When you visualize retirement, you may think about relaxing on a beach, traveling to far-flung destinations or dedicating yourself to a passion project.

No matter how you picture it, living in retirement will be different than working toward it. You’ll transition from the decades you spent building wealth, to converting it into a reliable income stream that will sustain the rest of your life.

Taxes are an important piece of the retirement-planning puzzle. Unlike your working years where your employer withheld and pre-paid your taxes, in retirement you have to fund your full tax bill. Understanding how your income will be taxed once you are in retirement is a crucial first step.

Strategies to diversify your income sources prior to retirement have the potential to lower your overall lifetime tax bill and protect your wealth for future generations.

Asset location matters

In real estate, it’s all about “location, location, location.” That mantra applies just as much to your retirement funds.

“At least 10 years before retirement, you should think about how you’re positioning all your accounts and what your tax liability will be,” says Angie O’Leary, head of Wealth Planning at RBC Wealth Management–U.S.

Identify all your sources of income and assets that will be used to fund your expenses in retirement. Having a mix of accounts with different tax treatments—a strategy called asset location—allows for greater flexibility when managing your taxes in retirement and may even lower your overall tax bill.

“People sometimes focus on their 401(k) and individual retirement account (IRA), but they also need to include other funding sources, such as taxable investment accounts, Social Security, annuities, pension and rental income,” she says.

Understanding the differences between taxable, tax-deferred, and tax-free accounts is key. Many soon-to-be retirees save for their retirement in tax-deferred accounts such as IRAs, 401(k)s and 403(b)s because they are funded with pretax income and reduce their current tax bill. But distributions from those accounts will be treated—and taxed—as ordinary income. When you tap your taxable investment accounts, you pay the capital gains tax rate on your gains, which can be offset by realized losses.

Tax-free accounts, such as Roth 401(k)s and Roth IRAs, are funded with after-tax dollars. You pay taxes when you contribute, but your investment will benefit from years of tax-free compounded growth, and withdrawals in retirement are also free from taxes as long as the money has been in the Roth for five years and you are at least 59 ½ years old.

Health Savings Accounts (HSAs) are triple tax-protected. You contribute to your account with pretax dollars, the funds grow tax deferred and your withdrawals are tax free if used for health care-related expenses.

“Those tax-deferred accounts have the potential to incur significant tax bills,” O’Leary says. “If your company has a Roth option, it’s wise to save as much money as possible that way, especially if you are in a relatively low tax bracket.”

Planning for tax payments

You might expect to fall into a lower tax bracket when you’re no longer working, but the amount of money you withdraw—and from where—can have a big impact on your tax bracket and bills.

In general, it’s wise to withdraw from your taxable accounts first, then tax-deferred, then tax-free. However, earlier in retirement when your income is lower, it might make sense to tap your tax-deferred accounts. A strategy called “tax bracket topping off” can help determine how to access tax-deferred funds and take advantage of the lower tax bracket, especially prior to when required minimum distributions (RMDs) kick in and you’ll have additional taxable income and less flexibility.

“It’s important to keep track of your taxes and plan ahead to pay them,” O’Leary says. “People with significant income may need to pay estimated taxes on a quarterly basis. Having taxes withheld from distributions can help you avoid a big tax bill in April.”

The great tax sunset—are you ready?

Many of the benefits of the Tax Cuts and Jobs Act (TCJA) of 2017, which reduced taxes for many individuals and families and raised the income threshold for various tax brackets, are set to expire at the end of 2025.

In 2026, tax brackets will revert back to pre-TCJA level. For example, the top individual income tax bracket will go back up to 39.6 percent from the current rate of 37 percent.

“Both pre-retirees and retirees need to plan for the possibility of being in a higher tax bracket in two years,” O’Leary says.

A Roth conversion or partial conversion can work well early in retirement, when income is lower than it will be when you have to start taking RMDs.

“You may want to convert those assets gradually over a few years to spread out the taxes you’ll pay,” says Bill Ringham, director of Private Wealth Strategies at RBC Wealth Management–U.S.

Along with other tax cuts, the TCJA provided eight years of estate tax relief through an elevated exemption that is now $13.61 million per individual but will be reset to about $7 million in 2026 as adjusted by inflation.

The decedent’s estate will pay a 40 percent estate tax on any assets above the exemption level, and Ringham says high-net-worth individuals should plan ahead for this change. For example, the estate tax on a decedent’s $13.61-million estate transferred to their heirs this year would be $0. Ringham estimates the tax bill for a similar inheritance in 2026 would be about $2.65 million, and this does not include any potential state estate tax.

“The tax impact of an IRA, if it is one of your largest assets and is part of your taxable estate, could be worse, as your kids would get 40 percent less out of the amount that exceeds the estate tax exemption and then have to pay income taxes on their distributions,” Ringham says. “Inheriting a Roth IRA instead would allow them to take out the income tax free.”

An estate planning attorney can help you develop strategies to mitigate the tax burden on your heirs, but planning for income in retirement is a balancing act. Assessing the need for income against investment risk, taxes and longevity is a dynamic process, and it’s wise to revisit your income plan on an annual basis with a financial advisor.