Asset location is a an investment strategy that is used to minimize the impact of taxes on one’s portfolio. If you properly use asset location, you could potentially lower your tax liability when it comes to your investments. Here are the basics of asset location and how it works.

Asset Location

As the name implies, this strategy is going to determine where your investments are located. You can put them in a traditional investment account with a brokerage firm or you could put them in a tax-advantaged retirement account such as a 401(k) or an IRA. If you put something in your IRA or 401(k), you are not going to have to pay taxes on it until you start withdrawing the money at the age of 59 1/2. With the investments that are in your brokerage account, you are going to pay the taxes on the profit in the year that it is incurred. This means that you want to try to put the investments that have the lowest tax rates in your investment account and that the investments with the highest tax rates in your retirement account. By doing this, you are going to be able to maximize your profit and minimize the impact of taxes on your overall portfolio. This is best used as a long-term approach to investing and to help you overall.

Equities vs Fixed Income

An important concept for you to understand with asset location is the difference between equities and fixed income tax rates. Equities are going to have fewer taxes for you to pay when compared to fixed income investments. When you invest in stocks, you are going to be able to make money from the appreciation in the value of the stock and from dividends. When you are paid dividends, you are going to pay 15 percent taxes on them. When you receive interest payments from fixed income investments, you are going to pay taxes on the interest at your full marginal tax rate. If you are in the highest tax bracket, this means you are going to be paying 35 percent tax on that amount. Therefore, in this case, you will want to keep your fixed income securities in your tax-advantaged account and keep the equities in a traditional stock brokerage account.

Retirement

If you are old enough to start withdrawing from your retirement account, you will want to think about another aspect of asset location. For example, let’s say that you earned $10000 from capital gains and dividends for the year. If this money was earned in your retirement account and you withdraw it, you are going to pay taxes on the money at your marginal tax rate. If you were in the highest tax bracket, you have to pay $3500 in taxes on this amount. If you held that same stock in a traditional investment account, you would only have to pay 15 percent in taxes or $1500. Therefore, you have to consider where you invest once you reach retirement age.

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