Asset location and taxes


The new administration has talked about tax reform, so investors want to know how to prepare for potential changes. Fran Kinniry of Vanguard Investment Strategy Group and Todd Bechtel of Vanguard Personal Advisor Services, caution investors about forecasting tax policy changes, but offer some things to think about, particularly the impact of asset location.

Notes:
Please remember that all investments involve some risk. Be aware that fluctuations in the financial markets and other factors may cause declines in the value of your account. There is no guarantee that any particular asset allocation or mix of funds will meet your investment objectives or provide you with a given level of income. Diversification does not ensure a profit or protect against a loss.
Advice services are provided by Vanguard Advisers, Inc., a registered investment advisor, or by Vanguard National Trust Company, a federally chartered, limited-purpose trust company.
Investments in bonds are subject to interest rate, credit, and inflation risk. Although the income from a municipal bond fund is exempt from federal tax, you may owe taxes on any capital gains realized through the fund’s trading or through your own redemption of shares. For some investors, a portion of the fund’s income may be subject to state and local taxes, as well as to the federal Alternative Minimum Tax.
High-yield bonds generally have medium- and lower-range credit quality ratings and are therefore subject to a higher level of credit risk than bonds with higher credit quality ratings.
This webcast is for educational purposes only. We recommend that you consult a tax or financial advisor about your individual situation.
© 2017 The Vanguard Group, Inc. All rights reserved.  


TRANSCRIPT

Amy Chain: Bill from Vero Beach, Florida, has asked us about the impact of potential tax law changes on investment strategy. Fran, I think I know where you’re going to go with this. But how might changes in tax policy change what we might recommend to investors?

Fran Kinniry:
Yes, so I mean first I would caution everyone to forecast changes in tax policy. But once a change would occur, you’re going to have to re-evaluate, right. So maybe your relationship of taxable to tax-exempt bonds may not be the same as it once was. If they simplify the brackets and your tax comes down, maybe a taxable bond, after-tax, is higher than a tax-exempt bond. That could very easily happen. Or maybe you change your asset location. We didn’t really touch on asset location too much.

Amy Chain: Define that.

Fran Kinniry:
So we talked a lot about asset allocation, how much you have in stocks versus bonds, sub-asset allocation, which would be international, domestic, growth, and value. Location is where you would place those between your tax-qualified. So a Roth or a traditional IRA or a 401(k) versus your taxable.Now our audience, demographics, and Todd did touch on this, we look at a lot of demographic information. And the high-net-worth crowd, because you can only see a smaller portion in your 401(k), it ends up being where the multi-millionaire has much more in the taxable, so asset location can add a lot. But it still can, you know, you can put corporate bonds right now in your tax-qualified plans. And pick up a nice yield over having municipals, even in the after-tax. So it’s something to definitely keep your eye on. It’s another reason why working with a tax professional or an advisor can easily add the value that you pay for it, unless you’re keeping track of it on your own every day.

Amy Chain: Todd, are you talking with clients a lot about this topic right now?

Todd Bechtel: Asset location?

Amy Chain: Asset location, tax policy, you name it.

Todd Bechtel: Tax policy. Yes, it’s coming up in conversations regarding municipals and whether or not you know that tax and yield that we all, that our clients look at that we look at and says, is it justifiable, should you be in munis versus taxable. Again it’s still where it’ at. The law hasn’t changed. There’s still a wide disparity between ordinary income rates and other rates. And it still favors municipals. So that’s coming up. Asset location, I thought that was your question. That’s coming up every time I work with a client. It has to, it’s a part of what we do. It is a major, not as major as asset allocation, but major decision in building portfolios and you have to do it, it’s a tax-free endeavor. So you, I always say you do the best you can in the markets, you can’t control them. You plan for them. You plan around them. You try to forecast as much as you can.But man, if you can make a couple percentage points in your portfolio just by doing things in a smart tax-efficient way, such as again putting, to expand on Fran’s comments, putting stocks in a retail account you get the capital gain treatment, you get a return of basis on your original investment. There’s estate planning benefits, currently, that I won’t get into. And then on the other side, on the bond side, a co-worker, a peer of mine once used to say that you have a partner in every IRA account that you own, and that partner’s name is the IRS. You don’t own 100% of that $1 million IRA, you own 70%, they own 30%or maybe 40%.

Amy Chain: That’s a great way to put it.

Important information
Please remember that all investments involve some risk. Be aware that fluctuations in the financial markets and other factors may cause declines in the value of your account. There is no guarantee that any particular asset allocation or mix of funds will meet your investment objectives or provide you with a given level of income. Diversification does not ensure a profit or protect against a loss.
Advice services are provided by Vanguard Advisers, Inc., a registered investment advisor, or by Vanguard National Trust Company, a federally chartered, limited-purpose trust company. Investments in bonds are subject to interest rate, credit, and inflation risk. Although the income from a municipal bond fund is exempt from federal tax, you may owe taxes on any capital gains realized through the fund’s trading or through your own redemption of shares. For some investors, a portion of the fund’s income may be subject to state and local taxes, as well as to the federal Alternative Minimum Tax.
High-yield bonds generally have medium- and lower-range credit quality ratings and are therefore subject to a higher level of credit risk than bonds with higher credit quality ratings.
This webcast is for educational purposes only. We recommend that you consult a tax or financial advisor about your individual situation.
© 2017 The Vanguard Group, Inc. All rights reserved.