Asset Location Strategy: How to Maximize Wealth in Retirement
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Asset Location Strategy: How to Maximize Wealth in Retirement

Writer's picture: Matt Brennan, CFP®Matt Brennan, CFP®

Asset location strategy: how to maximize wealth in retirement

Picture this: you've spent years diligently saving for retirement, carefully choosing investments, and watching your nest egg grow.


But what if I told you there's a way to potentially make your money work even harder for you, simply by being strategic about where you keep different types of investments?


Welcome to the world of asset location strategy - your secret weapon for smarter retirement planning!


While most investors are familiar with asset allocation (spreading investments across various asset classes), asset location strategy often flies under the radar. This powerful approach involves strategically placing investments across different account types to optimize tax efficiency and potentially boost your after-tax returns.


Think of it as organizing your financial house in a way that keeps Uncle Sam's hands out of your pockets as much as legally possible!


Key Takeaways:


  • Asset location strategy aligns investments with the most tax-advantageous account types

  • Strategic placement can significantly reduce your tax burden and enhance long-term returns

  • Different account types serve distinct purposes in your tax optimization strategy

  • Regular review and rebalancing ensure your strategy remains effective as tax laws and circumstances change

  • Proper implementation can lead to meaningful increases in after-tax wealth over time


💡 Pro Tip: Checklists can help ensure you don't miss costly mistakes with your investment portfolio and tax strategy. Download our free cheat sheet: What Issues Should I Consider When Reviewing My Investments?


Table of Contents:



The Dynamic Duo: Asset Location vs. Asset Allocation


Let’s start by clearing up a common source of confusion. Think of asset allocation as choosing the right ingredients for your retirement recipe—it’s about managing risk by diversifying across stocks, bonds, and other investments based on your goals and risk tolerance.



Key differences between asset allocation vs asset location


Asset location, meanwhile, is like deciding which cabinet to store each ingredient in to maintain maximum freshness and minimize waste (taxes, in this case).


While allocation focuses on risk management, location zeros in on tax efficiency by considering the tax characteristics of different investments. It’s like having a well-organized kitchen where everything has its perfect place.


Together, they create a more robust retirement strategy than either could achieve alone. The magic happens when these strategies work in harmony!


Potential Benefits of Asset Location Strategy


Let's break down all the potential juicy benefits of a smart asset location strategy!



Here's what you can look forward to when you organize your investments in the most tax-savvy way:


  • Immediate Tax Savings: Simply put, you'll likely pay less in taxes each year by keeping investments in their most tax-efficient homes. It's like getting a bonus just for being organized! Tax-inefficient investments (like bonds) go in tax-sheltered accounts, while tax-efficient investments (like index funds) go in taxable accounts.

  • Supercharged Long-term Growth: When you save on taxes, that money stays invested and compounds over time. Even small tax savings today can grow into impressive sums over decades. Think of it as giving your investments a little extra fertilizer to help them grow bigger!

  • Flexible Retirement Income Planning: Having different account types (tax-deferred, tax-free, and taxable) gives you amazing control over your retirement income. Need to keep your tax bracket in check? You can pick and choose which accounts to tap based on your tax situation each year. It's like having different piggy banks for different needs!

  • Enhanced Estate Planning Benefits: Your heirs will love you for this one! Different accounts get different tax treatment when inherited:

    • Roth accounts pass tax-free to heirs

    • Taxable accounts get a step-up in basis (bye-bye capital gains!)

    • Traditional IRAs allow heirs to spread tax impact over time

  • More Tax-Efficient Portfolio Rebalancing: With each investment in its optimal location, rebalancing becomes more tax-efficient. You can often rebalance within tax-sheltered accounts without triggering taxable events. Sweet!

  • Maximized Social Security Benefits: Smart withdrawal strategies across different account types can help reduce the taxation of your Social Security benefits in retirement. It's like getting more bang for your Social Security buck!

  • Greater Control Over RMDs: By thoughtfully distributing assets between traditional IRAs and other accounts, you can better manage required minimum distributions (RMDs) and their tax impact in retirement.

  • Investment Cost Efficiency: When investments are in their optimal locations, you might reduce transaction costs and avoid unnecessary trading. Every penny saved is a penny that can keep growing!

  • Peace of Mind & Clarity: A well-organized financial house just feels better! When everything has its proper place, it's easier to track, manage, and adjust your investment strategy as needed. Plus, you'll sleep better knowing you're being super efficient with your hard-earned money!


