Assigning Assets into Tax Buckets

Treat your and your spouse’s portfolios as a unified whole. Avoid making changes that incur significant tax costs merely for optimal asset location. Instead, gradually adjust by strategically reinvesting distributions in a tax-efficient manner, especially if tax-advantaged account space is limited. Take taxable distributions in cash and reinvest them in a tax-efficient manner.

Prioritize utilizing tax-advantaged accounts whenever possible.

1.

Assess Portfolio Tax Efficiency: Evaluate the tax implications of each investment in your portfolio. Understanding the tax efficiency of each asset class will guide your asset placement strategy.

2.

Prioritize Placement of Least Tax-Efficient Funds: Maximize the use of your tax-advantaged accounts by placing your least tax-efficient investments in them first. If these accounts become full, shift to more tax-efficient options, such as stock index funds or municipal bond funds, for your taxable accounts.

3.

Optimize International Stock Funds Placement: Place international stock funds in taxable accounts to benefit from potential tax credits on foreign taxes paid. You can potentially receive a tax credit for foreign taxes paid on international stock funds. However, this benefit is not available in tax-advantaged accounts where these taxes are still accrued. The benefit of this credit depends on several factors, including the percentage of the fund’s income derived from foreign sources, the foreign tax rate, the proportion of foreign dividends that qualify, and your U.S. marginal tax rate.

4.

Allocate High Growth Stock Funds Strategically: For investments expected to yield high returns, consider placing them in accounts like Roth IRAs or HSAs where they can grow tax-free, are not subject to Required Minimum Distributions (RMDs), and do not count as income for Social Security tax purposes. If your tax-advantaged space is exhausted and your taxable estate is approaching the $15,000,000 federal exemption made permanent by OBBBA ( IRC §2010), the same highest-growth assets are also the strongest candidates to transfer into an irrevocable grantor trust — see section “Intentionally Defective Grantor Trusts (IDGTs)” and section “Spousal Lifetime Access Trusts (SLATs)” — so the future appreciation compounds outside your estate entirely.

5.

Position Tax-Efficient Funds: Place tax-efficient funds in any account type. If space allows in your tax-advantaged accounts, it facilitates easier rebalancing of your stock/bond ratio without incurring tax consequences. In taxable accounts, consider using new contributions for rebalancing to avoid capital gains taxes.