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Asset Location...Location Location Thumbnail

Asset Location...Location Location

When I was young, we would drive from Connecticut to New York to visit my grandparents. We would sit around the kitchen table, where my Grandma Lenora made it her sacred duty to ensure everyone was (overly) full and my Grandpa Bill would sit at the head leading conversion. As clear as it was yesterday, I remember Grandpa Bill saying, "Dan, when it comes to real estate, the three most important things are location, location, location."

Not only is location important in real estate, but also where your investments are located.  

When discussing investments, the conversation typically leans towards the What as opposed to the Where. In other words, it tends to focus on what investments you own (or should own) rather than in what type of account they are located within. However, the Where of an investment is an important component for tax purposes and should not be overlooked.

To provide context, there are three types of investment accounts: taxable, tax-deferred, and tax-free. 

  • Taxable - Annual interest, dividends, and capital gains within the account are taxed. Examples: joint and individual taxable brokerage accounts. 
  • Tax-deferred - Annual growth is not taxed. Contributions are made before federal, state, and local taxes are assessed. Withdrawals during retirement are taxed. Examples: Pre-tax 401(k), Pre-tax 403(b), Traditional IRA, etc. 
  • Tax-free - Annual growth is not taxed. Contributions are made after tax. Withdrawals during retirement are not taxed. Examples: Roth 401(k), Roth 403b, Roth IRA, etc. 

To make the most of your investments, it is prudent to hold them within the appropriate account type.

3 Examples:

Municipal Bonds

Municipal bonds (“munis” for short) is a loan made to a third party (e.g., local, county, or state government), which they use to finance public projects, operations, construction, etc. In return, they pay you federal, and sometimes state/local, tax-free interest, along with returning your principal investment at maturity.  

This is beneficial as it may provide you with a reliable, tax-free income source to meet living expenses; however, it is important to ensure you are optimizing the yield on these investments.

Example: Julia is a tech executive in San Francisco at the 37% federal, 13% state income tax brackets (50% marginal rate). She is interested in owning bonds to balance the volatility in her stock portfolio. In her Traditional IRA, she buys $500,000 of CA munis paying 5% interest (i.e., $25,000 of annual income).  Pretty good, right? 

Maybe. Due to her Traditional IRA already being tax-deferred, there is no tax benefit from buying munis within the account. Generally, it makes sense to purchase tax-inefficient investments within the tax-efficient accounts and tax-efficient investments within tax-inefficient accounts.   

Saying this, Julia could have located the munis (tax-efficient) within her taxable brokerage (tax-inefficient) and accrued the same benefits that she would have if they were in her Traditional IRA.

More Risk, More Return Assets 

Some investments have the characteristic of being riskier but also have the potential for higher returns. Small company stocks typically fall into this category, given they have the potential for large growth but also can underperform. For assets with this trait, holding the investment in a tax-free account can be beneficial as future gains are tax-free.

To take an extreme example, back in 2021, the story broke about how Peter Thiel, a founder of PayPal, amassed a Roth IRA valued at 5 billion dollars. How did he accumulate this enormous bucket of tax-free money? He purchased shares of early-stage start-ups with substantial growth potential within his Roth IRA. The businesses took off and the account balance skyrocketed.

Another benefit of the Roth IRA is that there are no required minimum distributions (RMDs). This allows money to appreciate during your working life and retirement without having to worry about withdrawing funds. Lastly, this can be a good estate planning tool, providing your heirs with tax-free assets. 

Non-US Spouses

When a US person is married to a non-US person, there are unique financial and tax planning opportunities not available to US couples.

Example: Lee is a US citizen who lives in Singapore. He is married to a Singaporean named Rachel. Rachel opens an investment account, invests $100,000 in a start-up, and the value grows to $1,000,000. Due to Singapore not currently having a capital gains tax, upon selling the investment, she would pay $0 of tax. 

However, if Lee opened the account, made the investment, and sold for $1,000,000, the $900,000 of gain would be taxable by Uncle Sam. 

Assuming a 23.8% rate (20% long-term capital gain + 3.8% net investment income tax), he would owe $214,200 of tax and take home a net $785,800. $1,000,000 vs $785,800 - a big difference! 


Final Thoughts

While the investments you select are crucial to achieving your long-term personal-financial goals, it is also important to consider the tax characteristics of the account they are within. This will enable you to optimize your money and can make a significant impact over a lifetime. 

When it comes to investments, remember Grandpa Bill's advice: location, location, location!

Please reach out to one of our wealth planners to learn more about how to plan for tomorrow. 



This material is intended for educational and informational purposes only. It is not intended to provide specific advice or recommendations for any individual. Additionally, you should consult with your Financial Advisor, Tax Advisor, or Attorney on your specific situation. The views expressed in the material are that of the author and do not necessarily reflect those of any market, regulatory body, State or Federal Agency, or Association. All efforts have been made to report or share true and accurate information. However, the information may become materially outdated or otherwise rendered incorrect due to subsequent new research or other changes, without notice. The author nor the firm are able to always verify the content from third-party sources. For additional information about the firm, please visit the MAS Website at https://www.mas.gov.sg/ and the SEC Website at www.adviserinfo.sec.gov. For a copy of the firm's ADV Part 2 Brochure, please contact us at info@avriowealth.com.