Uncle Sam can take a solid bite out of retirees’ savings once they begin drawing down their hard-earned dollars, and UBS has a way to mitigate the tax bite. Investors may be familiar with portfolio diversification, in which they ensure they have sufficient exposure to an array of asset classes to avoid concentration risk. But there’s also the matter of tax diversification: That is, ensuring that you’re putting money away in accounts with different tax treatments so as to mitigate taxes when you start drawing down assets. These accounts can be taxable, tax-deferred (like your 401(k) plan or your traditional individual retirement account) or tax-free (like your Roth IRA, Roth 401(k) or health savings account). “The order in which you draw from your retirement accounts can significantly impact your after-tax wealth and the longevity of your retirement plan,” wrote Ainsley Carbone, total wealth strategist, chief investment officer Americas at UBS, in a June 25 report. The upside and downside of tax deferral Deferring taxes is a great idea in savers’ working years, but it can come back to bite retirees depending on how they draw down the money. Consider that withdrawals from tax-deferred accounts are levied as ordinary income, which can be subject to a federal marginal income tax rate as high as 37%. “Deferring taxes tends to create ‘tax torpedoes’ for later retirement years, forcing families into higher tax brackets and reducing after-tax growth potential,” Carbone wrote. There are also unintended consequences to pulling down this income. For instance, retirees’ whose modified adjusted gross income , or MAGI, exceeds $106,000 (or $212,000 for joint filers) are on the hook for steeper premiums on Medicare Part B and prescription drug coverage. The 2025 standard premium for individuals with a MAGI that’s less than or equal to $106,000 is $185 a month. But if you’re not careful about your withdrawals, you could inadvertently push yourself into a higher bracket. Consider that individuals with MAGI above $167,000 and up to $200,000 are on the hook for the standard Medicare Part B premium, plus $295.90. Another reason to watch your income sources in retirement: The prized tax-free interest income from your municipal bonds also counts toward the MAGI calculation. Managing the hit in retirement To help retirees navigate the spend-down process and mitigate taxes, UBS came up with a “spending waterfall” framework. For starters, retirees should have three spending buckets: A liquidity strategy that provides cash flow for three to five years of expenses, a longevity bucket that meets needs five years off and a legacy bucket for goals beyond the retirees’ lifetime. These retirees should compare their planned spending to their expected income. “Take the amount of cash you need to fill your Liquidity strategy and subtract the amount of your expected income,” wrote Carbone. The difference will reflect how much money the saver needs to raise from other sources, either by withdrawing from tax-deferred accounts or selling holdings in a taxable account. The next step involves coordinating with financial and tax advisors to estimate taxable income in the approaching retirement years, and draw up a target marginal income tax rate to help spread income, Carbone said. This can help retirees avoid inadvertently bumping themselves into higher tax brackets as they draw down assets. Once they have this plan, investors can work with their financial advisor or tax professional to determine which accounts they should tap – which will vary based on their spending needs. For instance, those who are spending below their targeted tax bracket might be fine to take a distribution from a tax-deferred account to “fill” their lower income tax brackets. Those with spending needs that exceed their goal tax bracket, however, might be better served taking a withdrawal from a Roth account, Carbone said. Investment plans and retirement drawdown strategies aren’t meant to be static, so retirees should work with their advisor to revisit and tweak the plan each year. “There are many moving parts in the spending waterfall framework, but remember: The goal is not to optimize every dollar, just to smooth your income and tax rates over time,” she said. —CNBC’s Michael Bloom contributed reporting.