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If you're an investor, you've probably heard of the 60/40 rule. Long seen as a tried-and-true way to invest in the stock market, this approach suggests allocating 60% of a portfolio to stocks for growth and 40% to bonds for income and stability.
The idea sounds simple, but it's missing a crucial part of the investing equation: Where you hold those investments can matter just as much as what you invest in.
You could have the same overall mix of investments and risk level in a variety of accounts, but you could get a more tax-efficient long-term outcome by putting the right assets into the right accounts.
By being more intentional about what investment goes where, you're not changing the level of risk, but being more intentional about tax treatment and how distributions may be taxed over time. In other words, tax diversification is as important as investment diversification.
Every investment account you own likely falls into one of three main tax categories, or what we call "tax buckets." Having money spread across these three buckets provides tax diversification, giving you the flexibility to draw income from a variety of sources in retirement.
If tax rates rise in the future, you can draw income from your Roth. If they fall, you might pull money from your pre-tax accounts. Managing which bucket you pull from each year can also help control your taxable income and prevent surprises with Medicare premiums or Social Security taxation.
One of the best examples highlighting the importance of asset location involves annuities. These guaranteed income sources are often misunderstood, and part of that confusion comes from the assumption that annuities should be funded with after-tax money because they provide tax deferral.
But that strategy can create problems. If you use after-tax dollars, all your gains inside the annuity are taxed as ordinary income, not the lower long-term capital gains rate. Your beneficiaries don't get a step-up in cost basis, and if you're under age 59½, you could face a 10% penalty on withdrawals.
On the other hand, if you fund the annuity with pre-tax money inside an IRA, those issues go away, because the tax rules naturally align as both are tax-deferred and fully taxable at withdrawal.
Asset location also helps avoid one of the biggest surprises facing retirees when they reach their early 70s: required minimum distributions.
Traditional wisdom says to save diligently in pre-tax accounts under the assumption that you'll pay lower taxes in retirement. But for many, that's not how it plays out. Instead, they face forced withdrawals that can push them into higher tax brackets, increasing Social Security taxation, even raising Medicare premiums. This is why tax diversification and strategic Roth conversions can be so powerful.
Asset allocation still matters, but asset location determines how much of your return you get to keep. By understanding how different accounts are taxed and aligning your investments accordingly, you can make your money work more efficiently without necessarily taking on more risk.
If you're not sure whether your investments are in the right places, now may be a good time to review your strategy. A financial adviser can help you uncover those opportunities, evaluate strategies that may improve tax efficiency over time, and support your overall retirement plan.
Conversations around your finances and estate should never occur separately. At Blue Ridge Wealth Planners, we take the complexity out of financial planning, helping clients create a plan for everything, from investments, income, taxes, healthcare and your legacy.
Disclosures: The information contained herein and any opinions expressed are provided for informational purposes only and should not be construed as a solicitation to buy or sell any security, or as personalized investment, tax, or legal advice. Originally published at https://www.kiplinger.com/retirement/investing/think-location-with-investments.
As a former football player at the University of Tennessee under Coach Phillip Fulmer and a high school state champion wrestler, John Vandergriff brings a team-first mindset and disciplined approach to serving clients at Blue Ridge Wealth. After spending five years in ministry and coaching, he joined the firm in 2012 and has since become a trusted advisor and leader, helping individuals and families pursue their financial goals with clarity and confidence.
John is a dually licensed Insurance Agent and Investment Advisor Representative. He holds a Bachelor of Arts in Psychology from the University of Tennessee, combining his understanding of people with a thoughtful, relationship-driven approach to financial planning.
Outside the office, John remains active in his church through teaching and enjoys golfing, exercising, watching sports, and spending time with his wife, Ashley, and their two children.
