Asset Location: What Is It, How Does It Work, and Why Does It Matter?

According to a recent report from Lincoln Financial, 62% of retirees wish they had planned differently for retirement. One of the top regrets among retirees is failing to account for the impact of taxes on their savings.

Whether you’re planning a traditional retirement or simply want the freedom to live and work on your terms, proactively managing your tax liability is essential for a financially secure future. By strategically allocating your assets among taxable, tax-deferred, and tax-exempt accounts—an approach called “asset location”—you can mitigate your tax burden and enhance the growth potential of your investments.

Asset location is a crucial concept for anyone seeking to make the most of their investment dollars and build lasting wealth. In this article, we’ll explore how asset location works and why it matters for long-term financial success.

How Does Asset Location Work?

Asset location is an investment strategy that focuses on optimizing the placement of assets across different types of investment accounts, seeking to minimize tax liabilities and maximize after-tax returns. This strategy involves allocating investments based on their tax treatment, considering the unique tax characteristics of various account types.

There are three main types of investment accounts to consider when implementing an asset location strategy:

• Taxable Accounts (e.g., Brokerage Accounts). In a taxable account, investment income, such as dividends and capital gains, is subject to taxation in the year it’s earned. These accounts offer the most flexibility and are generally best suited for tax-efficient investments like stocks and ETFs that generate low levels of taxable income and can benefit from lower long-term capital gains rates.
• Tax-Deferred Accounts (e.g., Traditional IRAs and 401(k)s). Contributions to these accounts are made with pre-tax dollars, and investment growth isn’t subject to taxes until withdrawals begin in retirement (at which point they’re taxed as ordinary income). Tax-deferred accounts are often ideal for assets that generate high levels of taxable income, such as bonds, REITs, and actively managed mutual funds. By deferring taxes until retirement, investors may be in a lower tax bracket when they withdraw funds.
• Tax-Exempt Accounts (e.g., Roth IRAs and 401(k)s). Contributions to these accounts are made with after-tax dollars, but investment growth and qualified withdrawals are tax-free. These accounts tend to be an excellent choice for assets with the highest long-term growth potential, such as individual stocks and growth funds. By avoiding taxes on investment gains and withdrawals, investors can maximize their return potential over the long run.

By understanding the unique tax treatment of each account type and strategically placing assets accordingly, you can potentially enhance your after-tax returns and keep more of your hard-earned money working for you over time.

Why Does Asset Location Matter?

Effective asset location can significantly impact your long-term investment success and financial well-being. By optimizing the placement of assets across different account types, you can minimize your tax liabilities, maximize after-tax returns, and potentially enhance your wealth accumulation over time.

#1: Tax Efficiency

First, strategic asset location can help minimize the impact of taxes on your investment returns. For example, placing tax-inefficient assets like bonds and REITs in tax-deferred accounts can help defer taxes until retirement, when you may be in a lower tax bracket.

Conversely, placing tax-efficient investments like stocks and ETFs in taxable accounts can help you take advantage of lower long-term capital gains rates. Over time, these tax savings can compound, potentially leading to significantly higher after-tax returns and faster wealth accumulation.

#2: Retirement Income Planning

Asset location strategies can also play a crucial role in optimizing your retirement income. By strategically drawing from different account types in retirement, you can potentially minimize your tax liabilities and stretch your retirement savings further.

For instance, drawing from tax-deferred accounts in years when your income is lower can help keep you in a lower tax bracket. Meanwhile, drawing from tax-exempt accounts in years when your income is higher can help you avoid paying taxes on those withdrawals altogether.

#3: Estate Planning

Finally, asset location can have important implications for estate planning. By properly allocating assets across different account types, you can potentially minimize estate taxes and maximize the wealth you pass on to your heirs.

For example, placing assets with a high potential for appreciation in tax-exempt accounts can help avoid estate taxes on those assets altogether. Similarly, placing assets with a lower potential for appreciation in taxable accounts can help minimize the overall value of your taxable estate.

Implementing an Asset Location Strategy

Implementing an effective asset location strategy involves careful planning and ongoing management. Here are some key steps to consider:

#1: Assess Your Current Financial Situation and Future Goals

Before implementing an asset location strategy, it’s essential to have a clear understanding of your current financial situation and long-term goals. This includes evaluating your current asset allocation, risk tolerance, and investment time horizon.

You should also consider factors such as your current tax bracket, expected future income, and retirement aspirations. By clearly defining your financial objectives and constraints, you can create a more targeted and effective asset location plan.

#2: Work With an Experienced Professional

Given the complexity of tax laws and the various factors to consider when implementing an asset location strategy, it’s often beneficial to work with an experienced financial advisor like SageMint Wealth. We can help you assess your unique financial situation, develop a personalized asset location plan, and provide ongoing guidance and support. Our team can also help you navigate the ever-changing tax landscape and adjust your strategy accordingly with the goal of optimizing your results over time.

#3: Regularly Review and Rebalance Your Portfolio

Once you’ve implemented your asset location strategy, it’s important to regularly review and rebalance* your portfolio to ensure it stays aligned with your goals and asset allocation targets. Over time, market fluctuations can cause your portfolio to drift from these targets, potentially impacting your risk exposure and tax efficiency. By periodically rebalancing your holdings across different account types, you can help maintain your intended asset location strategy and optimize your long-term results.

*Rebalancing a portfolio may cause investors to incur tax liabilities and/or transaction costs and does not assure a profit or protect against a loss.

Let SageMint Wealth Help You Develop a Personalized Asset Location Strategy

Implementing an effective asset location strategy is an ongoing process that requires careful planning, regular monitoring, and a willingness to adapt as your financial situation and the tax environment evolve. By staying proactive and working with a trusted financial professional, you can potentially minimize your tax liabilities, maximize your after-tax returns, and enhance your long-term financial success.

SageMint Wealth is a wealth management firm for high-net-worth individuals, families, and business owners that is committed to growing wealth and investing in a better world. Contact us today to create a personalized asset location plan that aligns with your unique financial situation and goals.

Asset allocation does not ensure a profit or protect against a loss.