An In-Depth Look at the Tax Consequences of Asset Location
by Kevin Trout
Asset location refers to where an investment asset is held: in a tax-deferred retirement account (e.g., an IRA) or in a taxable account. By fine-tuning asset location, investors can improve their aftertax return on their overall investment portfolio.
Articles on asset location cannot definitively rank the type of investments to place in a tax-deferred account because such a ranking depends on changeable factors: return parameters that are constantly in flux in the economy; tax rates, which change with the political environment and investors’ income level; and investment holding periods, which are specific to the investor. This article summarizes the general information on asset location and gives investors access to a model that can help refine asset location decisions to take their own unique situation into account.
In this article
- Overview of Asset Location
- Tax Deferral: A Large Benefit of Investing in a Tax-Deferred Account
- The Model
- Effect of Tax Rate Increases
- Asset Location Dos and Don’ts
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Overview of Asset Location
Investors maintaining the same asset allocation in their taxable and tax-deferred retirement accounts are not receiving maximum benefit from their tax-deferred accounts. Investors should place the investments in the tax-deferred accounts that will provide the greatest benefit. The benefit of placing an investment in a tax-deferred account can be measured by the increase in the annualized aftertax rate of return.
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Discussion
This article is not very useful, as the Author unfortunately overlooks important details, as to the advantages/perils of other various investment types, being held in taxable, or tax defered accts, notwithstanding dividend/growth earnings!
IE MLPS, various Prefereds, C corps, royalty trusts, CEFS, options,CDS, etc
posted 16 days ago by Gerald Lanois from Florida
Useful up to a point but much remains unsaid. Needs to include Roth IRAs. This topic begs for a great graphic that communicates what many paragraphs of text are trying to do.
posted 10 days ago by Bob Edds from Ohio
These comparisons always make the same error in that they compare equal investment amounts. If I earn $10,000 and place it in my 401k I place all $10k in. If I earn $10k and invest it after taxes I haven't invested $10k, more like $7k after taxes. You have to take into account the taxes paid before the investment is made as well as the taxes afterwards.
posted 9 days ago by Carl Birx from New York
It would be helpful if the spreadsheet weren't protected. Not only is it protected by it also requires a password in order to remove the protection. How are you supposed to modify the tax rates to conform to your own situation?
posted 8 days ago by Dan from Connecticut
Dan - the spreadsheet is protected so users don't inadvertantly override the formulas. But as shown in the tab "How to use the model" the cells filled with a yellow background can still be changed. So you can enter your own tax rates in the yellow cells marked "tax rate input".
Hope that helps.
Kevin Trout
posted 8 days ago by Robert Trout from Iowa
Carl - If you notice in the spreadsheet the formula for the after tax rate of return includes a gross up for the tax deduction on the Traditional IRA/401k. So the model does indeed does take into consideration the deduction or exclusion of those investments vehicles.
Kevin Trout
posted 8 days ago by Robert Trout from Iowa
There are so many potential variables that it would be very difficult to address them all in an article of this length. I thought it did a good job as a general look. My one recommendation would be to change the title to A General Look at... vice An In-Depth Look at...
posted 7 days ago by David Bertholf from Florida
Like many retirees, I no longer work and will not have real wages in 2013. Will you please let me know the tax rates for withdrawals from IRA and dividends from stocks, assuming that my IRA withdrawal will be less than $150,000 and my dividends will total less than $80,000 for 2013. Thanks.
posted 5 days ago by Toan Nguyen from California
Hi Toan,
The 2013 tax rates can be found here:
http://www.aaii.com/journal/article/2012-tax-guide-update
You will pay ordinary income tax rates on your withdrawals and the reduced dividend tax rate on qualified dividends.
-Charles
AAII
posted 5 days ago by Charles Rotblut from Illinois
Bob,
A graphic can be found in this article: www.kitces.com/blog/archives/479-Asset-Location-The-New-Wealth-Management-Value-Add-For-Optimal-Portfolio-Design.html?utm_source=feedburner&utm_medium=email&utm_campaign=Feed%3A+KitcesNerdsEyeView+%28kitces.com+%7C+Nerd%27s+Eye+View%29&utm_content=Yahoo%21+Mail
Maud
posted 4 days ago by M. A. from Minnesota
