If you aren’t using asset location—the deliberate practice of placing investments in specific types of accounts to maximize tax efficiency—you are missing the boat and it is costing retirees dearly, according to new research from Morningstar.
In a new report, “The Overlooked Edge: The Case for Asset Location in Managed Portfolios,” Morningstar quantifies exactly how using asset location—or not using it—can make a huge difference during a retiree’s decumulation phase.
“…for a retiree starting with a $1 million portfolio, a disciplined asset location strategy during the decumulation phase can increase the final bequest amount by an average of $112,000.”
By placing high-growth assets in tax-exempt accounts—like a Roth 401(k) or Roth IRA—and lower-growth assets in tax-deferred accounts—a 401(k), 403(b) or 457(b)—retirees can unlock meaningful gains without taking on extra risk or cutting spending.
“The results of our analysis are clear and compelling. We find that for a retiree starting with a $1 million portfolio, a disciplined asset location strategy during the decumulation phase can increase the final bequest amount by an average of $112,000,” states the Morningstar paper, by Senior Quantitative Analyst Abhijay Gupta and Director of Data Science Neelotpal Shukla, CFA. “This translates to an additional 7 to 30 basis points annually in portfolio performance over the decumulation period.”
The authors note the increase is directly attributable to enhanced total portfolio tax efficiency. “Like the so-called free lunch of diversification, asset location might be thought of as a free meal representing significant upside for retirees seeking to maximize their financial security and legacy,” the paper states. “We also found that the advantage delivered by asset location increases with higher tax rates and a higher proportion of wealth in tax-deferred accounts.”
The Morningstar research, based on thousands of simulated retirement scenarios, says the application of asset location is often ignored—despite its potential to materially improve results.
An example of strategic asset location cited in the paper is owning a bond fund within a person’s 401(k) instead of within their brokerage account. In a brokerage account, the investor must pay taxes, out of pocket, on the dividends that make up a considerable portion of the fund’s total return. Owning that same bond fund within a 401(k), there are no taxes to be paid, at least until the money is withdrawn from the account. This way, the investor can realize the full pretax return of the fund with that amount continuing to grow tax-deferred.
It’s more common sense than rocket science. By concentrating higher-growth assets in tax-exempt accounts and lower-growth assets in tax-deferred accounts, investors allow more wealth to compound free of tax drag. Over decades, the paper notes this structural efficiency compounds into a meaningful difference in both portfolio longevity and legacy value. And these benefits are achieved without additional risk, without new products, and without altering the investor’s overall asset allocation.
“For providers of managed account services, the implication is clear: ignoring asset location is a missed opportunity,” the authors write. “It is a structural advantage that should be embedded in every retirement solution. Investors deserve strategies that treat their portfolios holistically, not as a collection of disconnected accounts. If a platform does not optimize for asset location, it is leaving measurable value on the table.”
The full Morningstar report can be accessed at this link.
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