If you’re someone who has both a non-retirement account and a retirement account, you face the issue of which assets to place in which account.
You pay taxes on income and capital gains generated in your non-retirement account. You don’t pay such taxes for your retirement account -- until you withdraw the money.
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So the basic rule of thumb is to keep assets with taxable income and capital gains distributions out of your non-retirement account.
Christine Benz, director of personal finance and retirement planning for Morningstar, wrote a commentary listing eight asset classes to avoid in your taxable account.
1. Taxable bonds and bond funds
“Bonds tend to be less tax-efficient than stocks,” Benz noted. “That’s because most of the return that bond investors earn is income, and that income is taxed at your ordinary income tax rate.”
That rate is generally higher than the capital-gains and dividend-tax rates that apply to the returns from most stockholdings.
2. Multiasset funds
These funds, which include target-date and balanced funds, also are often a poor fit for taxable accounts, Benz said. That’s because they typically hold bonds with taxable interest payments.
In addition, target-date funds tilt away from stocks and more toward bonds over time. That can necessitate stock sales, triggering capital gains taxes.
3. Actively managed equity funds
“Some funds have kept their tax bills low, either because their managers employ low-turnover approaches or they’ve been receiving big shareholder inflows,” Benz said.
“But whether they can continue to do so is an open question. And some active funds have been absolutely awful, dishing out large capital gains year after year.”
4. High-dividend-paying equities and dividend-focused funds
The key reason you’re better off keeping dividend stocks in your retirement account is “control,” Benz said.
“Dividend income isn't discretionary. Whereas stock investors can delay the receipt of capital gains simply by hanging on to the stock, investors in dividend-paying stocks get a payout whether they like it or not.”
5. Real estate investment trust) and REIT funds
“Their income tends to be high and often composes a big share of the returns investors earn from them,” Benz said.
“Moreover, their dividends typically count as non-qualified, meaning they’re taxed at higher ordinary income tax rates versus the lower tax rates that apply to qualified dividends.”
6. Commodities futures funds
“Commodities-tracking funds typically use futures to obtain exposure to the commodities market, and futures’ tax efficiency is poor,” Benz said.
“Sixty percent of their gains are taxed at the long-term capital gains rate, and the remaining 40% is taxed at the much higher short-term capital gains rate.”
7. Convertible bonds and convertible bond funds.
“Gains on convertible bonds are generally taxed at ordinary income-tax rates, making them ill-suited to investors’ taxable accounts,” Benz said.
“The median convertible fund in Morningstar’s database has a 10-year tax-cost ratio of 2.12%, representing a 27% bite out of total return over that period.”
8. Alternatives Funds
Alternative funds contain assets outside of stocks and bonds. “While tax efficiency hasn’t been poor across the board, some of these funds have been quite tax-inefficient, especially when you consider their low return profile,” Benz said.
“The category’s median 10-year tax-cost ratio of 0.9% represents 39% of the median return in that period.”
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