For the final post in our tax management series, we’ll take a look at asset location. Everybody knows the three rules of real estate, but most don’t know that the same rule also applies to investment portfolio construction.

Asset location is the practice of positioning tax-inefficient assets in tax-advantaged accounts. For example, fixed income and REITs should first be held in tax-deferred accounts like an IRA, 401(k), or 403(b) while tax-free municipal bonds and equities should be positioned in taxable accounts.

A recent study by Vanguard estimated that professional advisors can add up to .75% annually to investment returns by utilizing proper asset location in client accounts. It is all too frequent that we find new clients coming on board with poor use of asset location, but with a few simple tweaks we can align your investments to maximize your after-tax return.

Continuing on in the tax management series, this month we’ll look at account sequencing during wealth accumulation and retirement withdrawal periods. The basic questions are:

1) When accumulating funds, what accounts (tax-deferred, taxable, etc.) should be funded first?

2) When withdrawing funds, in what order should funds be withdrawn?

Individual circumstances may constitute different strategies, but the following examples demonstrate two common approaches. The first is based on someone in the accumulation phase who pays taxes in the highest bracket, and the second is a retiree in the withdrawal phase who will leave behind some amount of inheritance:

Following logical strategies for adding and withdrawing funds ensures that you accumulate and retain the maximum after-tax amount possible.

Next month, we’ll look at matching investments with the most appropriate account types.

With our investing philosophy, by and large, we recommend a set it and forget it mindset as it relates to your investment plan, which generally doesn’t benefit from excess activity. Tax planning, on the other hand, offers more frequent opportunities to actively add value (even above and beyond the extreme tax-efficiency of the investments themselves).

Here are three examples:

1. Guiding the sequence of additions to your various accounts during your career and, likewise, ensuring that withdrawals are taken in proper order from those accounts in retirement

2. Matching the right type of asset (equity, fixed income, real estate) with the appropriate account registration (be it taxable, tax-deferred, or tax-exempt)

3. Making creative suggestions based on our understanding of your situation and goals (i.e. IRA contributions, Roth conversions, charitable giving)

As the CPA on the team, I can assure you that we all work together to minimize the impact of taxes on your portfolio and maximize opportunities to leverage tax planning. Tax sensitivity is one of the things that helps us support you in your goals.

Watch in future newsletters for detailed discussions on each of the items listed above.