Asset Location: How to Invest Tax Efficiently

By Justin May, Portfolio Manager

Here’s something that a lot of investors don’t understand: your IRA or 401(k) is not your most tax-efficient account. Many people confuse a tax break going in with tax efficiency coming out. If an account gives you a tax break when you contribute (like an IRA or 401k), every dollar that comes out, including all of its growth, is taxed as ordinary income. This means that, once money is inside such an account, it’s often the last place you want to see investment growth.

Let’s consider the three investment account types that most readers have: an IRA (or 401k), a Roth IRA, and a taxable investment account. The table below ranks how each of these account types is taxed upon contribution, while invested, and when withdrawn:

Comparison of IRA, Roth IRA, and taxable account tax treatment on contributions, investment growth, and withdrawals.

In the top bracket, IRA withdrawals are taxed at 37%, investment gains at 23.8%, and Roth withdrawals at 0%. Understanding which accounts are most tax efficient while invested and when eventually withdrawn should inform your current investment strategy. When determining where to place an investment, consider both how much it’s expected to grow and how much income it generates. You should hold the investments expected to grow the most where growth is taxed the least. At the same time, you should hold investments with the highest current income where current income is taxed the least. Here’s how we’d place common investments:

Asset location won’t change how much risk you take, but over decades it can meaningfully increase how much of your portfolio’s growth you actually keep. The right placement depends on your income, time horizon, and estate plans, so talk with a financial advisor before moving any money between your accounts. This is a simplified framework: real-world placement also depends on factors like state taxes, account sizes, contribution limits, and when you expect to draw from each account. Tax laws also change over time, so treat this as a starting point for the conversation, not tax advice for your specific situation.