Planning Your Financial Future
Timing is Everything with Estimated Tax Payments

Estimated tax payments four times per year can create stress and anxiety for many.

Timing is everything in life, and you don’t always have cash when you need it. As a law firm partner, cash distributions from your firm are inconsistent and may not coincide with large cash outflows in your personal life.

Before you dip into your investment portfolio, consider using margin on your non-retirement investment assets to make your tax payment and then pay it off immediately after your next distribution is made. Margin can make sense as a bridge loan to help fund tax payments or daily living expenses until the next partner distribution.

How does it work?

Margin accounts can be setup for almost all non-retirement investment accounts. Assets within the accounts act as collateral and the custodian (ex. Charles Schwab, Fidelity, Vanguard) will loan the owner money based on those assets. Different types of investments provide greater collateral, but a general rule of thumb is 40-50% of the account value can be borrowed. For example, an investment account that is worth $1,000,000 and is invested in a diversified portfolio of stocks and bonds will provide $400,000-$500,000 of borrowing capacity.

Below are a few highlights of margin accounts:

  • Zero cost to setup the account
  • Zero interest is charged if the account is never used (set one up just in case!)
  • Interest accrues daily and the balance can be paid off at any time
  • No pre-payment penalty

What’s the rate?

Each custodian or bank decides the rate they will charge their clients.  Often times the rate is variable so investors are susceptible to rising interest rates. This makes it perfect for short term bridge loans but not smart for long term financing like mortgages. Unlike some big brokerage firms, we do not receive any revenue from the margin interest our clients pay. Most big brokerage firms charge 6-8% on margin balances. We can not disclose our rate, but it is much lower.

Why margin?

Margin is great because it’s quick, easy, and CHEAP! We often see clients using a home equity line of credit to cover cash short falls but margin can be half the cost and offer greater capacity.

Margin is often associated with using leverage to enhance the gains (or losses!) of a portfolio. We don’t recommend that for clients due to the damage a significant market drop can have on the portfolio.

Is it tax deductible?  

We have seen big banks pitch the idea of margin being tax deductible for their clients. Yes, margin interest can be tax deductible IF it’s used for a taxable investment and the interest expense is greater than 2% of an individual’s adjusted gross income. Given the purpose we are recommending, the low cost to borrow, and the high income most partners earn, we rarely see partners deduct the margin interest. Please consult your tax advisor to discuss whether or not margin interest is deductible for you.

Know your options and make the decision that’s best for you

The income for law firm partners is not always predictable so it’s important to understand how to use your assets to fund short term cash needs. Margin is not for everyone, but a simple margin account can save you thousands of dollars in capital gains taxes or high interest debt.

The Benefits of Asset LOCATION in an Investment Portfolio

Did you mean to say asset allocation? That’s usually the response we get from clients when we bring up asset location within their portfolio. Both asset allocation and asset location are important considerations when building an investment portfolio to meet a client’s specific goals. The best way to think about this is that asset allocation is what investments are in the portfolio and asset location is where those assets are located.

Most clients concentrate on asset allocation, or how much they will hold in stocks, bonds, hard assets or alternative assets. It’s one of the first discussions we have with a client as we dive into their risk tolerance and expected cash needs and retirement goals, and it’s certainly the most important decision.

But we go the next step for our clients by taking into consideration where those assets should be held within their portfolio. Why? Two important reasons. Asset location may potentially increase portfolio return reduce taxes.


Benefits of Asset Location

Since most client portfolios include several different types of accounts like joint accounts, 401ks, IRA rollovers, and Roth IRAs; asset location considers where and how investments are populated throughout these accounts. The goals, tax benefits, and investment options are all different for these account types, and it’s important to consider that when deciding which account should hold what assets.

Asset location is also client specific, and the goals will vary depending on their age and time horizon. To understand this better, let’s look at a few examples and take the easier (and more conventional) situation first:


Example Situation #1: Married couple, both age 40, 3 kids under 10 years of age, ok with moderate/aggressive risk

Let’s assume that this couple’s portfolio includes taxable accounts, they both have 401ks with their current employers, and they have two IRA accounts.

