{"id":76902,"date":"2011-04-06T04:00:01","date_gmt":"2011-04-06T11:00:01","guid":{"rendered":"http:\/\/getrichslowly.org\/blog\/?p=76902"},"modified":"2023-12-06T11:04:04","modified_gmt":"2023-12-06T18:04:04","slug":"all-about-asset-location-how-to-make-the-most-of-your-accounts","status":"publish","type":"post","link":"https:\/\/www.getrichslowly.org\/all-about-asset-location-how-to-make-the-most-of-your-accounts\/","title":{"rendered":"All about asset location: How to make the most of your accounts"},"content":{"rendered":"
When Robert submitted this, he advised, “File this under the ‘long and tedious but important’ category. It might need pictures of cats.”<\/b> So, once again, J.D. has obliged with photos of one of his cats.<\/em><\/p>\n Want to have more money and pay less in taxes? It’s easy! Just call this number and send in your three easy payments of \u2014 no, wait. Actually, all you have to do is learn a little about asset location. No, not asset allocation<\/a> \u2014 asset location<\/i>: deciding which assets should go in which accounts. A recent surge of Roth assets, thanks to the increasing availability of the Roth 401(k) and the wave of conversions that occurred last year, makes this a particularly timely topic.<\/p>\n To understand asset location, you need to remember that most investors have accounts that receive different tax treatment<\/b>, such as the following:<\/p>\n Studies have shown that making the right choices about which investments belong in which accounts can increase an investor’s after-tax wealth by 15% to 20%<\/b> over a lifetime. So what are those \u201cright choices\u201d? They can be summed up by five basic rules.<\/p>\n If you hold bonds and CDs<\/a> outside of a traditional IRA or 401(k), the interest is fully taxable at ordinary income rates. You essentially hand over a good portion of the return each year to Uncle Sam and Sister State, leaving less to grow through the years.<\/p>\n Some bonds have their own built-in tax advantages. Treasuries are exempt from state and local taxes, and municipal bonds can be exempt from all taxes \u2014 federal, state, and local. If you place muni bonds in a traditional IRA, however, you lose the tax advantages.<\/p>\n Unless you live in a state with high taxes, it likely still makes sense for you to hold your Treasuries in your tax-deferred account, especially if you’re years away from retirement. However, it rarely makes sense to buy municipal bonds in your tax-advantaged retirement accounts. The only exception is if you’re buying bonds that are trading below par value (the price at which they were originally issued) and you expect the price to rise, leading to a capital gain. While the interest from government-issued bonds might have tax benefits, a capital gain \u2014 for example, the $100 profit you made if you bought the bond at $850 and sold it later for $950 \u2014 is fully taxable if held outside of an IRA or 401(k).<\/p>\n Let’s say two investors put $50,000 in the exact same stock and hold it for a decade. The stock doesn’t pay a dividend and earns an average of 8% annually. Investor A holds the stock in his traditional IRA, and Investor B holds it in her taxable brokerage account. A decade later, here’s the value of each account and the taxes each investor has paid through the years (at this point, they haven’t sold the stock yet):<\/p>\n Surprise! The values of the investments and the taxes paid (i.e.<\/i>, none) are exactly the same, even though Investor B held the stock in a \u201ctaxable\u201d account. That’s because when you buy and hold stocks, especially ones that pay little to no dividends, you have built-in<\/i> tax deferral.<\/p>\n But what happens when these investors sell their stocks to spend the proceeds in retirement? Assuming they’re both in the 25% tax bracket<\/a>, Investor A will have to pay a 25% tax rate on everything he withdraws from the IRA, whereas Investor B will pay just a 15% long-term capital gains rate \u2014 and only on the profit. If they each liquidated the investment and withdrew the cash from the accounts:<\/p>\n As if more after-tax wealth weren’t enough, there are other benefits to holding equities in your taxable account:<\/p>\n While all these benefits sound good, the tax efficiency of holding equities in a taxable account relies on your buying and holding for years and keeping dividends to a minimum. What do you do for high-yielding stocks or those you trade more frequently? Read on!<\/p>\n When it comes to deciding what to put in this tax-free account, keep two principles in mind:<\/p>\n Given those two principles, the ideal investments for your Roth are those that have the greatest return potential, especially if they’re tax-inefficient. Historically, small-cap value stocks have posted the highest returns, and because of their generally higher turnover and higher dividends, the mutual funds that invest in that sector are among the most tax-inefficient \u2014 so these would be good candidates for a Roth. You could also use the account for any other active-trading strategies or real estate investment trusts, which pay a high yield but have dividends that aren’t eligible for the lower qualified-dividend tax rate.