This post is important for investors that are (or want to be in the future) accumulating assets in different account types and want to improve their after-tax results.
Asset Allocation
We will never diminish the importance of asset allocation. Asset allocation is critical. Having said that, asset location is equally critical. Always remember, Why You Shouldn’t Chase the Latest Investment Fad.
Asset allocation is understanding our clients’ goals and objectives, risk tolerance and timeline. With this we allocate appropriately to the various asset classes.
Asset location has one primary objective, to minimize your lifetime income taxes. What accounts you hold your assets in really matters with regards to income taxes.
There are various investment vehicles from which you can choose. You do not need to use them all, and, in fact, you may not be eligible for some. That is fine. Find out which ones you are eligible for and leverage these.
You need to understand the tax implications of each of these investment vehicles. Here are the major investment vehicles and their tax implications. Additionally, which assets would be most appropriate in each vehicle.
Remember, What You Need to Know to Understand the Math of the Stock Market Now.
Asset allocation should not be a ‘set-it-and forget it’ exercise. Getting your allocation where you want it early, and updating it periodically, is required.
Do not forget, Before Investing, Know the Rules of the Road.
Asset allocation decisions should not be “set-it-and forget it.” These decisions evolve over time as income and assets increase. Getting this right early and adjusting overtime will reduce your lifetime income tax.
Roth IRA
Eligible investors that have earned income can contribute to a Roth IRA. The maximum Roth IRA contribution for 2025 is $7,000. For taxpayers aged 50 or older there is an additional $1,000 catch-up contribution. These numbers will increase slightly for 2026. The maximum Roth contribution for 2026 is $7,500 and the catch-up contribution is $1,100.
To fund a Roth IRA, you will need to have earned income. This is the wages you earn as an employee, and it can also be from self-employment earnings.
However, there are income limitations to be eligible to contribute to a Roth IRA. You can see these here at 3 Easy Reasons to Open a Roth IRA.
Unlike a Traditional IRA, there is no income tax deduction with a Roth IRA. Said differently, you are contributing after tax funds to the Roth IRA.
However, you may receive qualifying Roth IRA distributions tax free. There are two conditions to have Roth IRA distribution tax free:
- The account must be open for at least five years.
- The taxpayer must be over aged 59 1/2.
If you meet these two conditions, all the distributions are tax free.
The Roth IRA has another key distinction. Contributions to the Roth IRA can be withdrawn at any time and no income tax will be due. This is because your contributions were not income tax deductible.
As the Roth IRA has the potential to create tax free income this would be a place to put you more aggressive investments in.
Roth 401(k) Plan
Many employers now offer a Roth 401(k) plan. The mechanics are like a 401(k) plan. Employees contribute to the plan through payroll deductions.
However, there is a significant difference between a 401(k) plan and a Roth 401(k) plan. With the 401(k) plan the contributions go in pre-tax. The funds in the 401(k) plan grow tax deferred. This is a similar model to the traditional IRA.
However, with the Roth 401(k) plan, contributions are made after-tax.
So, unlike the 401(k) plan, there is no upfront income tax benefit when making contributions.
The Roth IRA, and Roth 401(k) plan are ideal for younger people just starting their careers. Typically, folks just beginning their career tend to have lower incomes. Lower incomes translate into a lower tax bracket. So, maximize the contributions to these plans while you are paying the tax at a lower tax rate.
Like the Roth IRA, the Roth 401(k) plan should also be used for your more aggressive investments.
Brokerage Account
Having a brokerage account allows investors a lot of flexibility. The funds put into a brokerage account are after tax. In other words, you have earned money paid taxes on it and put it into a brokerage account to invest.
Although the tax aspects of a brokerage account are not as good as the Roth IRA mentioned above, they are still excellent. Investing in a brokerage account will provide for various levels of taxation.
Interest income is taxed as ordinary income tax rates. Additionally, short-term capital gains are taxed as ordinary income. Short-term capital gains are for assets held for one year or less.
The highest federal individual income tax rate is currently 37%. The highest income tax rate in Connecticut is currently 6.99%.
Qualifying dividends are taxed at 15%. For dividends that are non-qualifying they are taxed as ordinary income tax rates. Non-qualifying dividends are Real Estate Investment Trusts (REITs), Master Limited Partnerships (MLPs), Money Market Funds or Mutual Funds that are taxed as interest and other miscellaneous items.
