The importance of asset location

Commentary by Joel Harris 

As we embark on setting our goals for 2014, it might be a good idea to take a closer look at the asset location of your investments. Many of us have heard about the benefits of asset allocation, a theory in which a person invests his or her money in several asset classes in an attempt to provide the greatest return potential over time.

This is all based on the person’s level of risk tolerance, time horizon and investment objectives.

But what about asset location?

The idea behind asset location is placing various investments in different types of accounts to help minimize taxes. One of the most often overlooked aspects of short- and long-term financial planning is minimizing taxation through careful asset location.

In the new year we will be inundated with ads on TV, radio and the Internet about taxes. Yes, that dreaded word we all loathe … taxes.

Instead of going through the motions and rushing to the post office on April 15, I challenge you to take a really close look at where your investments are located.

With the equity markets having an outstanding year in 2013, many commonly held investments will pass on short- and long-term capital gains to investors. These hidden tax bombs can really wreak havoc in a taxable brokerage account.

When you do your asset location analysis, focus particularly on the turnover ratio of your investments. Some investments can have upwards of 200 percent turnover in a given year. That means the capital gains exposure could be quite significant.

Why is that important? More than likely, you will receive a 1099 in February from your brokerage custodian because the capital gains were passed on to you as the shareholder, even if you didn’t sell any shares that given year.

Instead of owning investments with high turnover inside a taxable brokerage account, wouldn’t it be more tax advantageous to own passively managed exchange traded funds? It is certainly something to consider, and it should be closely examined with your financial professionals.

Additionally, taking advantage of tax-deferred accounts should be a priority. Taxation on your investments is the closest thing to acid rain for your money. It is imperative to keep an umbrella over your investments through the use of tax-qualified accounts such as 401(k)s, traditional and Roth IRAs, SEP IRAs, and even tax-deferred annuities.

The compounding effect of money in tax-qualified accounts is profound, so take a close look at these accounts when you analyze your asset location.

In 2014, you will be allowed to contribute up to $17,500 into your 401(k) accounts, plus an additional $5,500 if you’re over age 50. The 2014 contribution limits on traditional and Roth IRAs will be $5,500, plus an additional $1,000 if you’re over age 50.

Keep in mind that you still might qualify to contribute up to $5,500, plus an additional $1,000 if you’re over 50, into your IRAs for the 2013 tax year. You have until April 15 to take advantage of this potential tax savings. Please consult with your financial and tax professionals to see if qualify.

Happy New Year!

Joel Harris is a local Independent Financial Advisor with TFA. He can be reached at joelharris@tfamail.com or at 507-1825.