Michael O. AdairManaging Director, Senior Investment Consultant | 2018

Step 2: Asset Location and Implementation

As we begin building the client’s portfolio, the first step to tax management is the idea of “Asset Location.” In other words, putting the right securities in the right account to maximize their benefit to the client.

As we begin building the client’s portfolio, the first step to tax management is the idea of “Asset Location.” In other words, putting the right securities in the right account to maximize their benefit to the client.

EXAMPLE
A City National Rochdale client with a $1M portfolio has half his assets in his IRA and half in taxable dollars. Our asset allocation, as laid out in the Investment Policy Statement, says we need to own 20% in bonds that pay taxable interest. We put the $200,000 in bonds in the IRA so the interest these bonds pay is not taxed in this year (assuming we made no withdrawals form the IRA). This is asset location in action. Furthermore, the IPS says we need to allocate 20% of the portfolio to dividend stocks.

We put the dividend stocks, assuming they’re qualified dividends, in the taxable account because typically, qualified dividends are not taxed at the marginal tax level and get a federal tax break as a result. This, too, is asset location in action, as the client portfolio benefits by owning the dividend stocks in the taxable account. Had we placed these in the IRA, the client would have been taxed at ordinary income tax level once the client started withdrawing the IRA, potentially paying higher taxes.

Asset location also applies to the mutual fund space. City National Rochdale typically prefers to minimize mutual fund holdings in high-net-worth client portfolios, opting to own individual stocks and bonds as core holdings.

However, there are certain situations in which mutual funds are appropriate for a high-net-worth client’s asset allocation. These are usually in very specific market niches, such as international developed stocks or bonds, emerging market stocks or bonds, or opportunistic bonds (e.g., high yields, floating rate, global bonds), that can be difficult to build out with individual securities.

Mutual funds distribute their capital gains annually, which can provide a tax management challenge as investors have no control over what their mutual fund buys or sells—and subsequently the 1099 that they receive each year.

EXAMPLE
An investor decides to buy the XYZ Growth Mutual Fund today. This fund bought stock in a tech company 25 years ago for $5/share. The following day, the fund decides to sell the tech stock, which is now worth $170/share.

That entire capital gain of $165/share comes to the investor as part of the 1099 for the year, along with the fund’s other gains/losses during the year, even though that investor only owned the fund for one day. It potentially could have been wiser to own the fund in an IRA account, assuming the client had enough IRA assets to do so, to avoid an unexpected tax bill late in the year.

Many clients received 1099s with large gains from their funds during the 2008-2009 bear market because even though the market declined, many funds had large capital gains and were held in taxable accounts. Given that the markets recently have been near all-time highs, it’s likely that many funds have stocks and bonds in portfolios at substantial gains. This is something to be aware of as we move into the ninth year of the current expansion.

For clients in high brackets, City National Rochdale often utilizes municipal bonds (including high-yield munis) in taxable accounts, as interest is federally tax-exempt.


CONTINUE READING

As we begin building the client’s portfolio, the first step to tax management is the idea of “Asset Location.” In other words, putting the right securities in the right account to maximize their benefit to the client.

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Important Disclosures

Investment management services provided by City National Bank through its wholly owned subsidiary City National Rochdale, LLC, a registered invest¬ment advisor.

City National Rochdale, as a matter of policy, does not give tax or legal advice. Before implementation, you should consult with your other advisors on the tax, accounting, and legal implications of the proposed strategies based on your particular circumstances.

The information presented does not involve the rendering of personalized investment, financial, legal, or tax advice.

As with any investment strategy, there is no guarantee that investment objectives will be met, and investors may lose money.

City National Bank provides investment management services in conjunction with City National Rochdale, its wholly owned subsidiary. Attached herein are communications prepared by City National Rochdale that reflect City National Bank’s investment products and services.

All investing is subject to risk, including the possible loss of the money you invest. As with any investment strategy, there is no guarantee that invest¬ment objectives will be met, and investors may lose money. Diversification does not ensure a profit or protect against a loss in a declining market. Past performance is no guarantee of future performance.

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