Investment performance is often measured by what a portfolio earns. But for investors with substantial assets across taxable, tax-deferred, and tax-free accounts, what they keep after taxes can be just as important.
Tax-smart portfolio design considers not only which investments an investor owns, but also where those investments are held and how they are managed over time. This approach, commonly called asset location, can help reduce unnecessary tax exposure while keeping the portfolio aligned with broader financial goals.
What Is Asset Location?
Asset allocation determines the mix of investments such as stocks, bonds, and cash within a portfolio. Asset location determines which types of accounts hold those investments.
Different accounts receive different tax treatment. Earnings in traditional IRAs generally grow tax-deferred until distributed, while qualified Roth IRA distributions are tax-free. Investments held in taxable brokerage accounts may generate taxable interest, dividends, and capital gains along the way. 1,2
See more: Washington: What to Watch Now
For some investors, strategically locating assets among these accounts may improve the portfolio’s overall tax efficiency. Investments that regularly generate taxable income, for example, may warrant a different placement than investments primarily expected to appreciate over a longer period.
Consider the Tax Characteristics of Investments
Tax-smart investing also involves understanding how different investments generate taxable income.
Long-term capital gains generally receive different—and potentially lower—federal tax rates than ordinary income, while short-term capital gains are taxed as ordinary income. 3 For higher-income investors, certain interest, dividends, and capital gains may also be subject to the 3.8% Net Investment Income Tax. 4
Investment structure can matter, too. According to Investor.gov, ETFs typically generate fewer capital gains distributions than mutual funds because many ETFs use in-kind transactions when buying and selling portfolio securities, although both can generate taxable distributions. 5
These distinctions can make tax characteristics an important consideration when selecting investments for taxable accounts.
Manage Taxes Throughout the Investment Lifecycle
Tax efficiency is not a one-time portfolio decision. As markets, tax circumstances, cash needs, and financial goals change, opportunities may emerge to adjust the strategy.
One example is tax-loss harvesting, which involves selling investments at a loss to offset realized capital gains. If losses exceed gains, federal tax rules may allow a limited amount to offset ordinary income, with remaining losses potentially carried forward. Investors must also consider the wash-sale rule, which can disallow a loss when substantially identical securities are purchased within 30 days before or after the sale. 3,6
Building Tax Strategy into the Bigger Picture
Asset location, investment selection, realized gains and losses, retirement distributions, and liquidity needs do not operate independently. Decisions in one area can create consequences elsewhere.
That is where a BUILT FOR YOU approach can make a difference. Sequoia Financial Group helps clients manage the complexity of coordinating investment and wealth planning decisions around their individual circumstances. By viewing tax considerations alongside portfolio objectives, cash flow needs, retirement strategy, and long-term goals, investors can focus not simply on generating returns but on making more of those returns work toward the life they are building.
A message from Advisor Perspectives and VettaFi: Discover something new! Click here to register for our upcoming webcasts.
Sources
-
IRS, “IRA-Based Plans”
https://www.irs.gov/retirement-plans/ira-based-plans
-
IRS, “Traditional and Roth IRAs”
https://www.irs.gov/retirement-plans/traditional-and-roth-iras
-
IRS, “Topic No. 409, Capital Gains and Losses”
https://www.irs.gov/taxtopics/tc409
-
IRS, “Net Investment Income Tax”
https://www.irs.gov/individuals/net-investment-income-tax
-
Investor.gov, “Characteristics of Mutual Funds and Exchange-Traded Funds (ETFs)”
https://www.investor.gov/introduction-investing/general-resources/news-alerts/alerts-bulletins/characteristics-mutual-funds-exchange-traded-funds
-
IRS, “Instructions for Schedule D (Form 1040)”
https://www.irs.gov/instructions/i1040sd
The views expressed represent the opinion of Sequoia Financial Group. The views are subject to change and are not intended as a forecast or guarantee of future results. This material is for informational purposes only. It does not constitute investment advice and is not intended as an endorsement of any specific investment. Stated information is derived from proprietary and nonproprietary sources that have not been independently verified for accuracy or completeness. While Sequoia believes the information to be accurate and reliable, we do not claim or have responsibility for its completeness, accuracy, or reliability. Statements of future expectations, estimates, projections, and other forward-looking statements are based on available information and Sequoia’s view as of the time of these statements. Accordingly, such statements are inherently speculative as they are based on assumptions that may involve known and unknown risks and uncertainties. Actual results, performance or events may differ materially from those expressed or implied in such statements. Investing in equity securities involves risks, including the potential loss of principal. While equities may offer the potential for greater long-term growth than most debt securities, they generally have higher volatility. Past performance is not an indication of future results. Investment advisory services offered through Sequoia Financial Advisors, LLC, an SEC Registered Investment Advisor. Registration as an investment advisor does not imply a certain level of skill or training.
© Sequoia Financial Group
More Capital Growth Topics >