Their retirement accounts (401ks and IRAs) would be invested more aggressively because they have a longer time horizon than the taxable accounts.

From there, we look at the investment selections within their 401k and IRA accounts. It’s likely that the 401k accounts have limited investment options, so we take the best, lowest cost options available there. IRAs offered by custodians like Charles Schwab, Fidelity or Vanguard typically have unlimited investment options that may include more complex investments typically not offered by a 401k. We will use the more generous investment selections within the IRA to manage around the more limited options in the 401k. This provides diversification and reduces duplication within the various accounts.

For this family, it’s likely that some big ticket expenses like funding private school education, college expenses, or purchasing a house are on the horizon, so it would not make sense to take unnecessary risk in their taxable accounts.

The asset location example above is more conventional: risky assets in the retirement accounts and conservative investments in the taxable accounts.

Now let’s look at a situation we frequently see at Glassman Wealth Services:


Example Situation #2: Married couple, both age 62, 2 independent children, ok with moderate risk

Many of our clients are near retirement when they join us, and they want their portfolio to cover their retirement needs over the next 20-30 years. At this point, we look at all of their accounts as one large portfolio with moderate risk.

Our goal is to create the highest after-tax return on the portfolio while taking into consideration any expected cash needs from the portfolio.

We evaluate every investment we’re adding to the portfolio based on the following criteria:

  1. expected return over the next 3-5 years
  2. historical tax efficiency (i.e. how much taxable income or capital gains did the investments distribute)
  3. anticipated capital gain distributions in the next 12 months


We populate the retirement accounts with the higher growth, tax-inefficient investments. We also prefer to add high yield bonds to the retirement accounts as well. While yields can vary greatly, these funds are currently yielding ~6% of ordinary income, so locating these types of investments in their retirement accounts may greatly reduce their tax bill. Other income generating investments like REITs (Real Estate Investment Trusts) and MLPs (Master Limited Partnerships) are other examples of investments to locate in IRAs.

The taxable accounts will be populated with a combination of municipal bonds, conservative investments, or investments that don’t generate a lot of taxable income.

The result of our asset location efforts is a portfolio designed to provide our clients with the proper risk allocation in the most tax-efficient manner.

Roth IRA and Asset Location

A Roth IRA plays a special role within a portfolio because the assets grow tax-free with after-tax dollars. These will likely be the last dollars that we recommend our clients tap, so this allows us to take some additional risk in the portfolio due to the extended time horizon. We include the Roth IRA in the total portfolio, but we use asset location to populate these accounts with more aggressive stock funds.

Enhancing After-Tax Returns with Asset Location

A lot of individuals and some advisors choose to look at each account separately, or they just fill the retirement accounts with their more aggressive assets. We think this is a lost opportunity. Instead, take the time to look at your accounts collectively, and use asset location to enhance the after-tax return of your investment portfolio.

Does your financial advisor consider asset location when creating your investment strategy? How important do you think asset location is to your investment goals?

Tax-Smart Ways to Give to Charity

Before writing a check to your favorite charity, consider the tax advantages of gifting appreciated assets, like stock, instead.

The soaring U.S. stock market of the past few years has been great for portfolios; however, taxes will need to be paid on any realized gains. If you are philanthropic or gift an annual amount to a charity, it may make more sense to use those appreciated assets in your portfolio to support those causes.

You can donate almost any appreciated security held for longer than one year within a taxable brokerage account and receive the same tax deduction you would get if you donated cash. (There are some restrictions summarized below.) You save because there are no capital gains realized when you gift the security. Given the high income earned by many top attorneys, the financial benefits from the charitable deduction and reduction in capital gains tax can be significant.

Here’s how gifting appreciated assets works:

John & Jane Smith are generous supporters of the American Heart Association and donate $100,000 to them each year.

They own appreciated shares of Apple stock (ticker: AAPL) with a market value of $100,000 and a cost basis of $5,000. The stock is owned in their joint investment account and has been held for 10 years.

