How Asset Location Reduces Your Taxable Investment Income

Asset location is an investment strategy that takes a total portfolio view of the tax implications of your investments. As an investor, you need to be well aware of the tax implications of your investment decisions and asset location attempts to put a priority on this aspect. Here are a few things to consider about asset location and how it can reduce taxable investment income.

Asset Location

The idea behind asset location is that you are going to put different investments in different investment accounts. As a long-term investor, you are going to need to open a traditional investment account with a brokerage and a tax-advantaged retirement account. Different classes of investments have different tax rates associated with them. The point of this strategy is to put the investments with the higher tax rates in the tax-advantaged account and the investments with the lower tax rates in the taxable account. By doing this, you are going to be able to minimize the impact of taxes on your portfolio. If you do it correctly, you will be able to save thousands of dollars on taxes. 

What Belongs Where

Now that you understand the basic idea behind asset location, you will need to also understand where to put each type of investment. Understanding the concept is not the same as actually being able to put it into practice. You need to look at the different tax rates for the various investments that you have. For example, if you own bonds, or other interest-bearing securities, you will find that you have to pay taxes on this interest at your marginal tax rate. If you are in the highest tax bracket, you are going to be paying taxes on this amount of money at 35 percent. This means that it would most likely be in your best interest to put these types of investments into your retirement account and avoid paying 35 percent taxes on the interest.

If you own stocks, the long-term capital gains rate and the dividends tax rate is taxed at 15 percent. Therefore, you might want to think about putting stocks into your traditional taxable investment account. 

Retirement

When you reach retirement, you will need to think about some other aspects of this strategy as well. Anytime that you withdraw money from your retirement account, you are going to pay taxes on the money as if it were regular income instead of paying it at the normal investment rate. 

For example, let's say that you made $20,000 from stock investments in a given year and you withdrew the money from your retirement account. If you were at the 35 percent tax bracket, you would have to pay $7000 in taxes. If you would have made the same amount of money from stock sales in a regular taxable account, you would only potentially have to pay 15 percent of the total at the capital gains tax rate. This would result in a payment of $3000 instead. 

Taxes can severely limit the amount of money that you net from your investments so it is very important to research before you make any changes.

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