What is Asset Location and How Can It Reduce Taxes?

13 min read
October 11, 2022

While asset allocation often gets the most attention (and for good reason), asset location is less talked about. Let’s change it.

Asset location comes into play after you determine your asset allocation. Asset location is a tax strategy. While it may seem complicated at first, once you know the basics, it becomes easier. 

Let’s dive into what asset location is, the pros and cons of it, how asset location can reduce taxes, and how you can create an asset location strategy. 

What is Asset Location? 

Asset location is a tax minimization strategy where you put certain assets in different types of accounts based on their expected returns and tax treatment, as well as tax laws. 

You can think of asset location as a group of teenagers at a restaurant where each receives a random dish, such as plate, bowl, serving dish, etc. and can go through the food line once. They can put as much as they want on the plate, and they can put food on the plate in any order, but they can only go through the line once. 

Each teenager could go through the line selecting what they want in the random dish they received, but this would be less optimal than strategizing around which food fits best in each dish. 

For example, the person who received a plate may want soup, but that’s not going to hold well on a plate. The person who received a bowl may want pancakes, but can’t stack them very high. 

They could look at their dishes, discuss what they want, and strategize around which food should go in each dish, which is best for stacking food, and which foods can be grouped together on a plate for optimal value. Only after they know what they want can they decide how to arrange the food to get the most value. 

That’s asset location. 

Asset location is when you put assets in the account where they fit best. 

It’s important because the gross return you earn does not matter. It’s the return after taxes that matters. If you earn 10%, but your after-tax return is 8%, the 10% does not matter. It’s not what you can spend. The 8% is what you can spend. 

3 Types of Accounts for Asset Location – Pros and Cons of Each

Investors have three main types of accounts they can use in an asset location strategy: tax-exempt, tax-deferred, and taxable. 

Even if you don’t have all three types of accounts, you can use asset location with two types of accounts. 

Let’s explore the pros and cons of each account to help make sense of which assets might be best suited for each type of account.

Tax-Exempt (Roth 401(k)s, Roth IRAs, HSAs, etc.)

Tax-exempt accounts include Roth IRAs and HSAs. Since you already paid taxes on the money you contributed, except in the case of the HSA, they grow tax-free and future distributions are tax-free, assuming certain rules are met. 


  • Dividends, interest, and capital gains are not taxed. 
  • Future distributions are tax-free, assuming certain rules are met. 
  • No required minimum distributions.
  • Heirs can take distributions tax free. 
  • Heirs can distribute over a 5, 10, or life expectancy time frame, depending on ages and other rules. 


  • Contributions are after tax (no deduction). 
  • Income limits for making contributions. 

Since there are income limitations for contributions to certain types of tax-exempt accounts, and there is no tax deduction, the tax-free nature of accounts like Roth IRAs are very powerful.

Generally, you want assets with the highest expected returns, such as stocks, in Roth IRAs. You get to keep 100% of the return you earn in a tax-exempt account, which means if you earn 8%, your after-tax return is also 8%. 

Tax-Deferred (401(k), IRAs, 403(b)s, etc.)

Tax-deferred accounts include 401(k)s and IRAs. Since you receive a tax-deduction for the money you contributed, they grow tax-deferred and future distributions are taxed as ordinary income. 


  • Current year tax deduction for contributions. 
  • Dividends, interest, and capital gains are generally not taxed. 


Since dividends, interest, and capital gains are tax-deferred and money is forced out of tax-deferred accounts at age 72, generally, it’s best to hold assets that are tax-inefficient and have lower expected returns. This generally applies to people near or in retirement. 

If you are younger and saving into a tax-deferred account, you may want to hold assets with higher expected returns to be able to dollar cost average into the market. 

Since the account is shielded from current taxation, investments that spin off high income don’t matter. That’s why high-dividend paying stocks, bond ETFs that create ordinary income, and REITs can be good investments inside a tax-deferred account. 

The reason you want lower expected return assets in tax-deferred accounts is that money is forced out of it at age 72. Generally, your RMDs get larger as you age. Sometimes, RMDs combined with Social Security income and other portfolio income can push you into higher and higher tax brackets, which is why many people in retirement do Roth conversions. That’s why you generally want to slow the growth in tax-deferred accounts while keeping the asset allocation the same. 

Taxable (Brokerage Accounts)

Taxable accounts include brokerage accounts. Since you didn’t receive a tax deduction for a contribution, and they are not sheltered from taxation, dividends, interest, and capital gains are taxed in the year they occur. Non-qualified dividends, short-term capital gains, and interest are generally taxed as ordinary income while qualified dividends and long-term capital gains are taxed at long-term capital gains rates. 


