Asset allocation usually gets most of the attention when it comes to diversifying clients’ portfolios. That’s understandable because allocation drives long-term portfolio results. Adequate diversification can also make it easier for clients to stay the course when market volatility spikes, as it has lately.

Tax diversification is another important planning strategy, however. Investment accounts fall into one of three tax categories: taxable, tax-deferred and Roth. Excessively overweighting one category or failing to diversify among all three can limit clients’ tax-planning flexibility.

It’s essentially a hedging strategy, according to Maria Bruno, senior investment analyst with Vanguard in Malvern, Pennsylvania. Tax diversification takes the same approach as asset allocation in that you’re diversifying taxes in light of unknown future income levels and tax laws. “By having the different buckets it gives the retiree the most flexibility to strategically spend down their assets in a tax-efficient manner,” she explains.

Many current retirees have large tax-deferred balances, a concentration determined largely by tax laws, she points out. Roth accounts weren’t available until the late 1990s and Roth conversions were limited until 2010. Consequently, retirees can find themselves facing sizable required minimum distributions (RMDs) at age 70 1/2, which could potentially bump them into a higher tax bracket.

Since 2010 all taxpayers are eligible for Roth conversions. It’s not a free lunch, of course, and the taxpayer must pay applicable income taxes. But conversions aren’t an all-or-nothing proposition—the IRS allows partial conversions. That means clients can time their conversions and control the marginal tax rate on the converted funds.

This approach can work well in the years before the client starts collecting Social Security and subsequently RMDs, particularly if their tax bracket is lower in those years, says Bruno. Setting up a series of partial conversions during that period could be a good opportunity for clients who lack tax diversification to achieve that goal in a disciplined way.

Admittedly, accelerating income taxes seems to “fly in the face” of basic financial planning principles, Bruno admits, but the benefits are substantial. The converted funds benefit from tax-free growth, avoidance of lifetime RMDs and potentially reduced future tax liability because RMDs will be lower. “It’s a unique planning opportunity,” she says. “I think an advisor working with a client can really add a lot of value in terms of whether it makes sense but also the timing and how much to convert.”