Option 1: They sell the shares and donate the cash.

Assuming a 20% federal capital gains tax and 3.8% Medicare net investment income surtax, the Smith’s would owe $22,610 in tax when they file their return. They would receive a deduction of $100,000 for their cash donation.

Option 2: Donate their Apple stock directly from their investment account to the American Heart Association.

The Smiths still receive the full $100,000 deduction, but in this case, no capital gains tax is due. That’s a $22,610 savings while accomplishing the same objective!

Note: Almost all charities and organizations will be able to provide you with transfer instructions for securities. This analysis does not take into consideration state capital gains taxes.

Limitations on charitable deductions:

There are limitations to the amount an individual or couple can deduct from their adjusted gross income (AGI) for their charitable gifts in each calendar year. Below is a summary that applies:


Keep in mind, if your charitable gifts exceed these limits in a calendar year, they can be carried forward for five years.

Big income year strategies:

If you have had a larger than normal income year and anticipate making annual gifts over the next several years, we generally recommend establishing a donor-advised fund (DAF) to reduce your tax hit in the high-income year.

Donor-advised funds are offered through companies like Schwab and Fidelity and eliminate many of the administration expenses and hassles of a foundation. They allow you to donate appreciated securities to the DAF and receive a tax deduction in the calendar year the gift is made. You then distribute your annual gifts in future years to qualified 501 (c) (3) charities from your DAF.

This can be useful for individuals realizing significant income or capital gains in a calendar year, from things like selling a business or completing a Roth IRA conversion. This is also useful for attorneys nearing retirement but not yet age 70 ½, the age at which required distributions from retirement accounts begin. The deduction is more valuable while earnings are high.

Additionally, donor-advised funds can receive illiquid investments as well including investment properties, vacation homes, private equity investments, or even portions of a privately held company (assuming there is another buyer in place).

Learn more about donor-advised funds through Schwab Charitable.

Impact on your investment portfolio:

If you own highly appreciated securities, chances are that they may affect the balance of assets in your portfolio by over-weighting certain asset classes. We often see this with our own clients. Gifting those securities may restore your intended target allocation without suffering any tax consequences that may be caused by rebalancing your portfolio. If there is a security our client loves, we typically recommend gifting the security and then re-purchasing the stock to reset the cost basis.

Giving back is one of the most selfless and satisfying acts that anyone can do. As you set out to make a difference by making a donation, we recommend that you speak with your financial advisor first. Structured correctly, the impact you make may cost you far less.

Four Reasons You Should Consider a Revocable Trust

A revocable trust is considered a more effective estate planning tool than just a Last Will and Testament for several reasons. A revocable trust gives the grantor an orderly way to distribute their assets upon their death and privacy for themselves and their heirs during the process. We’ll explain what it is and why you should consider putting one in place.

What is a Revocable Trust?

A revocable trust is a trust created during an individual’s life that can be changed or terminated at any time. The individual that creates the trust is called the grantor, the trustor, or the settlor. In most cases, the grantor is also the trustee of the trust as well as the primary beneficiary of the trust during their lifetime.

What does it do?

  1. Ensures privacy:The main purpose for a revocable trust is to avoid probate, the legal process of distributing assets of a decedent at death. Why? Because the probate process which includes taking an inventory of assets, notifying and paying creditors, etc., is made available to the public. By avoiding probate, the privacy of the grantor and their beneficiaries is protected. 
  1. Adheres to the wishes of the grantor:Similar to a will, a revocable trust will provide a thoughtful distribution of their assets to their heirs. The trust document can be amended an unlimited number of times, so the distribution of assets can be changed as the grantor ages or additional assets are acquired. At the death of the grantor, a trustee named in the trust document will work with the executor of the estate to follow the guidelines of the trust document.
  1. Creditor protection for beneficiaries:While revocable trusts do not provide creditor protection for the grantor, they do for the beneficiaries of the trust, but only if the assets remain in the trust upon the passing of the grantor.
  1. May reduce state estate taxes:For families living in a state with an additional estate tax, a well-written revocable trust may provide significant value by reducing state estate taxes.


