Planning - Concepting - Whiteboard - Tax Planning Tips - Asset Location - Asset Placement

Asset Location: Reducing Taxes & Simplifying Your Tax Return

Intro

Asset Location (AKA Asset Placement) is a strategy for organizing your assets in such a way as to reduce tax burden, simplify your tax return, and manage risk. We discuss our Asset Location strategies, which includes specifics about tax treatment for:

  1. Growth stocks
  2. Dividend stocks
  3. Taxable bonds
  4. Real estate investment trusts (REITs)
  5. Precious metals (gold, silver)
  6. Commodities (oil and gas, etc.)

We also detail considerations for foreign tax credit, master limited partnerships (MLPs), and Schedule K-1.

Podcast

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Hey everybody, welcome back to the Bigger Insights Finance podcast, where we’ll help

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you live a life you don’t need a vacation from.

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In this episode, we’re going to talk about Asset Location, also known as Asset Placement,

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and how these strategies can help you reduce taxes, reduce risk, and simplify your tax return.

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But just as a quick caveat, this information is for education purposes only.

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We are not CPAs, enrolled agents, or tax attorneys, and none of this should be construed as tax

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or other advice.

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Please consult your tax advisor before making any changes to your tax situation.

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Also bear in mind that much of this information in this episode is specific to the United States,

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and even within the US, it may vary depending on your jurisdiction.

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For some of you, this concept of Asset Location isn’t exactly new. But the simplification

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aspect of this isn’t talked about often enough, so we’re going to start from there.

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My motivation for making this episode is that with regard to taxes, I do what you’re supposed

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to do, and that is year-round tax planning.

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As time goes on, my tax returns get more and more complicated.

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It’s frustrating, but I’ve learned a lot along the way and developed an appreciation

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for trying to keep your tax returns as simple as you can.

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Some time ago, I was rebalancing my taxable portfolio, and I decided I wasn’t very interested

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in broad-basket real estate investment trusts or REITs, so I sold these off.

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But I still wanted to maintain some real estate exposure, just not to things like shopping

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malls, offices, and multifamily.

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So I ended up buying a relatively small amount of a self-storage company because that would

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allow me to avoid these issues that I saw in these other sectors while still having some

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real estate exposure.

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When tax time rolled around, as per usual, my 1099 from my brokerage was late because

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of this company.

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They’re pretty much late every year, which is frustrating because a lot of accountants

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get backed up if you don’t get in the door very early.

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So I finally got my 1099, which was so late that I eventually had to file an extension

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for my returns.

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I take a look at my 1099, and I see that they’ve given me Section 199A distributions, capital

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gain distributions subject to the applicable rate, and unrecaptured Section 1250 gains.

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And that’s pretty annoying to me.

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I mean, we’re talking like dozens of dollars here and more tax headache than it’s worth.

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So right about now, some of you are probably thinking, “Yeah, well, that’s my accountant’s

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problem.

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Who cares?”

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And that may be, but A: You’re still responsible for knowing the tax code and making sure that

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your returns are correct and accurate. And B: Your accountant’s problems are your problems.

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You’ll find out when you get your bill. But the fun doesn’t stop there.

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A short time after that, they issued a corrected 1099 because apparently they screwed up some

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of these dividends, despite already being late on the first revision.

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So then I had to download the new form, figure out what they did, and give the new information

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to my accountant.

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To add insult to injury, all they did was recharacterize some of these dividends, which

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again, were quite small in my case.

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So regarding simplicity, there are a couple of lessons here.

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1. REITs kick out a lot of dividends and the tax treatment is not great.

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So in general, we recommend holding these in your tax-favored accounts, like your 401(k),

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IRA, and HSA, which is what I ended up doing.

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And 2. Before you make any investment or do some kind of business, do your best to

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understand how this activity is going to impact your tax return and decide if that’s worth

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it to you.

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In my case with this REIT here, I lost a lot of time, annoyed my accountant, and complicated

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my tax return for what, like $50?

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That’s not a great deal.

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Along these lines, you should also be careful about investments that yield a Schedule K-1,

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which you see a lot in the commodity space.

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And we’ll go over that in more detail later in this episode. Currencies and precious metals

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also have some annoying tax side effects.

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So make sure that you know what you’re doing and/or consider putting some of these in your

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tax-favored accounts.

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And you might not think that this is a big deal, but just keep in mind that complicating

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your tax return will increase accounting costs and the chance of an audit.

