Asset Location Can Reduce Taxation

Why Expose Assets to Taxes Today When They’re Not Being Used until Tomorrow?

Do you have clients who are investing for long-term goals? You can help these clients potentially reduce their tax bills by locating assets in both taxable and tax-deferred accounts. This is commonly called “asset location.”

It’s not always what your client’s portfolio is invested in that makes it tax-efficient; often, it’s where those assets are located.

Creating an Asset-Location Strategy

There are two basic steps to helping clients manage taxes through asset location:

Help the client categorize their current assets according to how the assets are taxed.

Review the client's opportunities to relocate assets for greater efficiency.

One good way to begin the categorization process is to take an inventory using a form such as the one below. Once the inventory is complete, separate the client’s assets according to the following asset and account types.


Asset and Account Types


Some income taxes may be payable each year.



  • Mutual funds
  • Stocks
  • Bonds
  • CDs


Income taxes are payable only when assets are distributed or, if applicable, sold.


  • Nonqualified annuities (earnings distributed are taxed first)
  • Retirement accounts (IRA, 401(k), etc.)
  • Life insurance Cash Value


Certain distributions are free of federal and/or state income taxes.



  • Municipal bond interest
  • U.S. Treasury securities
  • Roth IRAs
  • Roth 401(k)s
  • Life insurance death benefit1

1For federal income-tax purposes, life insurance death benefits generally pay income tax-free to beneficiaries pursuant to IRC Section 101(a)(1). In certain situations, however, life insurance death benefits may be partially or wholly taxable. Situations include, but are not limited to: the transfer of a life insurance policy for valuable consideration unless the transfer qualifies for an exception under IRC Section 101(a)(2) (i.e., the transfer-for-value rule); arrangements that lack an insurable interest based on state law; and an employer-owned policy unless the policy qualifies for an exception under IRC Section 101(j).


Tax Efficiency during a Client’s Working Years

While clients work, investments are typically used for short- and intermediate-term or long-term expenses.

Often, assets that are earmarked for long-term expenses are more tax-efficient if they are located in tax-deferred or tax-exempt/tax-free accounts. Here’s why:


Short- or Intermediate-Term Expenses

Taxable Accounts

Often used for short- and intermediate-term needs because they are relatively liquid. Even though income tax may arise annually on taxable earnings with this account, clients can access assets at any time without an additional 10% federal tax.


  • After-tax brokerage accounts holding stocks, bonds, and mutual funds where dividends, interest, and recognized gains are taxed annually.
  • CD investments provide liquidity based on the length of the CD maturity term. Interest from a CD will be taxed annually.

Long-Term Expenses

Tax-Deferred Accounts

Typically used for enhancing long-term growth potential. There may be adverse tax consequences for early withdrawals. However, in return, there are no taxes on any investment earnings until clients need to make withdrawals or take distributions. As a result, while clients are invested, they keep more of the investment earnings, enabling assets to grow faster.


  • A nonqualified deferred annuity, which is used to grow money for retirement. Early distributions (prior to age 59½) will generally be subject to both ordinary income tax and an additional 10% federal tax on the gains. Assets left within an annuity will continue to grow tax-deferred.

Tax-Exempt/Tax-Free Accounts

Can be used to help meet long-term expenses by generating tax-free income in retirement. Although clients pay taxes up front at today’s known rates, they may potentially eliminate any income tax on account earnings when withdrawn.


  • A Roth IRA, which can create tax-free income for retirement. Since clients pay taxes up front when they contribute to a Roth IRA, these accounts work best when clients expect to be in a higher tax bracket during retirement years.

Generally, for earnings from a Roth IRA account to be distributed tax-free, the Roth IRA holder must have held the account for five years AND either attained age 59½, become disabled, passed away, or qualified for a first-time home-purchase exception.


Asset-Location Opportunities

Now it’s time to consider the client’s asset-location opportunities. Examine the client’s current assets and determine which of these categories the assets might fall in:

Tax-Efficient Investments

  • Typically produce more long-term capital gains (which are not taxed until sold).
  • Pay small to no dividends, such as growth-oriented equity funds and stock index funds.




Consider Locating in Taxable Accounts

Tax-efficient investments produce a lower amount of taxable income or gains during the short or intermediate term, making them possible options to hold in taxable accounts.