What doesn’t it do? 

  1. No tax benefits:There are many misconceptions about revocable trusts, the biggest being the purpose and benefit of a revocable trust for estate tax purposes. It does not have any benefit for estate tax purposes or even taxes during a grantor’s lifetime. In the eyes of the government, assets held within a revocable trust are the same as if they were held in the individual’s name. 
  1. Fund itself:A revocable trust does not fund itself by merely creating the trust documents. To take advantage of the benefits listed above, account registration must be changed on each account owned by the grantor.

Many estate attorneys recommend a “pour over” will. Upon the grantor’s death, it will collect and transfer all additional assets (jewelry, cars, etc) into the revocable trust so that no assets go through probate.

  1. Eliminate the federal lifetime gifting and estate tax exemption:Moving assets into a revocable trust is not considered a gift and does not affect an individual’s federal lifetime gift or estate tax exemption, currently at $5,450,000 per person in 2016.


Should I have a revocable trust?

If you’re concerned about your assets going through probate or the need for privacy, for you or your beneficiaries, we recommend that clients discuss a revocable trust with their estate planning attorney.

Additional reasons one might consider a revocable trust include: 

  1. If you have assets in more than one state:Without a revocable trust, assets, including real estate, that are held in more than one state would be subject to a separate probate process for each state.
  1. If you have a complex collection of investments:including real estate, artwork, and other assets that would be difficult for beneficiaries to distribute.
  1. Planning for future health concerns.Assets held in the name of a Revocable Living Trust at the time a person becomes mentally incapacitated can be managed by their Disability Trustee instead of a court-supervised guardian or conservator.


We recommend that any investor with significant assets or assets in more than one state contact their estate planning attorney to review the benefits of this important estate planning tool.

Understanding Your Cash Balance Plan

The Basics

A cash balance plan is simple; the plan accumulates a cash value for every year of employment. Your employer adds two “credits” to the account each year. The first is a pay credit – a fixed percentage of your salary or a specified dollar value. The second is an interest credit – a fixed or variable rate of return on your account value. You get two credits once a year, every year. The plan is provided to you at no additional costs. As soon as you become an eligible employee, your company begins funding a cash balance plan. These are the basics, but, as you’ll see, the benefits are substantial. The value of a cash balance plan cannot be understated, especially for those with partial firm ownership.

Income Deferral

Attorneys owning part of a firm have the ability to defer a substantial amount of their paycheck to the cash balance plan each year. A cash balance plan falls under the definition of a defined benefit plan, not a defined contribution plan. A defined contribution plan limits how much can go into a 401(k) each year, $53,000 a year for 2016 ($59,000 if age 50+). A defined benefit plan only limits your potential yearly benefit in retirement, $210,000 a year in 2016. In other words, you are only limited in the amount you defer when your account can provide $210,000 a year benefit in retirement. This is a huge advantage! If your employer offers a 401(k) or 401(k) plus profit sharing, your retirement savings could be even more. To illustrate this point, take a look at the examples below for a 55 year-old equity partner (2016)1:

Example 1 – 401(k) plus profit sharing

  • Maximum pre-tax deferral: $24,000
  • Maximum profit sharing contribution: $35,000
  • Total retirement savings: $59,000

Example 2 – Cash balance plan and 401(k) plus profit sharing

  • Maximum cash balance pre-tax deferral: $180,000
  • Maximum pre-tax deferral: $24,000
  • Maximum profit sharing contribution: $35,000
  • Total retirement savings: $239,000

 1Plan limits here

IRS Regulations

It is important to be aware of the IRS testing guidelines ensuring retirement plans don’t cater too much to highly compensated employees. You may not be able to put away as much as you see above because the more the partners put away for themselves, the more they must provide for non-partner employees. Everything will be predicated on your firm’s plan documents; check with your HR department to find out the plan specifics. Regardless, the illustration should give you an idea of how much additional benefit a cash balance plan can provide, especially for those with a stake in the firm.

