Most people understand the importance of saving and investing for the future. Experienced investors also know that asset allocation—or having the right mix of stocks, bonds and cash—can help balance risks and returns.
What gets discussed far less? Asset location.
Yet where you hold different investments across taxable, tax-deferred and tax-free accounts can potentially have a meaningful impact on long-term after-tax returns.
When it comes to tax-efficient planning, it's about location, location, location
Asset location is the strategy of deciding where to hold different investments across taxable, tax-deferred, and tax-free accounts to potentially improve tax efficiency over time. In simple terms, it’s not only about what you invest in—it’s also about where those investments live.
That matters because not all investments are taxed the same way.
Some investments, like the interest earned from Hawaii municipal bonds, for example, may be exempt from federal and state taxes if you are a Hawaii resident. Qualified dividends are generally taxed at lower rates than ordinary income, while other investments may grow tax-deferred in retirement accounts and only be taxed when the money is withdrawn later.
That’s why experienced investors often think strategically about which investments belong in different types of accounts, including:
- Taxable accounts, where investment earnings and capital gains may be taxed over time.
- Tax-deferred accounts, such as traditional IRAs, where taxes are generally postponed until withdrawals begin.
- Tax-free accounts, such as Roth IRAs, where qualified withdrawals may be tax-free.
The goal isn’t simply to choose good investments—it’s to place them in accounts where they may be more tax-efficient. Think of it this way: some investments may work better in retirement accounts, where you typically don’t pay taxes until you withdraw the money later in life. Others may make more sense in accounts with different tax treatment. The right approach depends on your goals, income, and long-term plans.
Deciding where investments live today can have a meaningful impact on taxes, retirement income, and long-term wealth later.
There are tax consequences when selling investments or withdrawing money
Investment decisions don’t stop once your portfolio grows. Eventually, selling investments or withdrawing money from retirement accounts can trigger taxes—and the timing of those decisions matters.
For retirees especially, planning isn’t only about how much income to generate. It’s also about where that income comes from. Depending on your age, income, and tax situation, drawing from one account before another may affect your tax bill, retirement income, and how long your assets may last over time.
That’s why thoughtful planning often looks beyond investment performance alone and considers how different accounts can work together to support your goals throughout retirement.
Did you know you could end up paying taxes on an investment that lost money?
Not all investment gains—or losses—are taxed in obvious ways.
In addition to knowing where to place your funds, it’s also important to understand the tax consequences of each type of investment. A mutual fund that has a high portfolio turnover, for example, could create a tax bill at the end of the year, even if that mutual fund lost money! In other words, you could potentially owe taxes despite seeing disappointing returns.
Begin a conversation
If you’re in a higher income tax bracket, retiring soon, or approaching retirement, your relationship manager can help you review your options as part of your overall financial plan. For personal guidance for growing and protecting your wealth, reach out to your relationship manager at Bank of Hawaii The Private Bank.
This material has been prepared for informational purposes only, and is not intended to provide, and should not be relied on for, tax or investment advice. You should consult your own tax or accounting advisors before engaging in any transaction.
Investment and wealth planning strategies, including asset allocation and diversification, do not guarantee a profit or protect against loss in declining markets. All investing involves risk, including the possible loss of principal. Past performance is not indicative of future results. The appropriateness of any investment strategy depends on an individual's objectives, financial situation, risk tolerance and investment horizon.
