Investment Allocation for Tax Benefits

September 17, 2013 

Tax regulation and rate changes have made it more important to put your investments in the right account to achieve the greatest possible tax benefits. You can see more benefit by dividing your investments in different tax buckets.

Tax deferred accounts such as annuities, 401ks, 403bs and traditional IRAs allow your investments to grow tax free until withdrawal. That makes them good places to hold investments that are not tax efficient because any withdrawals from these accounts are taxed at your earned income rate. These include bonds, real estate trusts (REITs), commodities and many active ETFs and mutual funds. If you put investments that are taxed at a lower rate, such as stocks, inside these accounts, you lose the tax rate advantage.

One type of tax-deferred account is annuities, which are used to manage risks, defer taxes on investment gains and create a guaranteed income. Some are designed to protect you from market losses by forgoing some of the potential gains. They can also be used to generate a "pension" allowing you to know what income will be available in retirement. Now they can help you reduce your overall tax bill.

Until recently, real estate trusts (REITs), commodities and active funds were rarely included in the menu of choices in tax deferred accounts. You could buy them in an IRA, however. But contribution limits mean that often people do not have large IRAs. Recently several variable annuities have been released to allow investments. Although annuities should be used primarily to manage risks,

you can allocate to take advantage of the tax benefits.

If you are using an annuity to create a stable income in the future, you can also use it to achieve better tax efficiency.

First, determine the overall asset allocation you want to achieve.

Next, try to arrange the investments that generate capital gains or qualified dividends (those not taxed at your earned income rate) in your taxable accounts. This might include growth stocks that generate capital gains and qualified dividend paying stocks.

Finally, place tax inefficient investments in the annuity, IRA, 401k or other tax deferred accounts. Good candidates here are Exchange Traded Notes (ETNs) that generate interest payments, REITs, conservative allocation funds, leveraged funds and bonds of various types.

Some investments such as Master Limited Partnerships (MLPs) and Business Development Companies (BDCs) cannot be used in tax deferred accounts except in limited amounts. However, funds that hold these investments are good candidates for tax deferred accounts.

Some of the annuities and investments are complicated. It pays to do your homework or consult with someone familiar with the inner workings, cost and tax implications before making your moves. Taxes should not drive your investment choices but there is nothing wrong with putting them in the correct locations to take advantage of the rules.

Tom Roberts, a Certified Financial Planner and owner of A New Approach Financial Planning in Lakewood Ranch and Sarasota, can be reached at941- 927-9590 or

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