Long-Term Capital Gains Tax Rates
Long-term capital gains tax rates are assessed based on your income. To qualify for long-term capital gains, the asset needs to be held for more than a year. For lower incomes, the rate is 0%, for middle incomes it is 15%, and for higher incomes it is 20%. There is a higher long-term capital gains rate for collectibles of 28%. Collectibles include gold, artwork, antiques, rare coins, and baseball cards.
Additionally, you can deduct capital losses on your tax return. You need to offset your capital gains and losses. If you have a net capital loss, you can deduct up to $3,000 on your income tax return that year. Any capital losses not used in that year can be carried over into future years.
A brokerage account has significant income tax advantages; this is also a place for your more aggressive investments.
401(k) Plans
For many, your 401(k) plan will be the cornerstone of your retirement plan. However, you need to clearly understand the tax implications.
Contributions to your 401(k) plan go into the plan pretax. Earnings inside your 401(k) plan are tax deferred. Therefore, when distributions are made, they are all taxed as ordinary income.
The fact that your 401(k) contributions and the earnings are taxable upon distribution should not dissuade you from participating in and contributing to your 401(k).
Many employers will offer an employer match to the 401(k) plan. If yours does, you should contribute enough to at least get the full employer match.
In 2026, employees can contribute up to $24,500. Employees aged 50 and older can contribute an additional $8,000 in a catch-up contribution. This makes the total $32,500 for them. Employees aged 60 to 63 can make a super catch-up contribution of $11,250 making the total contribution $35,750.
If you are taking advantage of the Roth IRA, Roth 401(k), Brokerage Account and an HSA, your 401(k) plan will have more moderate investments in it. This traces back to your asset allocation.
Always remember the 3 Simple Reasons to Avoid Private Equity in Your 401(k) Plan.
Individual Retirement Accounts (IRAs)
IRAs are another tool. To contribute to an IRA, you need to have earned income. As mentioned above, earned income is from your wages as an employee or perhaps self-employment income.
The maximum contribution to an IRA is the same as Roth IRA discussed above. For a primer on IRAs, check out IRA vs. Roth IRA. What You Need to Know.
If you have put your more aggressive investments in the other vehicles mentioned here, the is also a home for your more moderate investments.
Health Savings Account (HSA)
There are a few conditions to be eligible for a Health Savings Account (HSA). First, you need to have a high-deductible health plan. In 2026, for a single person, this is $1,700. For a family, this is $3,400. Second, you need to have maximum out of pocket costs. For a single person, this is $8,500. For a family this is $17,000. Third, a Preferred Provider Organization (PPO) or a Health Maintenance Organizations (HMO) cannot cover you. Finally, you cannot be enrolled in Medicare.
If you are eligible for an HSA, in 2026 a single person can contribute $4,400, a married couple can contribute $8,750. Additionally, for a taxpayer age 55 or older, there is an additional $1,000 they can contribute.
Unlike contributing to a Roth IRA or a traditional IRA, you do not need to have any earned income. Earned income is from working as an employee or having self-employed income.
No Annual Distribution Required
Keep in mind, you do not have to distribute funds from your HSA annually. Said differently, you can leave your funds in the HSA. They will grow tax-advantaged. If you were to do this, you would need to have other funds to pay for your current medical bills.
Document your medical bills paid from another source. Down the road, when you do reimburse yourself, you will need to have kept track of this to make the distribution income tax-advantaged.
However, if you have other resources to pay for your current medical bills and you expect this to continue, consider being more aggressive with the investments in your HSA.
This is due to your belief that you will not need these funds for an extended period. Additionally, there is no requirement to distribute funds from an HSA. As a practical matter, you may want to access these funds during your retirement years.
Don’t forget the 3 Great Reasons to Fund a Health Savings Account.
529 College Savings Plans
529 College Savings Plans allow investors to save for education. If they qualify the distributions will be tax free if used for higher education.
In 2026, parents and grandparents can contribute up to $19,000 per year into a 529 College Saving Plan without having to file or pay any gift taxes. Additionally, the IRS allows a lump sum contribution to a 529 College Saving Plan to be made five years in advance.
