It really is a classic question many investors have. How do I decide what type of stocks, bonds and funds to put into my taxable brokerage account vs. my tax deferred 401K/IRA accounts? The overall idea is to reduce the impact of taxes on your investments. There is no “one size fits all” approach and sometimes your allocation depends on what stage of life you are in. I’ll assume in this article that you are over 50 and planning or are in retirement.
Tax Deferred 401K/IRA Accounts:
- The strategy is to have higher tax items in these accounts.
- Stocks or funds where dividends are taxed as “ordinary income”.
- Mutual Funds or ETF’s that have a high beta, or churn. This means the portfolio can have big tax consequences since they typically have short term capital gains taxed as ordinary income.
- REIT’s and BDC’s, whose dividend payouts are generally considered nonqualified and taxed at ordinary income tax rates.
- Any preferred stock who’s dividends are taxed as ordinary income, i.e. preferred REIT’s.
- Trust preferred’s that are taxed as ordinary income.
- Dividends from some foreign stocks and funds that are taxed as ordinary income.
- Options trading
- Strategy is to have tax friendly assets in this account and also a high degree of control.
- All cash for retirement living expenses or an emergency fund.
- Growth stocks that don’t pay dividends but will be held for long term gains.
- Tax-free bonds and bond funds.
- Unless you are looking for a “no-income” approach, stocks or funds with “qualified dividends”.
- MLP’s, if held for a long time since most distributions are a “return of capital” until the stock is sold.
- Any investment used as a “hedge” such as Gold stocks, inverse S&P etc. since they can be used for an offsetting capital loss at tax time if desired.
ROTH IRA Accounts
- This is the best account to hold high tax items in.
- It is also probably the safest place to shelter future income since the government has constantly changed tax rates and thresholds on taxable and tax deferred accounts (ordinary income tax rates). It’s hard to believe the government would change the tax-free provisions of the ROTH IRA.