Location, Location, Location.

Location of your assets matters, both for you and your heirs. Optimal asset location is a crucial strategy that should be utilized in every comprehensive financial plan. The main benefit clients can expect from a fully optimized asset location strategy is increased in after-tax return, also known as tax alpha. Additionally, clients can ensure their heirs inherit the estate in the most tax efficient manner possible. 

In general, accounts should be invested as follows: 

• Roth accounts (tax-exempt): Your Roth account should be invested primarily in stocks, as this is the last place you should theoretically take money from. It should be growth-oriented, given that it typically has the longest investment horizon, and can be passed down to your heirs tax-free. 

• IRAs (tax-deferred): If your investment strategy includes bonds, the IRA should be the first account to hold them. Interest generated from debt securities is taxed at ordinary income rates. The benefit of holding these securities in your IRA is that this income is sheltered from taxation until you withdraw funds at retirement. Limiting the use of growth-oriented equities in your IRA can make Required Minimum Distributions (RMDs) more manageable from a tax planning perspective. Additionally, this approach reduces the likelihood of your beneficiaries inheriting a tax-inefficient estate. 

• Taxable account: Any equity that does not fit into your Roth should be allocated to your taxable accounts. Growth in a taxable account is taxed at favorable capital gains rates, rather than the ordinary income rates applied to IRA withdrawals. If your IRA does not have enough room for all the bonds in your portfolio, allocate the remainder to your taxable account. Tax-sensitive clients may also consider holding state-specific municipal bonds, where the interest is exempt from both state and federal taxes.  

From an estate planning perspective, the Roth is one of the most useful accounts you can hold. Beneficiaries will inherit the account tax-free, often during their peak earning years.  

Taxable accounts are also very valuable for estate planning. When your heirs inherit these accounts, they receive a step up in cost basis. This means the embedded capital gains are reset, and the beneficiaries will inherit the securities with significantly reduced unrealized tax liability. Establishing a revocable trust is one of the best ways to pass taxable accounts to your heirs, as it can help avoid probate. 

IRAs and other tax-deferred accounts are the least tax-efficient investment accounts to pass down to beneficiaries. Your heirs will inherit the obligation to liquidate these accounts within a 10-year period and will be required to pay taxes on withdrawals. In low-income years, it may be beneficial to convert some of your IRA into a Roth, with the goal of reducing your heirs’ tax burden in the future. It would be prudent to discuss with your financial advisor to determine if Roth conversions are right for you.  

In conclusion, optimal asset location can have a significantly positive impact on both you and your heirs. Research has shown that it can increase your after-tax return while helping you build a tax-efficient estate to pass down to those you care about. 

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Disclosures: 

Apella Capital, LLC (“Apella”), DBA Apella Wealth is an investment advisory firm registered with the Securities and Exchange Commission. The firm only transacts business in states where it is properly registered or excluded or exempt from registration requirements. Registration with the SEC or any state securities authority does not imply a certain level of skill or training. Different types of investments involve varying degrees of risk, and there can be no assurance that the future performance of any specific investment, investment strategy, product or any non-investment-related content made reference to directly or indirectly in this material will be profitable, equal any corresponding indicated historical performance level(s), be suitable for your portfolio or individual situation, or prove successful. Due to various factors, including changing market conditions and/or applicable laws, the content may not be reflective of current opinions or positions. Please note the material is provided for educational and background use only. Diversification seeks to improve performance by spreading your investment dollars into various asset classes to add balance to your portfolio. Using this methodology, however, does not guarantee a profit or protection from loss in a declining market. Past performance does not guarantee future results. All data is from sources believed to be reliable but cannot be guaranteed or warranted.   

No current or future client should assume that any discussion or information contained in this material serves as the receipt of, or as a substitute for, personalized investment advice. As with any investment strategy, there is the possibility of profitability as well as loss.   

Apella Wealth does not provide legal advice or tax advice, and the information provided is general in nature and should not be considered legal or tax advice. Consult an attorney, tax professional, or other advisor regarding your specific legal or tax situation.