While most investors are familiar with the concept of asset ‘allocation’, fewer understand the importance of asset ‘location’. While the former addresses the diversification of investment capital to various asset classes, the latter involves the appropriation of this capital to varying account ‘types’, and more specifically, the way they are taxed. Since financial stewardship has more to do with the wealth we retain and distribute, as opposed to simply amass, taxes must be accounted for, and to the extent possible, shrewdly managed.
In the accumulation phase of one’s working, wealth-building years consideration should be devoted to accumulation efficiency, but not to the exclusion of the reality of future taxation. Many savers over-fund their retirement needs exclusively with Traditional Retirement Plan/IRA accounts, only to later realize they have constructed a tax time bomb! In the early working years, when the income and tax rates are lowest, retirement savings may often be directed primarily to Roth Retirement accounts, depending on individual circumstances. In the mid-working years when the income and tax rates are higher, a balanced approached is often beneficial. As retirement approaches and the income and tax rates hit a career peak, retirement savings may increasingly favor Traditional Retirement accounts. Investors who miss phase one and two are often deprived of the liberty of phase three as their efforts are redirected towards tax bomb defusal.
Retirement ushers-in decumulation as wealth is converted into streams of income, which should shift the tax strategy. A consistent tax rate/bracket in retirement is often associated with greater tax efficiency, while a gyrating rate/bracket equates to tax inefficiency. Diversified asset location, or having a meaningful portion of your God-given capital in each of the three account types: tax deferred (Traditional), tax free (Roth), and taxable (non-retirement), may enhance a retiree’s ability to manage their tax rate! At this juncture complexity appears which only a personal and high-level retirement income plan can solve because tax and account withdrawal strategies must be built around estimated future tax brackets, and only such a plan can reveal them; these calculations can become complex without structured planning.
Strategy solutions and tax code provisions which may help diffuse a tax bomb for those who disproportionately appropriated retirement funds to Traditional accounts include: a) delaying Social Security benefits and creating an income bridge via Traditional account withdrawals, b) strategic Roth Conversions in low bracket years, c) Qualified Charitable Distributions (QCD: age 70.5 minimum), and d) Qualified Longevity Annuity Contracts (QLAC). The rules for these strategies are complicated, so be sure to work with an advisor who understands them well.
Tax planning in both the accumulation and decumulation phases of wealth management is critical, and its neglect may increase exposure to higher taxes for both you and your heirs, but an increase in exposure to Income Tax Rate Risk and Longevity Risk. Think about it, and may God bless your asset location and tax planning efforts! Shaun
“In the abundance of counselors there is safety” ~Proverbs 11:14
“Render to Caesar the things that are Caesar’s, and to God the things that are God’s” ~Mark 12:17
Disclosures
Old Forge Wealth Management, LLC is a registered investment advisor.
This blog is for informational purposes only and is not intended as personalized financial, investment, or tax advice. The content may discuss retirement accounts, asset allocation, and tax strategies, but individual circumstances vary and may affect the applicability of any strategy.
Investing involves risk, including the possible loss of principal. There is no guarantee that any strategy discussed will achieve specific results, reduce taxes, or ensure financial success.
Rules regarding retirement accounts, taxes, and withdrawal strategies are subject to change, and professional guidance is strongly recommended. Please consult a qualified financial advisor and/or tax professional before making any decisions regarding your investments, tax planning, or retirement planning.