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Taxes: Asset Location, Location, Location!

The old saying “It isn’t what you make, it is what you keep” is at the core of building an effective wealth management plan to achieve goals.

Taking time to get a complete understanding of a family’s total financial picture is key to developing strategies to effectively manage taxes. Taxes are inevitable and after tax returns are crucial to achieving wealth planning goals.

One strategy called Asset Location is a technique that can greatly enhance the amount of return that is kept and not paid out in taxes. Asset Location refers to how an investor distributes their investments over taxable accounts such as a Trust brokerage accounts, tax-deferred accounts such as IRA’s and 401ks, and tax-exempt accounts such as Roth IRA’s and Roth 401k’s. Allocating assets that pay the lower long term capital gains tax rates to your taxable accounts and allocating assets that pay higher income tax rates to tax deferred and tax exempt accounts allows investors to keep more of the return they make.

One simple example: An investor with $1 million in an IRA and $1 million in a Family Trust may have an asset allocation of 50% Equities and 50% Fixed Income. If currently both portfolios are situated with this allocation, shifting the assets that are taxed as ordinary income, 39.6% Federal rate, to the tax-deferred IRA and shifting assets that are taxed at the more favorable long term capital gains rates of up to 20% Federal to the taxable trust account could generate tax savings. The potential shift may be to move the taxable fixed income assets over to the retirement account and move the more tax favorable long term capital gains taxed assets, such as equities and ETFs intended to be held for longer than a year, to the taxable account. This will change the allocation percentages inside of each account; however with proper execution the overall 50% Equities, 50% Fixed Income allocation will remain constant in order to achieve the desired total investment allocation and risk profile.

Shifting assets in this way must be looked at and executed carefully. It may take time to implement in order to keep fees generated low and to minimize the unnecessary triggering of a realized tax liability.

In order for this type of strategy to work requires viewing all investment portfolios through one asset allocation strategy that all the accounts make up. Having the ability to get consolidated performance reporting for all of your accounts from your advisor no matter where they are held is important to monitoring the success of this strategy. 


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