Remember, these potential benefits can compound over time - the sooner you implement a smart asset location strategy, the more you can potentially gain from it. It's like planting a tree; the best time was 20 years ago, but the second-best time is today!


Understanding Your Account Types for Optimal Location


Before we dive into the nitty-gritty of where to put what, let's explore the three main types of accounts at your disposal.


Each comes with its own tax personality, and understanding these differences is key to making smart placement decisions.



Understanding account types for optimal asset location strategy.


Tax-Deferred Accounts (Traditional IRAs, 401(k)s, TSP): Think of these as your "delay the tax bill" accounts. They're perfect for investments that generate regular taxable income, like bonds. The beauty here is that you won't pay taxes on the growth until you withdraw the money, ideally when you're in a lower tax bracket during retirement. It's like getting an interest-free loan from Uncle Sam on your tax bill!


Tax-Exempt Accounts (Roth IRAs, Roth 401(k)s, HSA): These are your "tax-free growth superstars." They're ideal for investments with high growth potential since all that appreciation won't face taxes when you withdraw it. Picture planting a seed that grows into a mighty oak—and you get to keep every branch tax-free! The catch? You pay taxes on the money before it goes in, but then you're done with taxes forever on that money.


Taxable Accounts: These regular brokerage accounts are like your everyday checking account's sophisticated cousin. They're perfect for tax-efficient investments like index funds and qualified dividend-paying stocks. While you'll pay taxes along the way, you can take advantage of lower capital gains rates and tax-loss harvesting opportunities. Plus, they offer maximum flexibility since there are no withdrawal rules or age restrictions.


The Art of Strategic Placement


Now that we understand our account types, let’s talk about how to match investments with their ideal homes. This is where the real magic happens!



Matching the right investment type with the right account type is paramount for proper asset location strategy.


Bonds and Fixed Income: These income-generating investments are typically best suited for tax-deferred accounts. Why? Because interest payments are taxed at your ordinary income rate, which can be pretty steep. By housing bonds in a traditional IRA or 401(k), you defer those taxes until retirement when you might be in a lower tax bracket. Additionally, taxable bonds are best suited for tax-deferred accounts to avoid higher ordinary income tax rates on interest payments.


Growth Stocks and Aggressive Investments: These are perfect candidates for your Roth accounts. If you’re betting on the next big thing or investing in high-growth potential companies, wouldn’t it be nice to keep all those gains tax-free? That’s exactly what a Roth account lets you do. It’s like having a tax-free garden where your financial flowers can bloom unrestricted! Equity funds and equity mutual funds can also be strategically placed in Roth accounts for tax-free growth.


Index Funds and ETFs: These often work well in taxable accounts because they’re generally already relatively tax-efficient. Many index funds have low turnover, meaning fewer taxable events, and qualified dividends are taxed at preferential rates. Plus, if you need to sell some investments for a major purchase, these accounts offer the most flexibility. These are considered tax efficient assets and are suitable for taxable accounts.


International Investments: International investments are often best placed in taxable accounts. The main reason comes down to something called the foreign tax credit - think of it as a dollar-for-dollar reduction in your U.S. taxes for the foreign taxes you've already paid on your international investments. Here's the catch though - you can only claim this credit in taxable accounts, not in retirement accounts like IRAs or 401(k)s.


Real Estate Investment Trusts (REITs): These can be tricky because they generate high yields but don’t qualify for preferred tax treatment. Consider keeping these in tax-deferred accounts or tax-free accounts to shelter their income until retirement.


Implementation: Making Asset Location Work for You


Step by step guide for implementing asset location strategy.

Here's your step-by-step guide to putting this strategy into action:


  1. Start with a Portfolio Review:


  • List all your investment accounts and their tax treatment

  • Document current investment locations and asset allocation

  • Identify opportunities for optimization

  • Calculate your current tax exposure


  1. Analyze Your Tax Situation:


  • Understand your current tax bracket

  • Project your likely retirement tax bracket

  • Consider state tax implications

  • Factor in required minimum distributions (RMDs)


  1. Create Your Placement Strategy:


  • Match investments with their optimal account types

  • Consider future flexibility needs

  • Factor in rebalancing requirements

  • Plan for eventual withdrawals


  1. Monitor and Adjust:


  • Review your strategy annually

  • Adjust for life changes and tax law updates

  • Rebalance when necessary

  • Track tax efficiency metrics


Common Pitfalls to Avoid: Capital Gains Taxes

Even the best-laid plans can go awry if you're not careful. Here are some common mistakes to watch out for:


  • The All-or-Nothing Trap: Don't feel like you need to move everything at once. Sometimes, transaction costs or tax implications make it better to implement changes gradually.

