Asset location between account types

How it works

A taxable account taxes interest and ordinary dividends every year at regular rates, qualified dividends and long term gains at the lower rates, and nothing until sale on unrealized growth. A traditional IRA or 401(k) taxes nothing until withdrawal, when every dollar comes out as ordinary income, so the lower rates on gains and qualified dividends are lost there. A Roth taxes nothing at all on qualified withdrawals. Because of this, income that would be taxed at ordinary rates in a taxable account, such as bond interest and real estate trust distributions, costs the least tax when sheltered, while holdings that produce mostly long term gains and qualified dividends give up the least when held in a taxable account.

What it gives

The same mix of investments can produce less yearly tax simply by rearranging which account holds what.

Nothing is bought or sold at the portfolio level, only the account each piece lives in.

The effect compounds, since tax not paid each year stays invested.

What it costs, or where the catch is

Moving holdings between accounts in a taxable account means selling, which can itself trigger tax.

It only matters when money sits in more than one account type.

The arithmetic changes when the lower gains rates or the brackets change by law.

A worked example

Quinn holds $50,000 of a bond fund paying 4 percent and $50,000 of a stock index fund in each of a taxable account and a traditional IRA. The $2,000 of bond interest in the taxable account, which is $50,000 times 0.04, is taxed at her 24 percent rate, costing $480 a year. Swapping so that the IRA holds all the bonds and the taxable account holds all the stock fund leaves the same investments, and the $480 a year of tax on interest is mostly avoided.

Where it goes wrong

The common miss is treating every account as a separate portfolio with the same mix, which puts bond interest in the taxable account year after year.

Who confirms it for you

For your own numbers, a fee only planner. This page explains how the rule works for people in general; it does not know your situation and does not tell you what to do.

The official source

Investor.gov: Investing basics. Every figure that changes by year comes from the site's rules table, which the watcher checks against the official page on a schedule; where a figure is not yet verified, this page says so instead of printing a number.