What is Asset Location?

Asset location is a tax-saving strategy that takes advantage of various investments receiving different tax treatments. To maximize after-tax returns, an investor uses this strategy to determine which securities must be held in tax-deferred accounts and which in other taxable accounts.

People can save and invest money in various types of accounts. These are divided into two categories: qualified and non-qualified accounts. Asset location is a tax-saving strategy that entails putting different investments in accounts with other tax treatments, such as tax-exempt, tax-deferred, and taxable accounts.

Although asset location provides lower taxes, it is not a substitute for asset allocation. It is the positioning of equities, funds, and other type of holdings in a portfolio across different sectors to cushion market downturns. You can place your investments in the most tax-efficient accounts only after you’ve determined the best asset mix for your portfolio.

The location of your investments—that is, the type of account you select—can significantly impact how much you can earn after taxes over time. various investments are subject to different tax rules, and different accounts are taxed differently. Sorting your investments into other accounts, known as asset location, can reduce your overall tax bill.

1.Who Gains from Asset Location 

Investors must have holdings in taxable and tax-deferred accounts to profit from this strategy. Typically, investors benefit most from asset location if they employ a balanced investment strategy that includes equity and fixed-income investments. All-fixed-income or all-equity investors can still profit, though not to the same extent.

A typical investor might have investments in both taxable accounts and tax-deferred accounts, with a balanced portfolio consisting about 60% stocks and 40% bonds. The overall portfolio of the investor should be balanced, but the asset mix in each account need not be the same. The tax benefits of properly placing securities in the type of account that will ensure the best after-tax return are ignored when the same asset allocation is created in each account.

2.Tax-Advantaged vs. Taxable Accounts

You can invest money in tax-deferred accounts without immediately paying taxes on the growth. Thus, traditional 401(k) plans, solo 401(k) plans, traditional IRAs, SEP and SIMPLE IRAs (which follow traditional IRA tax rules for withdrawals), and 403(b) plans are also included. You pay regular income tax on qualified withdrawals from each of these accounts. If you withdraw money from a tax-deferred account before age 59.5, there may be early withdrawal fees.

You can save money after taxes by using tax-free accounts. That means that, technically, you don’t escape taxation entirely since you’re contributing money you’ve already paid taxes on. But you don’t pay any additional income tax when you make qualified withdrawals. Examples are tax-free accounts, such as Roth IRAs, a Roth 403(b), Roth 401(k) plans.

A sound asset location strategy includes simultaneous investment in tax-advantaged and taxable accounts. Just be aware that you may be unable to manage all of these accounts at once.

3. Why Should You Use Asset Location? 

Why lose money to taxes if you don’t have to is the main justification for asset location. It helps to be wise about where you hold your assets to keep taxes on mutual funds as low as possible. One of the biggest obstacles to a fund’s performance as an investment can also be taxes on gains.

Asset location is essential for several reasons. For starters, it is part of developing a diverse portfolio. Diversification is a risk-management strategy that spreads your investment dollars across multiple assets. When you strategically place money in tax-advantaged and taxable accounts, you also contribute to the diversification formula.

Assume you’re concerned about having to withdraw from your retirement accounts too soon because of a downturn in your income. Having money in a taxable account, such as a brokerage account or even a taxable money market savings account, provides you with additional options for getting the cash you require without draining your 401(k) or IRA.

4. Asset Location Requirements 

  • You are currently subject to a high marginal income tax rate:

The higher your current marginal income tax rate, the greater the potential benefits of asset location. Remember that you may be in a higher marginal tax bracket as your income grows. As a result, if you are taxed at a higher marginal tax rate, the benefit of your additional income may be significantly reduced.

  • You are making a long-term investment:

Asset location strategies typically take time to implement. While small tax advantages may be realized year after year, sizable advantages may be realized by allowing potential tax advantages to compound. When implementing an asset location strategy in a taxable account, you possible incur initial tax costs, and the benefits may take time to outweigh the costs.

  • You anticipate paying a lower marginal tax rate in the future:

If you anticipate that your marginal income tax rate will be lower in the future, active asset location can allow you to not only defer but also reduce your taxes. 

On an important note, it is common for investors to get marginal income tax rate decrease after retirement, and if you have assets with a time horizon into retirement, this may be the case for you.

  • You have significant assets in taxable accounts in tax-inefficient investments:

The more tax-inefficient investments you currently hold in taxable accounts, such as taxable bonds and taxable bond funds (see chart below), the greater the potential to benefit from asset location.

The proper account in which to place investments for the most favorable overall tax treatment is determined by asset location. An investor’s financial profile, current tax laws, investment holding periods, and the underlying securities’ tax and return characteristics determine the best location for a particular security.


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