Asset Location Strategy

An Asset Location strategy refers to the practice of strategically placing different types of investments in specific types of accounts to maximize after-tax returns. It focuses on optimizing the allocation of assets across taxable and tax-advantaged accounts, such as individual retirement accounts (IRAs), 401(k)s, and taxable brokerage accounts.

The basic principle behind asset location is to consider the tax implications of different types of investments. Some investments generate more taxable income, such as interest payments from bonds or dividends from stocks, while others generate less taxable income, such as growth-oriented stocks that do not pay dividends. By placing high-income generating assets in tax-advantaged accounts and low-income generating assets in taxable accounts, investors aim to minimize the tax impact on their overall investment returns.

Another basic tenant of asset location is placing assets with the highest growth potential into account types that are completely tax-free (Roth or HSA accounts), or are likely to receive a step up in basis upon death (taxable accounts).

Conversely, assets with the lowest growth rates should be placed into accounts that are tax-deferred and have yet to be taxed. Limiting the growth of these accounts (to the extent your asset allocation requires) has the effect of reducing future RMDs, and lowering your overall tax liability.

A further rationale for asset location strategy is that tax-advantaged accounts, like IRAs and 401(k)s, offer tax benefits, such as tax-deferred growth or tax-free withdrawals in the case of Roth accounts. By sheltering high-income generating investments in these accounts, investors can postpone or potentially avoid paying taxes on that income until they withdraw funds from the accounts in retirement when their tax rate may be lower.

On the other hand, placing low-income generating investments, like stocks with growth potential, in taxable brokerage accounts can be advantageous. These investments typically generate less taxable income in the form of dividends, and if held for the long term, they may qualify for favorable capital gains tax rates when sold.

It's important to note that asset location strategy should align with your overall investment objectives, risk tolerance, and time horizon.