Maximizing Retirement Income—5 Ways Asset Location Can Save You Money in Taxes

Greg Hier |

Retirement planning can be complicated, and managing taxes in retirement is no exception. It's important to have a plan in place to make the most of your retirement savings while minimizing your tax liability. One strategy for managing taxes in retirement is utilizing asset location.

Asset location refers to the placement of different types of assets across different types of investment accounts. By strategically placing assets in taxable, tax-deferred, and tax-free accounts, you can optimize your portfolio for tax efficiency and potentially reduce your tax bill in retirement.

Here are some tips for managing taxes in retirement using asset location:

Understand the tax treatment of different account types.

Different types of accounts have different tax treatments. Traditional IRAs and 401(k)s allow you to contribute pre-tax dollars, which reduces your taxable income in the year of the contribution. However, withdrawals from these accounts in retirement are taxed as ordinary income at whatever rate is in place in retirement. Roth IRAs and Roth 401(k)s, on the other hand, are funded with after-tax dollars, so withdrawals in retirement are tax-free. Non-retirement investment accounts are usually taxed at lower capital gains rates.

Give yourself options.

By having assets in accounts with different types of tax treatment, you will have choices on where to take withdrawals to fund your retirement.  By utilizing multiple tax types, you can have control over how much you pay in taxes.  If your income is drawn from accounts taxed as income, accounts taxed as capital gains, and tax-free accounts, only a portion of your total withdrawals is taxable at income tax rates.

Consider your income sources.

In retirement, you may have income from a variety of sources, such as Social Security, pension payments, and investment income. You may have little flexibility to control the tax situation on pensions other than timing the start.  IRAs and 401ks may force out income as Required Minimum Distributions that’s outside your control.  These income streams may create additional tax liability on Social Security benefits. By strategically placing different types of investments in different accounts, you may be able to control your taxable income and minimize your tax liability.

Prioritize tax-efficient investments in taxable accounts.

Tax-efficient investments, such as index funds and ETFs, are more likely to generate long-term capital gains or qualified dividends, which are taxed at lower rates than ordinary income—possibly at 0% in the lower brackets. These types of investments are best held in taxable accounts, where the tax treatment is more favorable.  On the flip-side, tax inefficient investments may benefit more from being withing tax-deferred or tax-free accounts.

Utilize tax-loss harvesting.

Tax-loss harvesting is the practice of selling investments that have declined in value in order to offset capital gains in other investments. This can be a useful strategy for managing taxes in retirement, but it's important to do so carefully to avoid triggering a wash sale.  This strategy is not available in tax-deferred accounts that are taxed as income instead of capital gains.

Managing taxes in retirement can be a complex task, but asset location is a powerful strategy that can help you minimize your tax liability and maximize your retirement income. By understanding the tax treatment of different account types, and prioritizing tax-efficient investments in taxable accounts, you can make the most of your retirement savings. The earlier you incorporate asset location strategies into your retirement plan, the easier it can be to make changes. Contact us to help you develop a comprehensive retirement plan that incorporates asset location strategies.