  • Qualified dividends and long-term capital gains taxed at long-term capital gains rates (0%, 15%, or 20%), which is generally more favorable than ordinary income. 
  • Step up in basis for the person who inherits the account. 
  • No income phaseouts for contributions or rules about when you can take distributions. 
  • Can tax-loss harvest


  • Dividends, interest, and capital gains are taxed along the way. 
  • No tax deduction. 

Generally, a taxable account will hold the “leftover assets” that are not prioritized in a tax-exempt account or tax-deferred account. In a way, it generally is the catch all bucket. 

Depending on how much money is in each type of account, you may end up with tax-inefficient investments in a brokerage account, but that is okay. 

For example, a tax-inefficient investment, such as a REIT, where it has to distribute at least 90% of its taxable income is usually best held in an IRA or a Roth instead of a taxable account, but if the Roth IRA and IRA are already filled with the types of assets they should hold to minimize taxes, you may need to hold a REIT in a brokerage account. The majority of REIT dividends are taxed as ordinary income, which means if you earn 4% and are in the 24% tax bracket, your after-tax return is lower than 4%. 

How Asset Location Can Reduces Taxes

Let’s look at examples of how asset location can reduce taxes, but before we do, let’s look at how to tell if your portfolio is potentially not using an asset location strategy.  

Identify Tax Inefficiency in Your Accounts and Tax Return

First, there are a few ways to see if your portfolio is potentially tax inefficient. 

  1. You have a tax-exempt account that holds bonds while you have a tax-deferred account that holds stocks. 
  2. Line 2b (taxable interest) is high and you are in a high income tax bracket. 
  3. Line 3b is high relative to line 3a. 
  4. Line 7 is high if you didn’t sell assets with gains. 

Tax return line items

If you have a tax-exempt account that holds bonds while you have a tax-deferred account that holds stocks, you are not using asset location to the fullest extent possible. In other words, long-term, you are probably tipping the IRS and paying more in taxes than needed

Stocks generally have a higher expected return than bonds, which means if you are putting bonds in an account like a Roth IRA while holding stocks in an IRA, you are sacrificing your after-tax return. Generally, it’s better to put all stocks in a Roth IRA for the tax-free growth and put more of the bonds in the IRA to slow the growth and future RMDs. 

If your line 2b is high, you may have too much money sitting in a bank account that could be invested earning a potentially better, more tax-efficient rate of return. You may have cash in the bank for a specific purpose, but if you have too much, it’s a drag on your return and taxes. 

If your line 3b, ordinary dividends, is high relative to your line 3a, qualified dividends, that means more of your dividends are being taxed at ordinary income rates rather than long-term capital gains tax rates. 

For example, if line 3b is $20,000 while your line 3a is $5,000, that means you had only $5,000 of qualified dividends taxed at long-term capital gains tax rates and $15,000 of ordinary dividends taxed as ordinary income. 

This could mean you are invested in bond ETFs that have dividends, REITs, or Master Limited Partnerships (MLPs) in your brokerage account that might be better held in a tax-deferred or tax-free account. 

Line 7, your capital gains or losses, could show tax-inefficient investments with high capital gain distributions. For example, if you didn’t sell assets in your brokerage account for a gain, but line 7 is high, you could have a mutual fund or other investment that had a large capital gain distribution. You can check by looking at Schedule D, line 13. It reports your capital gain distributions.

Capital gain distributions line 13

Capital gain distributions usually occur when there is turnover inside of a mutual fund. Funds that are actively managed with high turnover tend to have higher capital gain distributions. These types of funds usually can be replaced with more tax-efficient funds, but if you still want to hold them, it may make sense to hold them in a tax-deferred or tax-exempt account.

Types of Investments and Tax Efficiency

Not all investments are taxed the same. You can take advantage of where you hold assets to potentially reduce your taxes. 

Please keep in mind this is not a hard rulebook. How investments are taxed now and in the future, future tax rates, your timeframe, and many other factors can affect where you want to hold assets. 

Below is a chart showing different assets, their tax treatment, and where you may want to hold the asset. 

Table of asset location and tax treatment of different assets

This is for general educational purposes only. Changing where assets are held can result in tax consequences, which may not make it an efficient change. Your individual circumstances may also change which assets are ideal in each type of account. 

Let’s talk about a few of these in more detail.

Municipal bonds are generally not ideal for tax-free or tax-deferred accounts because those accounts are already tax sheltered and municipal bonds often have lower yields than other bonds because of their already favored tax treatment. 

Corporate bonds are generally ideal in a tax-free or tax-deferred account because in a taxable account, they may be subject to ordinary income tax rates, which will reduce your after-tax return. 