Owners of the firm are required to keep the plan at a certain balance as mandated by the IRS. An actuary for the plan will provide the value the plan must maintain in order to meet IRS guidelines. Owners are responsible for adding additional dollars to meet the benefit promised by the aforementioned yearly credits (i.e. the plan must be able to payout the credits promised to employees).

Leaving the Firm or Retiring – Now What?

The annuity payout is the default option for cash balance plans. Annuities come in three basic forms: single-life, joint-and-survivor, and period-certain. If you decide to take an annuity payout, be sure to evaluate the pros and cons of the three options. Nearly all plans offer a lump sum rollover to an IRA or 401(k). Both rollovers are a non-taxable event. This portability is a huge advantage over traditional pensions that often require waiting until at least age 59 ½ before doing anything, regardless of employment status. Whether you are at retirement or changing firms, an IRA rollover is one of your options.

Understand Your Firm’s Plan

We encourage you to learn more about the specifics of your plan by checking in with your HR department. The terms of each cash balance plan often differ from firm to firm. For example, a cash balance plan requires eligible employees be vested in three years or less. It’s important to know these details before doing anything with your plan.

That’s it. Glassman Wealth is dedicated to educating partners on their finances and retirement benefits. If this summary leaves you with questions, give us a call, and we will fill in the blanks.


Things to Consider When Your Firm’s Cash Balance Plan Terminates

Law firms can terminate their cash balance plans for several reasons, and many of these can be positive for the law firm and the partners. As firms grow and assets within the cash balance plan grow, the financial liability a firm has to its partners and employees can be significant.

Not sure what a cash balance plan is? Click HERE to learn more about what it is, the benefits, and the opportunities.

When you receive a plan termination notice from your law firm, review your payment options, and make the decision that is best for you. That decision may be different than the partner in the next office or the 5th year associate on your floor. Don’t we swayed by other people’s choices.

Below is a list of typical distribution options, but keep in mind that each plan is different. Speak with your HR department with specific questions about your plan.

Annuity: The annuity payment is based on current annuity rates, the age of the participant, and whether it’s a single-life, joint-and-survivor, or period certain annuity. A joint-and-survivor annuity means the surviving spouse receives a benefit upon the death of the initial annuitant. In fact, the spouse will need to authorize (by notary) any distribution method that is not a joint-and-survivor annuity.

A lifetime annuity is great for people looking to lock-in their retirement income, are healthy with longevity in the family, and are concerned that they will outlive their money. Historically low interest rates have reduced lifetime payments, so this option is not as attractive as it was 10+ years ago.

Lump sum rollover to another qualified retirement plan: Rolling the lump sum payment to a 401(k) is a non-taxable event that accomplishes several things. The distribution puts all of the money in the control of the participant and that person makes investment decisions moving forward. Investment allocations can be rebalanced to an appropriate risk level based on the individual participant. The downside to this? The guaranteed return from the cash balance plan and lifetime income guarantee from an annuity are gone forever.

This option is ideal for participants looking to simplify their retirement savings and have all of their retirement dollars in one account.

Lump sum rollover to an IRA account: Moving the distribution to an outside IRA provides the greatest amount of flexibility for investments. Similar to the 401(k) rollover, this is not a taxable event and will allow the dollars to grow tax deferred until retirement or age 70 ½, when required minimum distributions begin.

Investing the dollars in an IRA opens up investment options such as individual stocks or bonds, mutual funds, or even illiquid investments like hedge funds or private equity. This can be a tremendous benefit to investors who qualify.

Using an IRA may be the proper option for participants looking to control their investment portfolio, and they are not happy with the investment options within their 401(k) platform. IRAs can be opened at many low-cost custodians such as Charles Schwab, Fidelity, and Vanguard among others.

The RIGHT move for you? All three of these common termination options can be the right fit for different clients. Consider what’s important to you and your family, your current financial situation, and how involved you intend to be with your investments.

