, it could even affect Medicare premiums.

This is also where the timing of different income sources can play an important role.
For instance, when Social Security income begins — or if a pension is part of the picture — those income sources can further influence overall taxable income and how different accounts are used in a given year.

However, if part of that income comes from a Roth account, which may not count toward taxable income in the same way, the overall tax picture could look very different.

Having assets in different tax categories can sometimes provide additional flexibility when coordinating retirement income from year to year.

How Tax Buckets May Be Used in Retirement

Every household’s financial situation is different, but some retirement plans coordinate withdrawals across multiple tax buckets depending on the stage of retirement.

For instance:

• Early in retirement — before Social Security begins — some households may withdraw more heavily from tax-deferred accounts while income is lower.

• Later in retirement, when Social Security and required minimum distributions begin, they may rely more on taxable or Roth accounts to help manage their overall taxable income.

In some cases, retirees explore strategies such as Roth conversions to help rebalance their tax buckets over time depending on their long-term tax outlook. While every situation is unique, having savings across multiple tax buckets can provide more flexibility when coordinating retirement income throughout retirement.

Looking at Retirement Planning as a Whole

Of course, retirement planning involves much more than simply identifying which tax bucket an account falls into.

Income needs, Social Security timing decisions, healthcare considerations, tax laws, and long-term goals can all play a role in shaping a retirement strategy. These types of decisions are often connected, which is why many retirement plans look at multiple areas of planning together rather than focusing on just one piece.

Understanding how retirement savings are taxed can simply provide a helpful starting point for seeing how these different pieces may fit together.

Bringing Greater Clarity to Retirement Income

Every household approaches retirement from a unique financial position, and there is rarely a one-size-fits-all solution when it comes to retirement planning.

However, gaining a clearer understanding of how retirement assets are taxed can often help people feel more confident about how income may be generated throughout retirement.

For many retirees and those approaching retirement, the goal isn’t simply accumulating savings — it’s building a thoughtful plan designed to support stability, flexibility, and confidence throughout retirement.

At Richmond Brothers, our purpose is simple: to empower clients to live fearlessly into and beyond retirement. Conversations around retirement income, tax planning, investments, healthcare and long-term financial strategy are all part of helping families move toward that goal with greater clarity and confidence.

Frequently Asked Questions About Retirement Tax Buckets

What are the three tax buckets in retirement?

The three tax buckets refer to the different ways retirement savings may be taxed when money is withdrawn. These buckets typically include taxable accounts, tax-deferred accounts such as traditional IRAs or 401(k)s, and tax-free accounts such as Roth IRAs where qualified withdrawals may not be subject to federal income tax.

Why do tax buckets matter in retirement planning?

Tax buckets matter because withdrawals from different types of accounts can influence taxable income in retirement. This may affect areas such as Social Security taxation, Medicare premium adjustments, and required minimum distributions later in retirement.

Are most retirees concentrated in one tax bucket?

Many retirees accumulate a significant portion of their savings in tax-deferred accounts during their working years, particularly through employer-sponsored retirement plans. While these accounts provide tax benefits when contributions are made, withdrawals later in retirement are generally taxed as ordinary income.