You are probably familiar with the three most important factors in real estate: location, location, location. Asset location is a similarly important best practice for keeping as much of your wealth as possible, after taxes have taken their toll. Given how steep that toll can be, it is worth knowing more about how to benefit from proper asset location.
Let’s begin by noting that asset location should not be confused with asset allocation. The two are related, but different, portfolio management techniques.
By locating your least tax-efficient investments in your tax-sheltered accounts, you can minimize or even eliminate tax inefficiencies. For example, typically (but not always!) holdings such as fixed income and REIT funds are less tax-efficient than stocks. And among stock asset classes, some are more or less tax-efficient than others.
It makes intuitive sense to locate these and other asset classes according to their expected tax efficiencies. But it is not as easily implemented as you might think.
First, there is only so much room in your tax-sheltered accounts. After all, if there were unlimited opportunity to avoid paying income taxes on your investments, you would simply shelter all of them and be done with it. In reality, challenging trade-offs must be made to ensure you are making best use of your tax-sheltered “space.”
Second, it is not just about tax-sheltering your assets. Eventually, you will also want to spend or bequeath them, so you want to plan for that, too. Here are some ideas on how to do that.
While you may not even know if you are missing out on optimal asset location, the resulting wealth unnecessarily lost to taxes can be very real. Here are some reasons your asset location planning may fall short:
It is an art and a science to apply effective asset location to your unique, often complex, wealth management. That said, the efforts can pay for themselves many times over by minimizing taxes for you and your heirs.
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This post was prepared and first distributed by Wendy J. Cook.
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