Retirement investments are usually divided into "taxable" and "tax deferred" buckets.

The typical recommendation is to "max out" your tax deferred contributions before making taxable investments. Most investors are aware of the benefits of diversification in their quest to improve returns while reducing risk. Few have considered diversifying their post retirement investments on a tax basis to reduce potential tax hits after retirement. Previously there were few opportunities to diversify investments based on tax impacts - now there are new options.

Let's face it; you will pay tax on your income at some point in time. When it comes to long term investing, the common wisdom is to delay paying tax as long as possible. This is based on the assumption that 1) the value of a dollar in the future will be lower due to the effects of inflation, 2) you may be in a lower tax bracket in retirement and 3) tax rates in the future are similar to current rates. Let's look at each of these; first, if inflation averages 4%, $1.00 of tax delayed one year will be only $.96. So delaying taxes makes sense if all else is equal. But is it?

The second assumption is you may be in a lower tax bracket upon retirement and income needs will be significantly reduced. Many retirees find that their required income is not reduced, especially in the earlier years of retirement. Even if the initial required income is 80% of pre retirement, it will only take six years before the pre retirement income is needed to overcome the effect of inflation. The tax brackets have been compressed so it is likely that many retirees will be in the same bracket as they were before retirement.

Finally, while few would admit that income tax rates are too low, on a historical basis they are lower now than most times in history. Most likely the government will be forced to increase tax rates in the future to keep functioning.

So what does this mean relative to your retirement investments? Similar to diversifying your investments to optimize returns, diversifying on a tax basis may reduce your risk when you distribute income in the future. I label this bucket "Roth" to describe investments that are taxed when deposited but have tax free withdrawals. Having, "taxable", "tax deferred" and "Roth" buckets allows greater flexibility to deal with tax changes in the future.

With recent changes in legislation that allow conversion of Traditional IRAs to Roth IRAs by all and the addition of Roth 401k plans, I recommend that you consider what these new options could do for you. Choosing the right mix of plans for you is based on your situation and goals. A good place to start is by reviewing your retirement plans (when and type of lifestyle), savings, current income and tax situation.