It’s easy to fixate on what types of investments you have in your portfolio. But what many people don’t focus on can be equally important – it is asset location. Asset location involves understanding where to hold your investments in tax-deferred, tax-free, or taxable accounts. These location decisions can have a significant impact on your financial well-being over more extended periods. This is particularly true when you and a McLean, VA CFP® professional are developing a tax-efficient distribution strategy for your retirement years.
In this article, we’ll look at:
● Comparing asset allocation and asset location
● Asset location strategy examples
● Social security considerations
Comparing Asset Allocation and Asset Location
Asset allocation is the process that determines how much of your assets are invested in different asset classes – for example, stocks, bonds, and cash equivalents. Asset location places your investments in the most tax-efficient accounts – for example, income-producing investments belong in tax-deferred or tax-free accounts.
Imagine you’re a chef preparing for a dinner service at your restaurant. Your “asset allocation” is like a menu — it’s a carefully chosen mix of dishes you plan to serve, each selected for its unique flavor and how it complements the other dishes.
Some dishes are hearty and filling (like the potential performance of stocks), providing protein for the meal, while others are lighter and add variety (like income producing bonds), and still others are unique garnishes that add a dash of excitement or a unique flavor (alternative investments).
Together, they create a balanced, diversified meal that meets your expectations.
Now, think of “asset location” as how best to use the different ovens, warmers, and refrigerators in your kitchen to optimize the quality of each dish. Asset location is the strategy of placing each dish (investment) in the right cooking environment (tax-advantaged or taxable accounts) to enhance the overall meal experience.
For example, putting the roast (growth-focused, tax-efficient stocks) in the slow cooker (Roth IRA) lets it cook over time and be served without additional taxes, as the earnings are tax-free upon withdrawal. Meanwhile, a salad (taxable bonds) might be best prepared fresh and close to service time (taxable brokerage account), understanding that some ingredients (interest payments) might be subject to tax.
Asset Location Strategy Examples
The strategic placement of assets can enhance your after-tax returns because the slower growth in your tax-deferred accounts translates to a smaller distribution tax obligation in the future, while your tax-free accounts have the potential to grow more significantly.
As CERTIFIED FINANCIAL PLANNER™ professionals in McLean, VA, we specialize in helping successful individuals create comprehensive, tax-efficient retirement plans that include asset location strategies.
Here are a few examples of how you could implement an asset location strategy for your investments:
1. One approach is to place more tax-efficient investments like low turnover index funds or ETFs in taxable accounts. These investments typically generate fewer taxable events to minimize your tax liability.
2. Another strategy involves placing tax-inefficient investments, such as bonds or actively managed funds, in tax-advantaged accounts like IRAs or 401(k)s. This shields the returns from current taxation.
3. For investments that anticipate higher returns, like small-cap value stocks or those from emerging markets, consider placing them in tax-free Roth accounts.
4. You would typically position investments with modest expected returns, like bonds, within tax-deferred accounts.
5. Implementing a strategy where you strategically sell investments that have incurred losses, also known as tax loss harvesting, can assist in offsetting gains in your taxable accounts. This can help reduce your overall tax liability.
6. If you are married, coordinate asset location between you and your spouse. This can maximize tax benefits by taking advantage of each spouse’s investment strategy, types of investments, and the locations of the assets.
7. Focus on holding investments for more than a year to benefit from lower long-term capital gains tax rates. Short-term gains are taxed higher, so reducing turnover rates in your portfolio can be advantageous.
Social Security Considerations
Another important component of your retirement planning efforts should be when to begin taking Social Security benefits (one or both spouses). Your timing and decisions can significantly impact your retirement income and asset location strategy.
We know there is more than a one-size-fits-all solution when deciding when to begin taking your Social Security benefits.
For instance, there is a significant incentive to delay taking Social Security benefits until age 70. Your benefit can increase by 8% each year you don’t start taking benefits.
Here’s how this decision ties into your asset location strategy:
- Your decision to delay or start taking Social Security benefits should align with your income needs in retirement. If you have accumulated enough assets to cover your living expenses and live comfortably until age 70 without relying on Social Security, it may make sense to delay benefits. This can maximize your future monthly benefit, providing a more substantial income stream later in life when you need it the most.
- Delaying Social Security can affect your taxable income in earlier retirement years. By drawing down other assets initially, you may reduce your taxable income, potentially placing you in a lower tax bracket. This strategic approach can lead to significant tax savings over time.
- Another critical factor in this decision is your health and life expectancy. If you expect to live a long and healthy life, delaying Social Security can be advantageous because it results in larger monthly benefits later in life. However, if health issues or other factors suggest a shorter life expectancy, consider starting benefits earlier to ensure you maximize the amount you receive.
How Brown|Miller Can Help You Create a Sustainable Asset Location Strategy
At the heart of our mission as a fiduciary financial advisory firm in McLean, VA, is to assist you in preparing for your retirement through comprehensive, holistic retirement planning.
Our decades of experience as financial advisors enable us to create an independent firm that provides high-touch customer service and comprehensive planning and investment solutions free from conflicts of interest. You’ll never be just a number to us.
“We are driven by the belief that we exist to help our clients pursue their most important financial goals.”
Our team of CERTIFIED FINANCIAL PLANNER™ professionals is committed to crafting retirement plans that enhance our clients’ lives and honor the legacy they wish to leave behind for their families and the causes they believe in.
We design retirement plans that are dynamic and adaptable, recognizing that your circumstances, concerns, goals, and tolerance for risk are all subject to change. A rigid plan that cannot accommodate change would not serve our clients’ best interests.
Our commitment to transparency is also unwavering. When you entrust Brown|Miller with your retirement plan and assets, we act as your dedicated guide, supporting you through every stage of your financial life.
We invite you to connect with us to learn how our asset location strategies can benefit you.
Disclaimer: This article is intended for informational purposes only, and not to be a client-specific suitability analysis or recommendation, an offer to participate in any investment, or a recommendation to buy, hold or sell securities. Do not use this report as the sole basis for investment decisions. Do not select an asset class or investment product based on performance alone. Consider all relevant information, including your existing portfolio, investment objectives, risk tolerance, liquidity needs, and investment time horizon. This report is for general informational purposes only and is not intended to predict or guarantee the future performance of any individual security, market sector, or the markets generally. The information provided in this article represents the opinions of Brown Miller Wealth Management (“BMWM”) and is expressed as of the date hereof and is subject to change. BMWM assumes no obligation to update or otherwise revise our opinions or this article. The observations and views expressed herein may be changed by BMWM at any time without notice. The information may be based on third-party information, which is deemed reliable, but its accuracy and completeness cannot be guaranteed.
BMWM provides links for your convenience to websites produced by other providers or industry related material. Accessing websites through links directs you away from our website. BMWM is not responsible for errors or omissions in the material on third-party websites and does not necessarily approve of or endorse the information provided. Users who gain access to third party websites may be subject to the copyright and other restrictions on use imposed by those providers and assume responsibility and risk from the use of those websites.