This allows a married couple to contribute $190,000 ($19,000 times 2 times 5 years) in one year into a 529 College Saving Plan. If you were to do this, as a donor, you would have to file a Federal (and any required state) Gift Tax Return (Form 709) for that year.
However, your CPA will complete the Gift Tax Return and disclose that your lump sum amount applies for the next five years. There will be no gift tax due to this filing.
The 529 College Savings Plan does not have a location question. You can either invest in it or not. However, it is important for parents that are paying for their children’s higher education to understand the tax benefits of these plans.
If your children are younger, invest more aggressively. As they get older, you should invest more moderately. As they get nearer to going away to school, it is time to invest more conservatively.
Here are 5 Easy Reasons to Fund a 529 College Savings Plan.
Municipal Bonds
Municipal bonds are issued by states. They also could be issued by other government agencies. Most municipal bonds the interest earned on them is federally tax free. However, some bonds issued by states or other agencies are taxable municipal bonds. Examples of bonds that are taxable are bonds issued to fund private activities. Private activities include bonds issued for sports stadiums, private hospitals, and industrial development.
If you purchase municipal bonds from the state that you live in it is probable that they would also be state income tax free.
Exercise caution when investing in municipal bonds. First, you need to understand if the municipal bond is, in fact, tax free. Secondarily, you also need to understand that as these bonds are tax free, they are likely to pay a lower interest rate than a taxable investment with similar credit risk.
So, investors need to figure out if a taxable investment or a tax-free investment would be appropriate for them.
When investing in municipal bonds, there is no question as to what account to use. Municipal bond investments belong in your brokerage account.
Decisions like asset location need to be coordinated with asset allocation and reviewed periodically to optimize after-tax returns.
Conclusion
If you need help with Why Asset Location is as Important as Asset Allocation, call Thomas F. Scanlon at (860) 645-1515 or e-mail Thomas.scanlon@raymondjames.com.
This is original content written by Manchester, CT Financial Advisor, Thomas F. Scanlon, CFP®, CPA.
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The information contained in this report does not purport to be a complete description of the securities, markets or developments referred to in this material. The information has been obtained from sources considered to be reliable, but we do not guarantee that the foregoing material is accurate or complete. Any opinions are those of Thomas F. Scanlon, CPA, CFP® and not necessarily those of RJFS or Raymond James. Expressions of opinion are as of this date and subject to change.
Changes in tax laws or regulations may occur at any time and could substantially impact your situation. While familiar with the tax provisions of the issues presented herein, Raymond James Financial Advisors are not qualified to render advice on tax or legal matters. You should discuss any tax or legal matters with the appropriate professional. Investing involves risk and investors may incur a profit or a loss.
Contributions to a traditional IRA may be tax-deductible depending on the taxpayer’s income, tax filing status, and other factors. Withdrawal of pre-tax contributions and / or earnings will be subject to ordinary income tax and, if taken prior to age 59 ½, may be subject to a10% federal tax penalty.
Like traditional IRA’s, contribution limits may apply to Roth IRA. In addition, with a Roth IRA, your allowable contribution may be reduced or eliminated if your annual income exceeds certain limits. Contributions to a Roth IRA are never tax deductible, but if certain conditions are met, distributions will be completely income tax free. Roth IRA owners must be 59 1/2 or older and have held the IRA for five years before tax-free withdrawals are permitted.
401(k) plans are long-term retirement savings vehicles. Withdrawal of pre-tax contributions and/or earnings will be subject to ordinary income tax and, if taken prior to age 59 1/2, may be subject to a 10% federal tax penalty.
Dividends are not guaranteed and must be authorized by the company’s board of directors.
Every investor’s situation is unique and you should consider your investment goals, risk tolerance and time horizon before making any investment. Investing involves risk and you may incur a profit or loss regardless of strategy selected, including diversification and asset allocation.
529 Plans come with fees and expenses, and there is a risk they may lose money or underperform. Most states offer their own 529 programs, which may provide benefits exclusively for their residents. Please consider whether the state plan offers any tax or other benefits. Tax implications can vary significantly from state to state.
Municipal securities typically provide a lower yield than comparably rated taxable investments in consideration of their tax-advantaged status. Investments in municipal securities may not be appropriate for all investors, particularly those who do not stand to benefit from the tax status of the investment. Please consult an income tax professional to assess the impact of holding such securities on your tax liability.