STILL not sure? Feel free to give me a call for an objective discussion about what’s best for you.

4 Reasons You Should Consider a Roth 401k

Putting money aside for retirement in your firm’s 401k plan is a great decision, and some firms give you a choice – save in a traditional 401k or a Roth 401k.

Most people know how a traditional 401k works. Your retirement dollars grow tax-deferred on income that you contribute, and you pay taxes when you withdraw your money in retirement. Unless you are still working, participating in the firm’s retirement plan or own greater than 5% of the company, Uncle Sam wants his money. You must make Required Minimum Distributions (RMDs) starting at age 70 ½.

The problem is that many high earning attorneys, or those on their way, will likely be in the top tax bracket even after retirement when they consider any pensions, investment income or other income accumulated along the way. That means any deferred income put into a traditional 401k will be taxed at the highest rates.

The annual 2015 contribution limit for the Roth 401k is the same as the traditional 401k – $18,000 plus up to an additional $6,000 for those over age 50, and the investment options are the same for both. The similarities end there.

The Roth 401k has a few distinct advantages over a traditional 401k for high earning partners:

  1. There is no income limit to making Roth 401k contributions unlike Roth IRAs which are phased out at higher income levels. Partners are generally phased out of Roth IRA contributions because of their income.
  2. While the deferred income is taxed before going into the Roth 401k, the growth on that money is tax free.
  3. Roth 401ks can be rolled into Roth IRAs upon retirement or leaving the firm.
  4. Best of all, since there are no required distributions from Roth IRAs upon reaching age 70 1/2, there are more opportunities for planning.

For instance, partners may want to consider the benefits of asset location when reviewing their portfolio allocation. One tactic is to place more aggressive assets within the Roth because these will be the last dollars they should tap in retirement. Individuals can use the long time horizon of the Roth 401k to their advantage and withstand the added risk in this account. To understand how this works, I recommend that you read: The Best Way to Minimize Taxes With Asset Location.

Not every firm offers a Roth 401k option, and if your firm does, you have a unique opportunity to diversify your future retirement income. It could play an important part in helping to reduce your future taxes and provide planning options for your family.

Welcome to More (and More Complicated) Taxes! What You Need to Know Now

Congratulations! You finally made partner at an esteemed law firm. It’ a significant accomplishment. Along with the added responsibility, additional workload and higher compensation comes a more complex tax return. You can now expect to make quarterly estimated tax payments, file a K-1, and possibly file additional state returns.

Each law firm issues their K-1 at different times, so check with your HR department to get an idea of when to expect yours. Most likely, you will need to file an extension because it won’t be available until after April 15th.

The biggest change is the move from a W2 employee (with regular paychecks and tax withholding) to becoming a partner with distributions throughout the year. When making this transition, it’s important to prepare for the “lumpiness” of your cash flow as you may be paid larger lump sum amounts at various times throughout the year. I recommend that you prepare a budget and set aside enough cash for every day expenses for several months. Next, make sure you have cash available for quarterly estimated tax payments when they come due in January, April, July, and October. This often causes the need for additional tax planning so it may make sense to use a tax accountant, if you’re not already. Don’t stress the changes, but just make sure you prepare. Give yourself a “safety net” and build a cash reserve to cover any unexpected expenses as you get comfortable with your new normal.

The next wrinkle to your tax return is the extra state filings that may be required. No longer must you just file your federal return and a state return of your primary residence state. Now that you are a partner at your firm, taxable activity in other states the firm does business in will flow through to your tax return. Speak with your CPA to determine which state returns are necessary.

If you didn’t use an accountant before becoming a partner, this big promotion may be the reason to evaluate other options. Tax planning and additional state filings are now more important than ever.