ETFs (that aren’t bond ETFs) are generally more ideal for a taxable account because they tend to be tax-efficient and you don’t want to lose the opportunity to put them in an account without any tax shelter, but they still can be ideal for tax-free or tax-deferred accounts, depending on their expected returns. For example, an ETF with a high expected return may be better in a Roth IRA while one with a lower expected return might be better in an IRA. 

Depending on which study you look at, asset location could add 0 to 0.75% in added annual returns without increasing the risk of the portfolio.

As you can see, there are general rules of thumb, but it depends on the specific investment and your circumstances. 

How to Create an Asset Location Strategy

Let’s bring it together with an example of how you could create an asset location strategy using three different types of accounts.

Let’s say you have the following types of accounts and balances:

  1. Roth IRA: $500,000
  2. IRA: $1,000,000
  3. Taxable: $500,000

After careful research, knowing your risk tolerance, and creating an investment policy statement, you decide you are comfortable at 50% stocks and 50% bonds overall. 

Instead of holding 50% stocks and 50% bonds in each type of account like the following:

  1. Roth IRA: $250,000 in stocks and $250,000 in bonds
  2. IRA: $500,000 in stocks and $500,000 in bonds
  3. Taxable: $250,000 in stocks and $250,000 in bonds
asset allocation evenly split among accounts

You could hold the 50% stocks and 50% bonds like this:

  1. Roth IRA: $500,000 in stocks
  2. IRA: $1,000,000 in bonds
  3. Taxable: $500,000 in stocks
Asset location scenario 1

This might be a good strategy if you don’t plan on taking withdrawals from your taxable account for the next 5+ years. 

The benefit of this strategy is you remove the bonds from the Roth IRA and increase the expected return. You also remove the bonds from the taxable account, which gives you more opportunity for tax-loss harvesting and increases the expected return in an account with long-term capital gains treatment, which is often a lower rate than ordinary income withdrawals from the IRA. By putting the bonds in the IRA, you lowered the expected return (while keeping the overall allocation the same), which may reduce future RMDs and the ordinary income tax you pay.

Or, if you planned on taking small withdrawals from your taxable account, such as $20,000 per year, you could do the following:

  1. Roth IRA: $500,000 in stocks
  2. IRA: $100,000 in stocks, $900,000 in bonds
  3. Taxable: $400,000 in stocks, $100,000 in bonds
    • The bonds could be less risky, lower-yielding bonds, such as treasuries or short-term corporates, or municipal bonds, depending on your tax rate. 
Asset location scenario 2 with withdrawals

This helps balance out the risk that the stock market goes down and you don’t want to sell stocks in your taxable account while they are down. While you could rebalance in another account, perhaps you are not comfortable holding 100% stocks in an account where you plan to take withdrawals in the next 10 years.  

You could get even more specific and hold asset classes or stocks with the highest expected returns in the Roth IRA, the next highest expected returning assets in the taxable, and REITs in the IRA to shield the income from taxation.

The stock-to-bond ratio is the higher level way to look at asset location, then you can refine it further down to the asset class, and finally down to the individual investment level. 

There are many different combinations using asset location. What ends up being the most ideal long-term will depend on many factors that are impossible to predict. 

Asset location is more about moving in the right direction to optimize your after-tax returns than trying to get it “perfect.” 

Please keep in mind that your portfolio turnover, timeframe, and many other factors affect the general rules about where to hold assets. In your individual circumstances, it may mean adjusting where you want to hold assets. 

Final Thoughts – My Question for You

Asset location is a strategy to maximize your after-tax returns. By choosing your overall asset allocation and then putting different assets in each of the three types of accounts, you can minimize the amount of return you lose to taxes. 

I see many investors with similar allocations across their accounts, and while that’s okay, it often means paying more in taxes than necessary. I’ve never met someone who wants to pay more in taxes than necessary. 

Do you? 

Remember, asset location isn’t about trying to get the perfectly optimal portfolio. There are too many variables to know what the perfectly optimal portfolio would be. Asset location is about structuring a portfolio more tax-efficiently. Sometimes, you’ll need to break the general rules of where to put assets. Other times, the general rules won’t be the most appropriate rules for your situation. 

I’ll leave you with one question to act on. 

Is your portfolio using asset location, and if not, are there changes you may want to make? 

Elliott Appel

About the Author

Elliott Appel, CFP®, CLU®, RLP®, is a Financial Planner and Founder of Kindness Financial Planning, LLC, a fee-only financial planning firm located in Madison, WI that works virtually with people across the country. Kindness Financial Planning is focused on helping widows, caregivers, and people affected by major health events organize and simplify their financial lives, do proactive tax planning, and make sure insurance and estate planning is coordinated with smart investment advice.


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