Asset location means placing assets in the right type of accounts (taxable, tax-deferred, or tax-free) based on how income from those accounts will be taxed today, in retirement, and as part of your estate. Appropriate asset location during the wealth management process increases the after-tax returns of your investment portfolio.
The HCM Tax Location Matrix™ was developed to organize your investment accounts into the most efficient investment portfolio for your Wealth Plan. Different tax environments and classifications of income generate different tax burdens on the same level of income. We locate your assets in a manner that generates tax efficient after-tax returns.
For example, assets that generate ordinary income such as bonds, high turnover equity funds and certificates of deposit, should generally be placed in tax-deferred accounts where the ordinary income is sheltered until you need the money. Tax-advantaged assets such as stocks and equity funds that generate qualified dividends and are held for long-term capital gains are taxed at rates substantially lower than ordinary income assets and should be held in the taxable environment.
Investors often pay very little attention to tax environments. They may have a few stocks in their IRA, stock mutual funds in their 401(k) plan, and certificates of deposit in their personal name at the bank. This particular allocation forces them to pay ordinary income tax, at their highest marginal rates, on the interest from their certificates of deposit, even if they don’t need the money. At the same time, they are losing the tax advantages associated with qualified dividends and long-term capital gains by holding stocks in their tax-deferred accounts.
For example, a $1million portfolio with an annual growth of 6.5% will be worth $3,523,645 in 20 years. An identical portfolio, invested using more tax-efficient allocation that generates an after-tax return of 7.5%, would grow to $4,247,851 in 20 years. The additional $724,206 of wealth created with this method has nothing to do with better investment results; it is simply the result of more intelligent tax management of the portfolio.
Remember, it’s not what you make, it’s how much you keep after taxes that matters! At Hengehold Capital Management, HCM’s Tax Location Matrix™ helps you place assets in the appropriate locations to maximize after-tax returns. If you have any questions, or would like to discuss asset location in your portfolio, please contact one of our Wealth Advisors.
Content in this article is not intended to be financial advice. Instead, we think of it as educational, and financial education is important to us. Retirement and financial planning services at the Cincinnati firm Hengehold Capital Management.