Supercharging Your Investments: Asset Location
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Transcript of Supercharging Your Investments: Asset Location
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Supercharging Your Investments: Asset Location
Looking for a better way to allocate your assets in your portfolio? Check out this concept of asset location to strengthen your return on investments.
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You may be familiar with asset allocation but did you know asset location takes it a step further? Instead of just allocating investments in different areas (i.e. bonds, cash, stocks), it's important to choose where they are located: personal account or an IRA.
Asset Location
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Let's assume you have $2 million in investments that are split between your personal account and IRA:
◦$1 million in the personal account◦$1 million in the IRA
Prime Example
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Personal account investments are subjected to taxes on:
◦Bond interest◦Stock dividends◦Taxes on capital gains from the sales of bonds and
stocks
Personal Account
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IRA investments are not subjected to taxes, which means there isn't income or capital gains taxes
*This example is focusing on the accumulation/pre-distribution phase; the IRA account will be taxable when you turn 70 1/2 years old on the required minimum amount*
IRA Account
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Let's assume your overall asset allocation of all the accounts makes up 40% of bonds and 60% of stocks.
40/60 Split
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Government/Corporate bonds: generally yield higher interest rates but the interest is taxable.
Municipal bonds: generally yield a lower interest rate but the interest is tax-free.
Types of Bonds
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Which bonds do you buy in your personal account and which do you buy in your IRA?
Question
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Peter Culver suggests you use the personal account to buy municipal bonds since they are tax-free, and use the IRA to buy government/corporate bonds because they will also be tax-free when purchased with the IRA.
Answer
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Using the 40% bonds allocation, a $2 million portfolio will account for $800,000 in bonds.
◦ IRA will share $400,000 of government/corporate bonds◦Personal account will share $400,000 of municipal bonds
The Numbers
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Looking at historical data, the government/corporate bonds will yield an annual rate of 5% and the municipal bonds will yield an annual rate of 4%.
Historical Data
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These numbers will help you understand the total annual interest that is tax-free:
Personal Account: $400,000 @ 4% $16,000 annual interestIRA Account: $400,000 @ 5% $20,000 annual interestTotal: $36,000 annual interest
Outcome
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If you had purchased government/corporate bonds in your personal account, the after-tax yield would be 40% because of the 40% income tax on government/corporate bonds need in a personal account.
See what a difference asset location can make!
Benefits Of Asset Location