Tax-Inefficient Investments

  • Generate taxes due to regular distribution of dividends and interest, which includes bonds, dividend-paying equities, and real estate investment trusts (REITs).
  • Generate short-term capital gains, which includes actively traded funds.




Consider Locating in Tax-Deferred or Tax-Free Accounts

Tax-inefficient investments produce a higher amount of taxable income and/or gains. Tax-deferred and tax-free accounts can take advantage of either a deferral or possible elimination of taxes on these types of investments.


Tax Efficiency during a Client’s Retirement Years

When clients transition from their working to later years, their financial focus often shifts from growing assets to ensuring they are managing their investments in a way that maximizes retirement income. To achieve that goal, the purpose of thinking in terms of “asset location” should shift from “where should I locate assets?” to “from which locations (accounts) should I withdraw assets?” Consider reviewing the following scenarios with your clients:


1. Before Making Withdrawals, Clients Should Think about Their Net Income

While doing some financial planning with your financial professional, you and your spouse realize that after Social Security benefits and pension payments, you’ll need to withdraw a net $13,500 from savings to meet living expenses. Which account should you withdraw from? If the goal is to minimize income taxes and help make your retirement savings last, it may be a good idea to withdraw from the tax-free account. Why?

In this hypothetical example, if you withdraw from the tax-deferred account, it will deplete your savings by an additional $1,840 (12% tax rate). Withdrawing $15,340 would allow you to receive a net $13,500. In contrast, the tax-free account would only require $13,500 to be withdrawn without any additional federal tax.


Withdrawals will be taxed at ordinary income-tax rates.

Tax = $1,840

No income tax will be due on withdrawals.

Total withdrawal needed to receive a net amount of $13,500:

$13,500 + $1,840 = $15,340

Total withdrawal needed to receive a net amount of $13,500:



2. Be Aware of Your Clients' Tax Bracket

Now, let’s add another hypothetical consideration to the previous example. You and your spouse’s annual taxable income from sources other than savings—specifically, long-term capital gains from the installment sale of a business, your pension, and the taxable portion of Social Security benefits—is $68,500.

  • $16,000 (rather than $15,340) from your tax-deferred account, your total taxable income (long-term capital gains, Social Security benefits, pension, and withdrawals) would be $16,000 + $68,500 = $84,500. By looking at the current IRS tax tables, you realize this amount of taxable income moves you from a 12% tax bracket to a 22% bracket (which now results in long-term capital gains rates moving from a 0% to a 15% tax rate).
  • However, if you withdraw $13,500 from your tax-free account, your total taxable income would still be $68,500, and this would keep your long-term capital gains at the 0% tax rate.
2020 Federal Income-Tax Brackets and Rates

The takeaway from this example: Let clients know that moving to a higher income-tax bracket not only impacts taxation on ordinary income, but may also result in paying:

  • More in capital gains tax.
  • The 3.8% Net Investment Income Tax (NIT) for nonqualified assets.
  • Tax on a higher percentage of Social Security benefits.
  • The Alternative Minimum Tax.
  • More retirement healthcare costs, such as increased premiums for Medicare Parts B and D.
A Tool for Your Next Client Conversation
  • Effective Tax Rate Estimator
    Federal income tax is calculated using a progressive tax structure, meaning that your effective tax rate is lower than your income tax bracket. As this calculator shows, even if taxable income shows you in a particular income tax bracket, overall, you benefit from being taxed at the lower brackets first.
Tax Management Topics

The above is provided for informational purposes only and should not be construed as investment, tax, or legal advice. Information is based on current laws, which are subject to change at any time. Clients should consult with their accounting or tax professionals for guidance regarding their specific financial situations.

Under current law, a nonqualified annuity that is owned by an individual is generally entitled to tax deferral. IRAs and qualified plans - such as 401(k)s and 403(b)s - are already tax-deferred. Therefore, a deferred annuity should be used only to fund an IRA or qualified plan to benefit from the annuity's features other than tax deferral. These include lifetime income, death benefit options, and the ability to transfer among investment options without sales or withdrawal charges.


Want to Talk Further on this Topic?

The Retirement Strategies Group, subject-matter specialists with advanced degrees and designations such as CFA®, CFP®, ChFC®, CLU®, and JD, are ready to help.

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