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So make sure that the expected returns of what you’re doing justifies those costs.

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Now let’s switch gears and talk about reducing your taxes.

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In general, from a tax efficiency standpoint, your taxable account should favor more of

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your growth and foreign assets, whereas your tax-favored accounts should favor dividend

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paying and domestic assets.

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The reason for this is when you invest in assets that give you more appreciation than

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income, you don’t get taxed on that appreciation until you sell.

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This not only delays when you get taxed, but it also gives you more control as to when

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you pay that tax.

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This is one of the reasons why we’re not generally fans of dividends and taxable accounts, especially

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for taxable bonds, because the dividends those generate are taxable at ordinary rates.

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For stocks, it is true that if you get qualified dividends, these are taxed at long term capital

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gains rates.

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So you might be thinking, “Well, what’s the difference then?”

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And the difference is timing.

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A dividend forces you to take a tax liability that you might not want.

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This is another thing to keep in mind when doing tax planning.

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I’ve had funds kick out 13% dividends before in January for the previous year.

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And this was unannounced as well, which is pretty insane.

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So sometimes what I’ll do for a fund like that is sell it before the dividend,

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so I know what’s going on with my taxes, then re-buy it later in January.

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That might not make sense to some of you because of how dividends and fund pricing work, but

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it can in some circumstances, depending on your cost basis.

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It’s complicated, I know. But the point is that dividends force you to accept income,

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which is a tax liability that you might not want.

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Maybe your income is really high this year, and you don’t want that income until next

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year.

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So for this reason, we tend to put more of our growth assets in our taxable account and

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the dividend investments in the tax-favored accounts.

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Regarding foreign assets, what you might not realize is that most jurisdictions withhold taxes

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from dividends.

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And with some assets like ETFs, you won’t even see those except on your 1099.

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So when you get a $10 dividend from some emerging market ETF, you might not realize that that

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was actually something like $11 or $12, but $1 or $2 was paid in taxes to foreign entities.

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If those taxes were paid in your taxable account, you might be able to offset that with the

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foreign tax credit.

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But in your tax-favored accounts, you just have to eat that cost, which really sucks.

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So don’t ignore that because some countries have pretty high tax rates on dividends.

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As I alluded to earlier with REITs, some of those dividends will be taxed at ordinary rates,

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which may be high for some of you.

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So in addition to simplifying your tax return, you can also save some taxes by putting those

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into your tax-favored accounts, which is what I did.

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Now let’s talk about precious metals.

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A lot of people are interested in investing in gold and silver, but may not understand

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the tax consequences.

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We’re going to do a separate episode on buying gold and silver, where we’ll talk about

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spot ETFs, physical bullion, miners, and so on.

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In general, as asinine as this is, the federal government taxes gains from precious metals

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as collectibles, which have a maximum long-term rate of 28%.

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Now most people listening to this probably have a 15% long-term capital gain rate for

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stocks, for example, so this is a pretty big deal.

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For this reason, we prefer to hold shares of spot gold and silver ETFs in tax-favored

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accounts because those don’t pay tax on those gains.

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But if you do want to own these shares in a taxable account, make sure you run this

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by your tax advisor because we’ve seen some pretty conflicting information on how this

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is taxed.

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For other commodities like oil, wheat, sugar, and so on, there are special rules here as

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well.

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Some commodity funds are structured as partnerships, which will give you a Schedule K-1, which may

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be more hassle than it’s worth depending on how much you’re investing.

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There are exchange traded funds (ETFs) and exchange traded notes (ETNs) with different structures and

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rules.

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We’re not going to go into detail on that in this episode, but just trust us that if

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you’re going to invest in these products, you should consider putting them in a tax-favored

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account to at least simplify your tax returns.

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And again, you should run that by your tax advisor.

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So before I move on, let me go over a little bit more detail about master limited partnerships

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or MLPs.

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These are pretty common in the commodity space, especially in oil and gas. And they can introduce

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tax complications,

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so please consult your tax advisor before investing in one.

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Corporations pay tax at the corporate level.

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When you receive income from a corporation, you then pay tax as well,

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and Uncle Sam is happy. But MLPs don’t pay federal taxes on earnings,

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so the government goes to the shareholder to get those taxes, which is problematic for

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the feds if the shareholder is a tax-favored account.

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A tax-favored account can own shares in an MLP, but you have to keep in mind that any

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income above $1,000 is considered unrelated business taxable income (UBTI) and is taxed as ordinary

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income outside of the tax-favored account.