<\/p>\n Also note that Roth assets are the best kind for your heirs to inherit, since they’ll also enjoy tax-free growth. If leaving a legacy is important to you, then the Roth has an investment time horizon that extends beyond your lifetime; thus, it can theoretically hold riskier assets.<\/p>\n Once you retire, if you plan to invest in high-yield stocks for the income, it makes sense to hold them outside of a tax-deferred account to take advantage of the lower tax rate on qualified dividends. It’s less important where you hold the bonds that produce interest you plan on spending, since that interest will be taxed as ordinary income no matter what (muni bonds excepted).<\/p>\n Smart asset location also means you’ll pay fewer taxes. The higher your taxable income, the less likely you are to qualify for certain tax breaks. Also, once you begin receiving Social Security, the more you earn, the more likely your benefits will be taxed, and the more likely you’ll pay higher Medicare premiums.<\/p>\n So while paying attention to your asset location won’t double your portfolio overnight, it will pay off for decades to come \u2014 perhaps even after you’ve headed off to the Antiques Roadshow<\/i> beyond the pearly gates.<\/p>\n Here’s a quick summary of which investments to keep in which accounts:<\/p>\n Note:<\/b><\/i> This article uses current federal tax rates, which will continue through 2012. Tax law will certainly be different a few years from now, but I think it’s a good bet that some current principles \u2014 such as long-term capital gains rates will be lower than ordinary income rates, and that municipal bonds will have tax advantages \u2014 will continue.<\/p>\n<\/div>\n","protected":false},"excerpt":{"rendered":" When Robert submitted this, he advised, “File this under the ‘long and tedious but important’ category. It might need pictures of cats.”<\/b> So, once again, J.D. has obliged with photos of one of his cats.<\/em><\/p>\n Want to have more money and pay less in taxes? It’s easy! Just call this number and send in your three easy payments of \u2014 no, wait. Actually, all you have to do is learn a little about asset location. No, not asset allocation<\/a> \u2014 asset location<\/i>: deciding which assets should go in which accounts. A recent surge of Roth assets, thanks to the increasing availability of the Roth 401(k) and the wave of conversions that occurred last year, makes this a particularly timely topic.<\/p>\n To understand asset location, you need to remember that most investors have accounts that receive different tax treatment<\/b>, such as the following:<\/p>\n","protected":false},"author":1422,"featured_media":0,"comment_status":"open","ping_status":"closed","sticky":false,"template":"","format":"standard","meta":[],"categories":[492,496,493],"acf":[],"_links":{"self":[{"href":"https:\/\/www.getrichslowly.org\/wp-json\/wp\/v2\/posts\/76902"}],"collection":[{"href":"https:\/\/www.getrichslowly.org\/wp-json\/wp\/v2\/posts"}],"about":[{"href":"https:\/\/www.getrichslowly.org\/wp-json\/wp\/v2\/types\/post"}],"author":[{"embeddable":true,"href":"https:\/\/www.getrichslowly.org\/wp-json\/wp\/v2\/users\/1422"}],"replies":[{"embeddable":true,"href":"https:\/\/www.getrichslowly.org\/wp-json\/wp\/v2\/comments?post=76902"}],"version-history":[{"count":0,"href":"https:\/\/www.getrichslowly.org\/wp-json\/wp\/v2\/posts\/76902\/revisions"}],"wp:attachment":[{"href":"https:\/\/www.getrichslowly.org\/wp-json\/wp\/v2\/media?parent=76902"}],"wp:term":[{"taxonomy":"category","embeddable":true,"href":"https:\/\/www.getrichslowly.org\/wp-json\/wp\/v2\/categories?post=76902"}],"curies":[{"name":"wp","href":"https:\/\/api.w.org\/{rel}","templated":true}]}}
\nWait! Don’t leave! Though a little tedious, this is an important subject.<\/i><\/div>\n\n
<\/span>Rule #1: Keep Taxable Bonds and Certificates of Deposit in Tax-Deferred Accounts<\/span><\/h2>\n
<\/span>Rule #2: Consider Keeping Bonds With Tax Advantages in Taxable Accounts<\/span><\/h2>\n
\nHold off the tax man by putting the right investments in the right accounts.<\/i><\/div>\n<\/span>Rule #3: In Taxable Accounts, Favor Stocks With Little to No Dividends and Those You’ll Hold for Many Years<\/span><\/h2>\n
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\nChoosing the right accounts lets you keep more of your money.<\/i><\/div>\n<\/span>Rule #4: For Your Roth, Choose High-Growth, Tax-Inefficient Investments<\/span><\/h2>\n
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<\/span>Rule #5: Retirement Changes Asset Location a Bit<\/span><\/h2>\n
\nWhen you’re ready to retire, you may want to mix things up a bit.<\/i><\/div>\n<\/span>Remember: It’s Not What You Make, It’s What You Keep<\/span><\/h2>\n
<\/span>Asset Location at a Glance<\/span><\/h2>\n
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\nWait! Don’t leave! Though a little tedious, this is an important subject.<\/i><\/div>\n