I have written often about the value of keeping one’s investment portfolio well-diversified across numerous investment asset classes. But diversifying your portfolio with respect to income taxes also can be a valuable way of maximizing the wealth you get to keep.

Most taxpayers have access to three types of investment accounts: those that are taxable annually, those that are tax-deferred until retirement and those that are tax-free over one’s lifetime (and even beyond).

At the same time, certain individual investments are more tax-efficient than others. For ex-ample, gains in individual stocks are not taxed until the shares are sold – and at a capital gains tax rate that, though currently in flux under the Biden tax plan, has been historically lower than ordi-nary income-tax rates, particularly for higher-income earners.

So, stocks and stock funds are quite tax-efficient. Bonds and other fixed-income investments generate taxable income regularly whenever interest is paid and therefore are less tax-efficient (except for certain types such as municipals). Taxes on a portion of the distributions from real estate investment trusts (REITs) are delayed until the shares are subsequently sold, making them even more tax-efficient. On the other hand, precious metals such as gold and silver are taxed at a higher capital gains rate than stocks and real estate when sold.

As if that’s not complex enough, a third consideration for minimizing lifetime income taxation involves future tax rates. Since the passage of the Tax Cuts and Jobs Act in 2018, federal income-tax rates are among the lowest they’ve been in decades. While that suggests a greater likelihood of increases rather than decreases, we have no clue as to what rates will become. So, don’t put too much weight on this factor.

Diversifying your portfolio

What’s the optimal way to tax-diversify your portfolio?

During your working years, start by diversifying your savings across all three account types. In your taxable accounts, maintain at least enough cash to cover taxes each year (which are most efficiently paid from these types of accounts rather than out of your retirement accounts). The perfect lifetime balance between tax-deferred and tax-free retirement accounts is impossible to achieve because of future rate uncertainty.

One approach is to increase contributions into tax-free accounts during lower-income years and into tax-deferred accounts during the opposite. After you retire but before age 72 when you are required to start taking minimum distributions from your tax-deferred accounts, building up your tax-free accounts via Roth conversions can be especially effective.

It also helps to focus on the investments in the accounts. Plan to locate (purchase) the more tax-efficient investments such as stock funds or REITs in less tax-efficient brokerage accounts and the less tax-efficient investments in tax-beneficial retirement accounts. But don’t go too far eliminating all fixed income from your taxable accounts – you will end up incurring the higher taxes associated with stock sales rather than bond sales whenever it’s time to do asset class rebalancing.

Recognize also that after retirement you will likely have to change your tax allocation strategy, as you will be withdrawing more from your portfolio than adding to it, which changes the model.

Optimizing tax diversification over time is one more technique you can add to your investment strategy to increase your lifetime savings. Always keep in mind, however, that asset-class diversification is more important than tax diversification. As the saying goes, “Never let the tax tail wag the investment dog.”

Los Altos resident Artie Green is a Certified Financial Planner and founder of Cognizant Wealth Advisors. For more information, visit cognizantwealth.com.