Why asset location trumps asset allocation for retirees


In a memorable moment from the film The graduation, a neighbor pulls Dustin Hoffman aside at his graduation party. The neighbor, Mr. McGuire, tells Hoffman’s character, Benjamin Braddock, that he has “one word” for him: plastics.

I have one word for you: taxes.

As my colleague and notable investor Paul Samuelson has written, no factor is as influential as taxes in determining how much money retirees will have to spend or leave to heirs. And, advises Paul, minimizing taxes through tax-smart asset tracking is the best way to improve clients’ retirement outcomes.

Recent News Light On Asset Location Trains
Active site isn’t half as well-known to investors as its cousin, the asset allocationbut recent events are changing that.

Asset tracking involves choosing which investments to place in which accounts based on the accounts’ tax treatment with the goal of improving the results of an entire portfolio. According to Paul, tax-smart asset location is the most overlooked lever available to investors. Ignoring it is expensive.

As the the wall street journal reported recently, some investors are furious that capital gains distributions from some Vanguard target retirement funds have resulted in “painful tax bills.” This is because the investors held the funds in taxable brokerage accounts and not in tax-advantaged accounts, such as 401(k)s or Individual Retirement Accounts (IRAs).

Investors say they haven’t been given enough warning that target date funds are manufactured for tax-advantaged accounts. They saw them as smart choices to put money they didn’t want to actively manage after maximizing their savings in tax-advantaged accounts.

In other words, investors were unaware of the importance of asset location in managing their tax exposure. A Vanguard investor told the Newspaper he had about $3.6 million in a fund and now owes about $150,000 in federal and state taxes.

Vanguard’s complaints prompted regulators in Massachusetts, who gave BlackRock, T. Rowe Price, American Funds, Fidelity and Vanguard until Feb. 9 to provide information about the companies’ marketing practices and investor education regarding target date funds.

Inflation throws gasoline on the fiscal fire
Prices for food, cars, housing and more have skyrocketed. Twelve-month inflation hit 7% in December, hitting a 39-year high. This worries everyone, especially those who no longer earn a salary and depend on savings to cover living expenses.

Inflation plays another cruel role: increasing people’s tax bills and effectively reducing their retirement income. Inflation could mean higher bond yields, triggering higher taxes for bondholders. Equity investors may find that they pay higher taxes when corporate profits benefit from higher prices.

The protracted resurgence of inflation means financial advisors need to leverage their tax efficiency tools to:
• Protect customers from paying unnecessary taxes, and
• Quantify and guide the short and long-term savings that clients can realize through tax efficiency.


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