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This surprises some people.

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And in that case, your custodian will file form 990-T to document this for you and the

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IRS, which from what I’ve read, the custodian will charge you $200-$300 to prepare.

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Ouch.

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If you’ve read about this online, the general suggestion is to instead hold these shares

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in a taxable account, but this goes back to simplicity.

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Is it really worth it to you to deal with the K-1?

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That’s a personal choice, but something to consider.

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All right, so we’ve talked about simplifying your returns and tax treatment.

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Now let’s share some thoughts on risk management.

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The younger you are, the more pertinent this is.

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What I mean by that is that if you’re a year away from retirement, for example, your asset

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location strategy should probably maximize tax efficiency because you’ll soon be able

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to withdraw from your retirement accounts penalty free.

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But for younger investors, there is risk here to consider.

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So let’s say, for example, that you wanted a portfolio of 50% growth stocks and 50% taxable

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bonds. And also that your monies are split 50-50% between your taxable and retirement accounts.

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For the sake of tax efficiency, it would be best to put all of those growth stocks in

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your taxable account and all of the bonds in your retirement account. But from a risk

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management standpoint, you might not want to do that because you might find yourself

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in a situation where you need to sell assets to raise cash for some reason, like a legal

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issue or whatever.

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Well, what happens if you need to do that during a bear market where your growth stocks

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just pulled an ARK innovation ETF ($ARKK) and dropped 70%? It’s likely that your retirement account

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is doing okay because it holds bonds. But that’ll only do you so much good if you can’t

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withdraw that money without paying taxes and penalties because you’re not in retirement.

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Do you see what I mean?

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So what we typically suggest to our clients is that they should get more aggressive with

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their asset location strategy, either A: If they’re relatively close to retirement or

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B: Have so much in assets and income relative to their liabilities and expenses that they

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can handle extra volatility in their taxable accounts.

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And finally, just to give you some general wisdom regarding taxes, the general rule

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of thumb is to do three things.

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A: Learn to identify taxable events.

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This might sound obvious, but there are taxable events that might surprise some people.

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For example: Gifting amounts of money over the gift tax exclusion, extending an interest

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free loan over $10,000, or grandma contributing to little Johnny’s education fund and triggering

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generation skipping transfer tax. 2. Before you execute a taxable event, review how it

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will impact your taxes. And D: Execute the event in such a way that it optimizes taxes, complexity,

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and risk.

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And yes, that’s a Home Alone reference for those of you paying attention.

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All right, so that’s it for this episode.

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If you’d like more help with your financial planning and education, consider becoming

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a Bigger Insights client.

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We help clients like you achieve their financial goals in one-on-one consulting sessions.

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If that sounds interesting to you, go to our website, biggerinsights.com and fill out the

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short form at the bottom of the page so we can schedule your initial consultation.

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Thanks for staying until the end.

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Go work on your asset location strategy, stay healthy, and stay wealthy.

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Drake - Bad Choice-Good Choice - Linux vs Windows macOS ChromeOS Technology

Linux Doesn’t Suck – Here’s Why Even Normies Should Use It

Linux has long been viewed as a science fair project for nerds. We explain why Linux doesn’t suck and why it's now usable even for normies. Some of the items discussed: Issues with Windows, ease of use, performance (efficient use of resources), hardware support, application support, OS licensing, concerns about ...
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Email - Mobile Phone - Privacy and Security - Technology - Hands Privacy & Security

Email is Insecure – Stop Using it for Sensitive Communications

Email is the primary means of sending messages and documents for many people. Unfortunately, email was never designed to be private or secure. Over time, we’ve developed several tools and techniques to help make it more secure. But at the end of the day, no matter how uncomfortable it makes ...
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Woman Shopping - Holding Shopping Bags - Retail - Spending Money Finance

What Does it Mean to be Able to Afford Something?

Most everyone will agree that you shouldn’t buy things that you can’t afford, yet so many do. Why is that? It seems to us that one of the reasons for this is because many don’t know what it means to be able to afford something. Spoiler alert – it doesn’t ...
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Cybersecurity - Privacy and Security - Virtual Private Network (VPN) Privacy & Security

Are Virtual Private Networks (VPNs) Useless Honeypot Scams?

You may have heard others in the privacy and security community call virtual private networks (VPNs) “useless”, “scams”, or “honeypots”, but is this actually the case? There are certainly a lot of sketchy VPNs and creators who shill them, but does that invalidate the thesis for using a VPN? We ...
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