How Everyday Taxpayers Can Benefit from Diversifying Their Tax Strategies

Investors face uncertainty daily, striving to achieve solid returns without taking on undue risk.

Diversification—spreading investments across a wide range of global stocks and bonds—remains the foundational strategy to mitigate risk. This approach has helped shield portfolios from extreme market fluctuations, such as those caused by trade tensions and tariffs in recent years.

This principle of diversification is equally applicable when managing your tax exposure.

Taxpayers confront two major uncertainties: unpredictable future income and unknown changes to tax laws over the coming years. The growing federal budget deficit, influenced by recent tax and spending policies, adds further unpredictability to tax planning.

Current congressional budget talks leave the future tax landscape unclear. While there seems to be little political will for immediate tax hikes, it would be premature to assume tax rates won’t rise eventually.

In fact, the bond market has reacted negatively to projections of mounting federal deficits embedded in recent tax proposals, signaling concerns over the government's fiscal sustainability.

Credit rating agencies have expressed worries about political gridlock threatening the nation’s financial stability, suggesting that significant tax increases may be necessary to address escalating debt costs.

Given these complexities, what strategies should taxpayers consider?

The answer lies in diversification—embracing a variety of accessible tax shelters designed not only for the ultra-wealthy but also for ordinary earners—to hedge against multiple potential tax scenarios.

Joel Dickson, head of tax planning at Vanguard, has long advocated for this approach. Although many investors are familiar with diversification in portfolios, diversifying tax exposure is a concept worth adopting.

"Taxes resemble investments in that both involve uncertainty about the future," Dickson explains. "By diversifying your tax strategy, you minimize the risk of being caught off guard by changes, rather than betting everything on one possible outcome."

While traditionally reserved for wealthy individuals and corporations with expert advisors, many tax planning options are available to those with modest incomes and savings.

Exploring Roth and Traditional Tax-Advantaged Accounts

Although no strategy guarantees complete protection, diversification typically reduces risk—just as diversified investment portfolios tend to perform better over time with less volatility.

Tax diversification involves maintaining a mix of tax-advantaged accounts to provide flexibility regardless of future tax law changes.

Dickson recommends examining both traditional and Roth versions of 401(k)s and IRAs. Traditional accounts defer taxes until withdrawal, ideal if your tax rate falls later. Roth accounts require taxes paid upfront, beneficial if you anticipate higher rates in retirement.

Generally, younger workers in lower tax brackets might favor Roth accounts, which can also serve as emergency funds, while those with higher current incomes may benefit from traditional tax deferral.

Since future tax environments are uncertain, allocating funds across both account types can offer a balanced approach.

Though Roth accounts provide tax-free withdrawals, they became widely available only after 1997, meaning many long-time workers have more assets in traditional accounts.

Legislation such as the Secure 2.0 Act of 2022 influences this balance. Starting in 2026, catch-up contributions for higher earners over 50 must be made to Roth accounts, altering traditional tax planning calculations.

Financial planners note this shift makes Roth options increasingly appealing, especially for retirees focused on estate planning, since inherited Roth accounts are exempt from certain tax withdrawal requirements.

Leveraging Alternative Tax-Advantaged Accounts

Other tax-advantaged savings vehicles, such as 529 education plans and high-deductible health savings accounts (HSAs), can also be part of a diversified tax strategy.

Though primarily intended for education and health expenses, these accounts offer flexible investment and tax benefits. For example, unused funds in a 529 plan may sometimes be transferred to a Roth IRA for the beneficiary.

HSAs allow contributions that reduce taxable income like traditional retirement accounts. Withdrawals used for qualified medical expenses are tax-free, and if you save receipts, you can reimburse yourself tax-free in retirement, making HSAs a potent tax shelter for those who can afford to pay current medical costs out-of-pocket.

Despite the potential complexity, diversifying tax strategies can provide valuable protection in uncertain times.

While no single tax plan can fully shield modest-income taxpayers from future changes, spreading assets across multiple tax-advantaged accounts offers a prudent way to manage risk.

In an era of fiscal unpredictability, diversifying tax approaches can position you more securely, regardless of what changes Congress enacts.