  • Forgetting About Flexibility: While tax efficiency is important, don't sacrifice liquidity if you might need access to funds before retirement.

  • Ignoring Account Limits: Remember that retirement accounts have contribution limits and withdrawal restrictions. Factor these into your planning.

  • Behavioral Mistakes: With asset location, each account will perform and behave very differently. This might leave you wondering why one account is outperforming or underperforming another account. Investors often make the mistake of wanting to change their tax-deferred account allocation after seeing that their fixed income may not be performing as well as their equities. Remember, the key is to target the proper mix across all of your accounts when combined!


Advanced Strategies for Maximizing Tax Benefits


Once you’ve mastered the basics, consider these advanced techniques:


  • Tax-Loss Harvesting: In taxable accounts, strategically realize losses to offset gains while maintaining your overall investment strategy.

  • Asset Location Rebalancing: Instead of selling investments to rebalance, direct new contributions to underweight areas across your accounts.

  • Multi-Year Tax Planning: Consider strategies like Roth conversions or strategic withdrawals to manage your tax bracket over time. Ordinary income tax rates, which can be as high as 37%, significantly impact the tax liabilities associated with these actions, making strategic planning essential.


 

Need help with your asset location strategy? Get Your Free Retirement Roadmap to Help You Retire With Confidence


  • Retirement Planning - Optimize your income and create a roadmap for a secure retirement.

  • Investment Management - Personalized investing to grow and protect your wealth.

  • Tax Planning - Identify tax strategies including Roth conversions, RMD management, charitable giving and more...



 

Key Metrics to Track with Asset Allocation


Key metrics to track for proper asset location strategy

How do you know if your asset location strategy is working? Here are some key metrics to track:


  • After-tax returns across your entire portfolio

  • Tax efficiency ratio (taxes paid divided by portfolio value)

  • Withdrawal flexibility and options

  • Overall portfolio expenses and transaction costs


A Real-World Example: Sarah's Smart Asset Location Strategy


Meet Sarah, a 45-year-old tech executive with a $1 million portfolio spread across traditional IRA ($400,000), Roth IRA ($200,000), and taxable accounts ($400,000).

Like many successful professionals, she had a solid investment mix but hadn't paid much attention to which investments lived where. Think of it like having a well-stocked kitchen but with ingredients stored randomly - everything's there, but not necessarily in the best spot!


The "Before" Picture: 

Sarah had similar investment mixes across all accounts:

  • Growth Stocks: 50% ($500,000)

  • Bonds: 30% ($300,000)

  • REITs: 10% ($100,000)

  • International Stocks: 10% ($100,000)


Her annual tax bill on investment income? About $6,000. Ouch!


The "After" Picture: 

Working with her advisor, Sarah reorganized her investments like a pro:


Traditional IRA ($400,000):

  • Bonds and REITs (the tax-inefficient stuff) Why? Income from these investments now grows tax-deferred


Roth IRA ($200,000):

  • High expected growth small-cap stocks Why? Potential future growth is tax-free forever!


Taxable Account ($400,000):


The Result: Sarah's new annual tax bill on investment income? Just $1,200! That's $4,800 in annual tax savings. Over 20 years, assuming these savings are reinvested and grow at 7% annually, this "free lunch" could add up to an extra $160,000 in her retirement nest egg.


Not bad for simply rearranging where she keeps her investments!


The best part?


Sarah didn't change her overall investment mix - she just got smarter about where she keeps everything. It's like getting a better return without taking on any extra risk. Who says you can't have your cake and eat it too? 😊


Remember, while Sarah's fictional story shows the power of smart asset location, your situation might be different. Consider working with a financial advisor to create a strategy tailored to your unique circumstances. After all, everyone's financial recipe for success is a little different!


FAQs


Q: Is Asset Location Worth It?

