Are you prepared for the tax implications of your retirement savings?

When is a $1.47 million retirement fund not actually $1.47 million? It's not a trick question about unrealized gains-it's the reality of taxes. Baby boomers often stayed with one employer most of their career with encouragement to funnel their savings into a 40i (k) to achieve tax-deferred investment growth, a lower current taxable income, and to take advantage of high contribution limits. Unfortunately, many investors fail to remember that withdrawals are taxed as ordinary income. Further compounding the situation is the assumption that in retirement, your taxes will be lower because you're not earning an income. Many baby boomers also have pensions and Social Security, two leading sources of income that people tend to overlook and fail to consider how these will affect their tax rate. When all you have is tax-deferred savings, distributions are considered taxable income, and with a substantial adjusted gross income, your Social Security can be taxed up to 85 percent.

There is no doubt that a 40i (k) is one of the best savings vehicles for retirement; however, while a $1.47 million balance is every bit of $1.47 million for investment purposes, it is not $1.47 million once you enter the distribution phase. If you need to withdraw $1.30 for every $1 you want to spend because of taxes, your retirement funds will not last nearly as long as you thought.

Furthermore, by saving tax deferred in a 40i (k), you're also speculating about what tax rates might be in the future. It is probably safe to say that 20 to 30 years from now, taxes will most likely be higher. In the best case, tax rates will remain the same, but there is little chance they will decrease.

I generally recommend saving 60 percent to 70 percent of retirement income in tax-deferred savings but also highly recommend having after-tax savings. If all your savings are tax deferred, it is possible to start diversifying the tax status of your savings. Within your 40i (k) plan, you may be able to save or convert funds to a Roth 40i (k). Outside of your work retirement plan, I recommend saving after-tax money in a Roth IRA or taking advantage of a backdoor Roth IRA if your income exceeds the income limits or use a standard brokerage account.

When it comes to the spending phase, I generally recommend spending your after-tax brokerage account savings first, as the tax due on distributions should only be capital gains, which generally have some of the lowest tax rates. Next, I recommend using tax-deferred savings, such as your 40i (k), and lastly, any Roth IRA savings. The goal is to let your tax-free savings grow for as long as possible.

One of the advantages of having taxdiversified savings is the flexibility it provides. If you need to withdraw more for unexpected expenses, taking more from your 40i (k) will increase your taxable income and could push you into a higher tax bracket. With varied tax status savings, you can better control your long-term tax situation.