Hayden Adams, a certified public accountant and financial planner, has illuminated the potential benefits of strategic asset location in a recent study. The findings suggest that employing an asset location strategy could enhance annual after-tax returns by 0.14 to 0.41 percentage points for conservative investors. This strategy hinges on optimizing the placement of investments, specifically by switching to municipal bonds and index stock funds in taxable accounts, while placing active stock funds in tax-advantaged accounts.
The study reveals that about 90% of the additional after-tax returns stem from these strategic adjustments. Tax-inefficient assets, such as bond funds and actively managed funds, are better suited for tax-advantaged accounts to avoid hefty tax bills. High earners are particularly encouraged to consider this strategy to mitigate taxes, while middle-class savers, who primarily invest in retirement accounts, face fewer tax concerns. However, for non-retirement goals like saving for a home down payment, taxable accounts can be more appropriate.
Vanguard Group recently settled with the SEC over allegations related to its target-date funds and investor taxes, agreeing to pay $106 million. The SEC accused Vanguard of making misleading statements regarding the tax consequences of reducing the asset minimum for a low-cost version of its Target Retirement Funds. This reduction allegedly prompted a significant movement of investors to these funds. As of the end of 2023, Vanguard held approximately $1.3 trillion in target-date fund assets, according to Morningstar.
Christine Benz, director of personal finance and retirement planning at Morningstar, emphasizes the importance of asset location for investors who regularly reach the annual contribution limits on tax-sheltered retirement accounts. She notes that such investors need to save in taxable accounts as well.
"By having to pull money out of your coffers to pay the tax bill, it leaves less in your portfolio to compound and grow," said Christine Benz.
The necessity of strategic asset placement becomes clearer when considering the tax implications for different types of investors. For example, a retired couple with a $2 million portfolio—split evenly between taxable and tax-advantaged accounts—could potentially reduce their tax drag by an additional $2,800 to $8,200 annually, depending on their tax bracket.
"A retired couple with a $2 million portfolio [$1 million in a taxable account and $1 million in a tax advantaged account] could potentially see a reduction in tax drag that equates to an additional $2,800 to $8,200 per year depending on their tax bracket," explained Hayden Adams.
Vanguard's settlement with the SEC highlights the complex nature of investment strategies and the importance of transparency. A spokesperson from Vanguard reaffirmed the company's dedication to its investors.
"Vanguard is committed to supporting the more than 50 million everyday investors and retirement savers who entrust us with their savings," stated a company spokesperson from Vanguard.
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