Tax Location: A Crucial Component of Retirement Success
Tax Location: A Crucial Component of Retirement Success
Are you wondering, "Am I going to be okay?" or "When can I retire?" At Trailhead Planners, we understand these concerns and specialize in helping you navigate the complex world of retirement planning. One of the most powerful tools in our arsenal is tax location - an often overlooked strategy that can significantly impact your retirement success.
What is Tax Location?
Tax location is a strategic approach to maximizing after-tax spending and wealth in retirement. It involves placing different types of investments in the most tax-advantageous accounts. As tax-savvy retirement planners, we at Trailhead Planners offer this valuable service to optimize your retirement portfolio.
The Three Tax Buckets
1. Deferred Accounts: These grow tax-deferred, with income tax due upon withdrawal.
2. Roth Accounts: Essentially tax-free, as growth, income, and withdrawals are not taxed.
3. Taxable Accounts: Income from dividends, bond interest, and capital gains are taxed in the current year.
The Tangible Value of Tax Location
Recent research by Vanguard (2022) has quantified the significant impact of tax location strategies on retirement portfolios. According to their findings:
- A thoughtful asset location strategy can add between 5 to 30 basis points (0.05% to 0.30%) of after-tax return annually compared to an equal-location strategy (Padmawar and Jacobs, 2022).
- This additional return can compound over time, potentially leading to substantially higher retirement savings.
The value of tax location is particularly pronounced for:
1. Investors in higher tax brackets
2. Those who plan to leave a larger portion of their taxable account as a bequest
3. Investors with more balanced asset allocations (i.e., a significant portion allocated to both stocks and bonds)
These findings underscore the importance of working with a retirement planner who understands and implements effective tax location strategies.
Optimizing Your Retirement Accounts
What Should IRAs and Other Deferred Accounts Hold?
Deferred accounts are ideal for income-producing assets:
- Bonds
- High dividend-paying stocks
- International shares
- Alternative asset classes (REITs, TIPS, managed futures, commodities)
What Should Roth IRAs and Roth 401ks Hold?
Roth accounts are perfect for assets with high growth potential:
- Stocks, especially small-cap value and emerging markets stocks
What Should Taxable Accounts Hold?
Taxable accounts are best for:
- Core domestic stock exposure (e.g., U.S. Large-cap stocks)
- Municipal bonds (if liquidity is needed)
- Tax-managed or index-based stock allocations
The Trailhead Planners Approach to Tax Location
At Trailhead Planners, we believe in a holistic approach to financial planning. Our tax-focused retirement strategy services include:
- Cash flow planning
- Legacy planning
- Investment management
- Developing a lifetime income plan
- Lifetime tax bill reduction strategy
We coordinate your investment strategy with your retirement goals, ensuring that tax location plays a crucial role in maximizing your wealth.
Why Tax Location Matters
Implementing an effective tax location strategy can:
- Reduce your overall tax burden
- Increase your after-tax returns
- Provide more flexibility in retirement spending
- Potentially extend the life of your portfolio
The Vanguard study (Padmawar and Jacobs, 2022) found that for most investors, the conventional strategy of placing bonds first in tax-advantaged accounts (particularly traditional IRAs) and equities in taxable accounts remains wealth-maximizing. However, the optimal strategy can vary based on individual circumstances, highlighting the importance of personalized financial planning.
Case Study: Tax Location in Action
Jim and Pam are a married couple with a $2,000,000 investment portfolio. They retired three years ago and at the suggestion of their financial advisor and tax advisor, they have been doing Roth conversions annually for the last three years. Their tax diversification looks this:
- $300,000 in Roth IRA accounts
- $700,000 in taxable accounts
- $1,000,000 in Traditional IRAs
Based on their retirement income plan, and in consultation with their advisor, Jim and Pam have decided on a 70% allocation to stocks and a 30% allocation to bonds for their investment portfolio. How will they best allocate their portfolio from a tax location perspective?
- 15% of their portfolio, or $300,000, will be allocated to US Small-Cap Stocks in their Roth IRA, which makes up 100% of their Roth IRA.
- 35% of their portfolio, or $700,000, will be allocated to US large-cap Stocks. This will be 100% held in their taxable account.
- 30% of their portfolio, or $600,000, will be allocated to high-quality US fixed income. This will be 100% held in their Traditional IRAs (or deferred-style accounts).
- 20% of their portfolio, or $400,000, will be allocated to International stocks. This will also be 100% held in their Traditional IRAs.
The Trailhead Planners Advantage
Many financial advisors overlook tax location because it's a manual process that requires extra work and time. At Trailhead Planners, we're committed to going the extra mile for our clients. We implement effective and tax-sensitive investment portfolios tailored to each client's unique situation, potentially adding significant value to your retirement savings over time.
Take Control of Your Retirement Today
Don't let taxes eat away at your hard-earned retirement savings. Partner with Trailhead Planners to develop a comprehensive retirement strategy that includes smart tax location.
Are you ready to feel confident instead of stressed about your retirement transition? Do you want to know how much you can spend in retirement or when to file for Social Security?
Your Next Step
Schedule a free consultation with our team of tax-savvy and experienced retirement experts. We'll help you address all your concerns and develop a strategy that meets your financial goals, aligns with your values, and secures your legacy.
Schedule Your Free Consultation Now
Remember, at Trailhead Planners, we believe that holistic financial planning is about more than just money - it's about legacy, fulfillment, and values. Let us help you build the retirement you've always dreamed of.
References:
Padmawar, S., & Jacobs, D. (2022). Revisiting the conventional wisdom regarding asset location. Vanguard Research.