Asset Location Strategy: A Tax Concept Most Investors Never Consider

When planning for retirement, most families focus on building a well-diversified portfolio. In fact, you may have spent countless hours discussing asset allocation with your advisor, making sure you have the right balance for your age and risk tolerance. But did you know that where you hold these investments — your asset location strategy — can be just as important as what you’re investing in? 

Clients come to us with substantial portfolios spread across taxable accounts, 401(k)s, and IRAs. Their investments may be placed randomly, such as having a municipal bond fund sitting in an IRA or high-yield bonds creating annual tax bills in taxable accounts.  

These oversights in asset location strategy could cost you thousands of dollars every year in unnecessary taxes, money that could be staying in your pocket to help you build toward retirement or maintain your current lifestyle. 

Your investment accounts have different tax rules, and understanding these differences can help you save money. 

• Regular investment accounts require you to pay taxes on dividends and interest in the year you receive them. You can get preferential tax treatment on the gains when you sell investments you’ve held for over one year. Plus, if you pass investments down to your heirs, they receive a “step-up in basis” that can eliminate capital gains taxes. 

• A traditional 401(k) or IRA lets you avoid taxes on your contributions and investment growth today. But when you withdraw money in retirement, every dollar is taxed as ordinary income. 

• A Roth account requires you to pay taxes upfront on contributions but gives you the benefit of tax-free growth and tax-free retirement withdrawals.  

At Credent, we focus on what you can control in your financial plan, and asset location is a perfect example. While you can’t control market volatility or future tax law changes, you can understand account tax rules and control where you hold different investments to keep more of your hard-earned money. 

What is the danger in not considering your asset location strategy? Here’s one possible scenario: Imagine a couple comes to an advisor with municipal bonds in their IRA because they want “tax-free income” in retirement. On the surface, this makes sense. 

The problem is that municipal bonds are already tax-free, and when you place a tax-free investment inside an already tax-deferred account, you waste the account’s tax benefits.  

Here’s how: Due to the tax-free nature of municipal bonds, investors are willing to accept a lower coupon. In a taxable account, this tax-free nature may create a higher tax-equivalent yield than other bonds with a similar credit rating. When you hold municipal bonds in a tax-deferred account, you are accepting a lower yield without reaping the tax benefits, as the tax-free income is going to an already tax-deferred account and forgoing the benefit of the tax-free income received.  

Plus, when you eventually withdraw that money from your IRA, the previously tax-free municipal bond income becomes fully taxable as ordinary income. 

A better approach would be to hold the same municipal bonds in taxable accounts, where their tax-free status provides real value, and use an IRA for investments that would otherwise generate taxable income, such as high-yield bonds, REITs, or actively managed funds that may produce short-term gains and benefit from a deferred tax drag.  

As you build your asset location strategy, here’s a practical framework that goes beyond just contributing to different account types and can help meaningfully reduce lifetime tax burdens and improve after-tax returns. We recommend consulting with an advisor to ensure you make the right choices for your financial plan.  

• High-yield bonds and bond funds: These generate ordinary income that’s taxed at your highest marginal rate 
• REITs: Most real estate investment trust (REIT) distributions are taxed as ordinary income 
• Actively managed funds: These often produce short-term capital gains, which are taxed as ordinary income 
• International investments: Foreign tax credits are wasted in tax-deferred accounts, but the underlying growth can compound without current taxation 

• Highest-growth potential investments: Since you’ll never pay taxes on this growth, maximize the account’s long-term potential 
• Alternative investments: Private equity, hedge funds, or other assets with unpredictable tax characteristics 
• Investments you plan to hold forever: Let the magic of tax-free compounding work over decades 

• Tax-efficient index funds: These generate minimal annual taxable distributions 
• Individual stocks held long-term: Benefit from preferential capital gains rates and a step-up in basis 
• Tax-managed funds: Specifically designed to minimize taxable distributions 
• Municipal bonds: Their tax-free income provides real value in taxable accounts 

For families with substantial wealth or unique circumstances, there are additional asset location strategies worth considering.  

1. Family Limited Partnerships: These structures allow for centralized management for multi-generational-wealth families while providing benefits to estate planning. Clients may find these helpful when navigating estate taxes, intergenerational wealth transfer, and supporting adult children while protecting their retirement security. 
2. Marital Deduction Trusts: These are frequently overlooked as a planning vehicle to take advantage of the unlimited marital deduction while structuring long-term estate efficiency. 
3. Charitable Remainder Trusts: These trusts can provide current income while deferring capital gains taxes and benefiting charity — a sophisticated form of asset location that simultaneously serves multiple goals. 

We partnered with a client who had a large taxable portfolio and significant charitable intentions. In working with them, we identified highly appreciated individual stock positions that were not tax efficient to hold in their current asset location. Rather than sell them and trigger hefty capital gains taxes, we helped the client shift the asset location, donating these shares directly to a donor-advised fund. 

This move: 

• Eliminated capital gains taxes entirely 
• Provided a fair market value charitable deduction 
• Allowed us to properly manage portfolio risk and rebalance using their retirement accounts 

The coordination of asset location, charitable planning, and rebalancing added real after-tax value without affecting the client’s lifestyle cash flow. More importantly, it gave them the confidence that their money was working as effectively as possible.

Asset location isn’t a one-time decision. As your accounts grow, rebalancing needs arise, and tax laws change, the optimal placement of your investments evolves. What works best today may need adjustment as you move through different life stages and market cycles. Asset location has become more critical than ever for families who want to keep more of what they’ve earned over their lifetimes. 

At Credent, we believe in focusing on what you can control. While market volatility and tax law changes are beyond anyone’s influence, smart asset location strategies are within your power to implement and reap the benefits. 

To talk to an advisor about optimizing your asset location strategy, reach out using the form below.