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Other Articles
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Asset Allocation
Location, Location, Location: A Primer on Asset Location
By Madaline Creehan
Vice President & Investment Consultant, Brand Asset Management Group
In the construction of your portfolio,
asset allocation, investment selection,
cost containment, and tax efficiency
may be the most important decisions
that you face. Each of these
decisions affects the performance of
your portfolio to varying degrees, some more
significantly than others as described in Todd’s
article. Structuring a tax-efficient portfolio
through asset location has the potential to
maximize the after-tax return of the portfolio. The
term asset location refers to the strategic
placement of specific asset classes in either a taxdeferred
account or a taxable account depending
upon the tax efficiency of the asset class and the
benefits provided.
A typical portfolio usually consists of taxable
accounts and tax-advantaged retirement accounts
funded with multiple asset classes. Asset location
maintains that investments that tend to lose less of
their return to income taxes should be placed in
taxable accounts (trusts) while investments that
lose more of their return to income taxes be placed
in tax-deferred accounts (IRAs and 401Ks). Asset
location achieves this objective by identifying the
optimal location for each asset class. For
simplification, the primary asset classes referenced
in this discussion are stocks and bonds.
When implementing asset location, the factors to
be considered for each client’s portfolio range
from their cash flow needs, tax bracket, prevailing
tax laws, and the tax characteristics of the asset
classes. This method of placement has the
potential over time to add value over a pro-rata
approach to funding each account within a
portfolio. The pro-rata approach structures each
account similarly, while the asset location
methodology determines the location of each asset
class based on where it provides the most after tax
benefit to the portfolio.
The Tax Relief legislation of 2003 (JGTRRA)
provided greater incentive and opportunity to
implement asset location by reducing the tax rates
on qualified dividend income from ordinary tax
rates to a maximum rate of 15%. Broadly
speaking, most, but not all, qualified dividends are
generated by stocks held in your equity mutual
funds. In the past, dividends from equities were
not receiving preferential tax treatment. As a
result, it made sense to hold equities in retirement
accounts to avoid paying tax on the dividend
income until that income had to be withdrawn.
The reduction in tax rates for qualified dividends
was a strong factor in the support of implementing
asset location in the structure of your overall
wealth to minimize tax ramifications. This adds
value over time to the after-tax return of the
portfolio.
Conversely, taxable fixed income investments and
REITs generate non-qualified dividends making
them more suitable investments for retirement
accounts such as IRAs. Non-qualified dividends
do not receive preferential tax treatment, which
subjects the income to ordinary income rates
regardless of where the assets are housed. With
that being the case, placing these assets in
retirement accounts such as IRAs provides the
opportunity for tax-deferred growth and the
deferral of tax on the income until withdrawn.
Roth IRAs are generally excluded from the general
principles of asset location due to the fact that
qualified withdrawals are tax-free. Therefore,
assets that have the potential to generate higher
returns make good candidates for Roth IRAs.
When reviewing your quarterly statements, if you
have any questions as to the location of your
assets, please give us a call or list it on your agenda
for discussion at your next review.
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