6 Things Every Young Partner Should Do To Increase Their Wealth

Being a younger partner at many law firms comes with tremendous pressures. There are demands on time, expectations of becoming a rainmaker, and even feeling the need to spend more of your new larger annual income on upgrades like a bigger home or fancier car. Before you increase your expenses, check out these tips to simplify your finances and increase your wealth:

  • Keep a budget: Becoming a partner can take your annual bi-weekly pay check and turn your cash flow into lumpy distributions throughout the year. Estimate your annual cash needs and make sure you have a cash cushion to get through the variability. Start with a conservative budget and treat yourself when things turn out better than planned!
  • Maximize retirement savings: If you aren’t already, make sure you’re maximizing the retirement savings for you and your spouse. Even if you’re maximizing your contributions, it may make sense to begin making Roth (post-tax) contributions.
  • Protect your family: Extra earnings over the last few years may have changed the lifestyle and needs of your family. Make sure you are properly covered for both life and disability insurance. This may be in addition to the insurance required by the law firm.
  • Eliminate monthly credit card debt: Credit cards can be a great thing when used properly. Make sure your credit card debt doesn’t grow as you attempt to spend like older partners. Pay off your credit card debt each month. If you have an original balance, come up with a plan to pay it off as quickly as possible.
  • FINALLY get rid of those student loans: You may have accumulated significant debt during undergraduate and law school. It’s never fun, but make sure this debt is addressed before any large, unnecessary expenses are incurred (second home, a more expensive car, a boat – you get the idea). This debt will never go away unless there is a plan in place to take care of it!
  •  Eliminate mortgage insurance: If you purchased a home with less than 20% down, you may be paying mortgage insurance in addition to your principal and interest. Take part of your partner distributions to get rid of this extra payment. Keep in mind, you may need to call your mortgage company to eliminate this payment.

It’s tempting for young partners to reward their long hours at the office with additional luxuries. There’s certainly nothing wrong with that as long as they fit into your overall financial plan. Start by doing these six things to simplify your finances.

You’ll feel better when you do make the decision to splurge because you will know you can afford to.

 Read: Top 3 Financial Apps for Managing Your Money

Great Strategy to Maximize Returns, Minimize Taxes, and Reduce Expenses

Location, location, location. No, I’m not referring to real estate, but to asset location. Most investors are familiar with asset allocation, but may not have been introduced to the power of asset location.

Asset allocation and asset location are important considerations when building an investment portfolio and most investors concentrate on asset allocation, or how much they will hold in stocks, bonds, hard assets or alternative assets. On the other hand, asset location considers where those assets should be held within their portfolio. Why? For several important reasons:

  1. Potentially increase portfolio returns
  2. Reduce taxes
  3. Reduce trading costs

Your portfolio may include several different types of accounts like joint accounts, 401ks, IRA rollovers, and Roth IRAs. For those who have started to think through estate planning, the portfolio may also include revocable trusts or even irrevocable trusts with assets outside of the estate. Asset location considers the most advantageous location for each investment as they are populated throughout the accounts within your portfolio. The goals, tax benefits, and investment options are all different for these account types, and it’s important to consider each when deciding which account should hold what assets. Think about high yield bonds. Do you own any of those in your portfolio? If so, consider putting these funds in your IRA so you’re not paying income tax on the 6% yield each year.

Asset location is one strategy that is client-specific, meaning that the goals will vary depending on each client’s age and time horizon. Even so, the result of these efforts share a common goal – provide clients with the proper risk allocation in the most tax-efficient manner.

Roth IRA and Asset Location

A Roth IRA plays a special role within a portfolio because the assets grow tax-free with after-tax dollars. These will likely be the last dollars that we recommend our clients tap, so this allows us to take some additional risk in the portfolio due to the extended time horizon. We include the Roth IRA in the total portfolio, but we use asset location to populate this account with more aggressive stock funds.

Enhancing After-Tax Returns with Asset Location

A lot of individuals and some advisors choose to look at each account separately, or they just populate the retirement accounts with more aggressive assets. We think this is a lost opportunity. Instead, take the time to look at your accounts collectively, and use asset location to enhance the after-tax return of your investment portfolio. You may already have the proper asset allocation, but are you paying unnecessary taxes?

Interested in learning more? Read: The Best Way to Minimize Taxes With Asset Location