A: According to Vanguard research, asset location strategies can add up to 0.75% in annual after-tax returns. While this might sound modest, it's like finding free money under your couch cushions year after year! The benefits compound significantly over time, especially for larger portfolios and investors in higher tax brackets. The catch? You need multiple account types and some patience to see the magic happen.


Q: Should I DIY or Hire a Pro?

A: Think of asset location like cooking - some people can whip up a gourmet meal solo, while others prefer a professional chef!


If you're comfortable managing investments, you have deep tax planning expertise, and have a straightforward portfolio, a DIY approach can work well. However, if you're juggling multiple accounts, value your time, have a high net worth over $2 million, or complex estate planning needs, professional guidance might be worth the investment. 


Vanguard's research suggests professional financial advice can add up to 3% in additional annual returns beyond what an investor can do on their own through various strategies, including asset location.


Q: How Much Can Asset Location Strategy Improve My Returns?

A: The potential benefit from proper asset location will depend on your personal situation. However, the research paints an encouraging picture and reveals that asset location may improve your after-tax returns by 0.05% to 0.41% depending upon the studies below:



On a $2 million portfolio, even a modest 0.25% improvement could mean an extra $639,217 over 30 years. This assumes a 5% after-tax return vs a portfolio with a 5.25% after-tax return. Not too shabby for simply being strategic about where you keep your investments!


Q: When Does Asset Location Strategy Make the Most Sense?

A: Asset location is most effective in the following situations:


  • Significant Taxable Investments: If you have a substantial portion of your investments in taxable accounts.

  • Long Time Horizon: The benefits of asset location compound over time, making it more impactful for long-term investors.  

  • High Tax Bracket: The higher your tax bracket, the more you can benefit from tax-efficient strategies like asset location.

  • Varied Asset Classes: If you invest in a mix of asset classes with different tax treatments (e.g., stocks, bonds, REITs).


Think of it like a fine wine - it gets better with time, but you need the right conditions to make it worthwhile. If you check these boxes, asset location could be your secret sauce for better after-tax returns!


Conclusion


A well-executed asset location strategy is like conducting a financial orchestra—each investment plays its part in the right place at the right time. While it requires some initial planning and regular maintenance, the potential boost to your after-tax returns can make a meaningful difference in your retirement lifestyle.


Remember, everyone's situation is unique. Consider working with a financial advisor who can help tailor these strategies to your specific circumstances and goals. They can help you fine-tune your approach and ensure your retirement symphony plays out exactly as you've planned.


The beauty of asset location strategy is that it's one of the few "free lunches" in investing—a way to potentially improve your returns without taking on additional risk. By being thoughtful about where you hold your investments, you can help ensure more of your hard-earned money stays in your pocket where it belongs!


Want help optimizing your portfolio for improved asset location? Request a free retirement roadmap from our firm. We'll address asset location, retirement, taxes, and more. 




 

Matt Brennan financial advisor in Reston VA

About the author:

Senior Financial Advisor


Matt is a Senior Financial Advisor with Covenant Wealth Advisors and a CERTIFIED FINANCIAL PLANNER™ practitioner. He has over 20 years of experience in the financial services industry in the areas of financial planning for retirement, tax planning, and investment management.


 

Disclosures: Covenant Wealth Advisors is a registered investment advisor with offices in Richmond, Reston, and Williamsburg, VA. Registration of an investment advisor does not imply a certain level of skill or training. Past performance is no guarantee of future returns. Investing involves risk and possible loss of principal capital. The views and opinions expressed in this content are as of the date of the posting, are subject to change based on market and other conditions. This content may contain certain statements that may be deemed forward-looking statements. Please note that any such statements are not guarantees of any future performance and actual results or developments may differ materially from those projected. Please note that nothing in this content should be construed as an offer to sell or the solicitation of an offer to purchase an interest in any security or separate account. Nothing is intended to be, and you should not consider anything to be, investment, accounting, tax, or legal advice. If you would like accounting, tax, or legal advice, you should consult with your own accountants or attorneys regarding your individual circumstances and needs. This article was written and edited by a CERTIFIED FINANCIAL PLANNER™ professional with the assistance of AI. No advice may be rendered by Covenant Wealth Advisors unless a client service agreement is in place. Hypothetical examples are fictitious and are only used to illustrate a specific point of view. Diversification does not guarantee against risk of loss. While this guide attempts to be as comprehensive as possible but no article can cover all aspects of retirement planning. Be sure to consult an advisor for comprehensive advice.

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