When it comes to building wealth, we often hear about the importance of choosing the right investments—stocks, bonds, mutual funds, etf's, etc. But what’s just as important (and often overlooked) is where you put those investments. This is where asset location comes into play.
If you’re looking to minimize your tax burden and maximize your returns, understanding asset location is essential. The goal is to place the right investments in the right accounts—whether that’s a taxable brokerage account, a 401(k), or a Roth IRA. Each account has different tax benefits, and leveraging these differences can significantly improve your long-term wealth-building strategy.
What Is Asset Location?
Simply put, asset location refers to the strategy of deciding which types of investments to place in which accounts based on tax advantages. Different types of investment accounts have different tax treatments, and strategically using them to your advantage can minimize taxes, grow your investments more efficiently, and keep more of your hard-earned money working for you.
For example, tax-deferred accounts like a pre-tax 401(k) let you postpone paying taxes on your contributions and earnings until you withdraw funds, while Roth IRAs and Roth 401k's allow for tax-free growth and withdrawals. On the other hand, taxable brokerage accounts require you to pay taxes on realized earnings each year. Understanding these differences and strategically placing your assets in the right accounts can be a game-changer for your portfolio.
Why Asset Location Matters
The right asset location strategy can help you minimize taxes, which is crucial because taxes are one of the largest expenses you’ll face over your lifetime. Different investments are taxed differently, and knowing how to allocate those assets properly can help you keep more of your gains. It’s like having a secret weapon for wealth-building that not everyone takes full advantage of.
Think about it—if you invest in a taxable account, the dividends or interest you receive are taxed in the year they’re earned. But if you place the right types of assets in the right accounts, you could avoid or delay those taxes, letting your investments grow more quickly.
The Best Place for Income-Generating Investments: Tax-Deferred Accounts
Let’s start with income-generating investments, like bonds or dividend-paying stocks. These investments often produce income that’s taxed each year—whether you want it to or not. This is where tax-deferred accounts like 401(k)s or traditional IRAs come in.
By placing these types of assets in a tax-deferred account, you can delay paying taxes on that income until you withdraw the funds—likely in retirement when you may be in a lower tax bracket. This lets your investments grow without being taxed annually, which can help your wealth grow at a faster rate.
Growth Stocks and Roth IRAs: A Match Made in Tax Heaven
Now, let’s talk about growth stocks—these are the types of investments that tend to appreciate over time, but don’t generate much income until they’re sold. For these kinds of investments, a Roth IRA is the perfect home.
Why? Because growth stocks don’t produce taxable income until you sell them. With a Roth IRA, you can let these investments grow without worrying about taxes, and as long as you follow the rules, when you withdraw the funds in retirement, they’ll be tax-free. This is a huge advantage, especially if you plan to hold those stocks for a long time, as the tax-free growth potential is massive over the years.
Balancing Asset Location for Maximum Efficiency
While some assets are better suited for tax-deferred accounts, others are better placed in taxable accounts. It’s all about finding the right balance.
Tax-Exempt Municipal Bonds: These types of bonds are often a good fit for taxable brokerage accounts because the interest they produce is already exempt from federal taxes.
Real Estate Investment Trusts (REITs): These generate income but also have the potential for growth, so placing them in tax-deferred accounts like a 401(k) can help you avoid paying taxes on that income each year.
International Stocks or Funds: These investments may come with foreign tax credits that can help offset some of the taxes on gains, making them a good fit for taxable accounts.
The key here is to diversify your assets and place them where they will be most tax-efficient, depending on the nature of the investment.
What to Keep in Taxable Brokerage Accounts
You’ll also want to consider your taxable brokerage account as a place for investments that won’t generate much taxable income. Growth-oriented stocks, index funds, or ETFs that appreciate over time are great candidates for a taxable account. Since they don’t pay out much in dividends or interest, you’re not hit with taxes on income every year.
These investments are also more likely to benefit from long-term capital gains tax rates when you sell them, which are usually lower than ordinary income tax rates. So, holding growth investments in your taxable account helps you maximize tax efficiency while still achieving long-term gains.
Using Taxable Accounts to Your Advantage: Tax-Loss Harvesting
One unique advantage of holding investments in taxable brokerage accounts is the ability to use tax-loss harvesting. If one of your investments loses value, you can sell it and offset the losses against your capital gains, potentially lowering your tax bill for that year. This is a strategy that can be especially valuable for those with a longer-term investment horizon.
Withdrawal Strategy: Minimizing Taxes in Retirement
Asset location doesn’t just apply to how you invest your money—it’s also important when it comes to withdrawals in retirement. If you’ve accumulated a variety of tax-advantaged accounts over the years, strategically choosing which accounts to withdraw from can help minimize your tax bill during retirement.
For instance, if you expect to be in a lower tax bracket in retirement, you might want to withdraw from your tax-deferred accounts first. If you have a Roth IRA, that’s often the best account to leave untouched for as long as possible, as withdrawals from a Roth are tax-free.
Key Considerations for Asset Location
Before you implement an asset location strategy, it’s important to keep these things in mind:
Contribution Limits: Many tax-advantaged accounts have annual contribution limits, so you’ll need to prioritize where to invest first based on your strategy.
Risk Profile: Some assets—like bonds—might be better suited for tax-deferred accounts, while growth stocks should go into Roth IRAs for maximum tax-free growth.
Investment Horizon: If you’re young and have a long time to let your investments grow, placing growth assets in a Roth IRA allows those assets to compound without tax interruptions.
Tax Bracket in Retirement: If you expect to be in a lower tax bracket in retirement, tax-deferred accounts may work well for you. If you anticipate being in a higher bracket, Roth accounts may be a better option.
Conclusion: Optimize Your Wealth-Building Strategy with Asset Location
Asset location is one of the most powerful wealth-building strategies you can use to minimize taxes and maximize the growth of your investments. By placing income-generating assets in tax-deferred accounts, growth stocks in Roth IRAs, and other investments in taxable accounts, you can set yourself up for long-term success and keep more of your money working for you.
If you're ready to take your asset location strategy to the next level or need help figuring out where to place your investments, let's chat. At WealthBound Advisors, we specialize in optimizing investment strategies to minimize taxes and maximize returns.
Disclaimer: This content is for informational purposes only. Consult with your tax advisor or financial planner before making any changes to your investment strategy.