Holding Bonds In IRAs - A Big Mistake?

Before I get into why, let's review the basics.

Location optimization organizes accounts into 3 types:

-          Taxable: accounts such as joint accounts, trust accounts and personal accounts that are subject to state and federal tax as income and gains are recognized

-          Tax Deferred: accounts that will be subject to ordinary tax rates at the time that amounts are withdrawn, such as IRAs, 401(k)s and annuities

-          Tax Free: Roth IRAs (assuming held for 5 years and age 59-1/2, otherwise, only the basis is tax-free)

Applying location optimization strategy, investments should be divvied up as follows:

-          Put investments with the highest expected returns in the Roth IRA. Since the Roth will never be taxed (see above), higher returning investments will get the greatest benefit.

-          Put investments that produce regular ordinary income in tax deferred accounts. When distributions begin, they will be taxed at ordinary rates - the same as if held in a taxable account.

-          Put appreciating investments, such as equities, in the taxable accounts. Since appreciation isn't taxed until sold, these assets effectively achieve tax deferral without being held in a tax deferred account. When eventually sold, the appreciation is taxed at capital gain rates.

Currently, most advisors applying location optimization hold U.S. corporate bonds in tax deferred accounts.  This is not ideal in today's market environment. With the new surtax on investment income and municipal bonds often paying more than corporate bonds, advisors should be structuring portfolios differently.  How? Take U.S. bond investments out of IRAs and, instead, hold municipal bonds in taxable accounts. Put other high yielding investments (such as real estate or international bonds) in tax deferred accounts.

When "repositioning" bonds in a client's portfolio, the advisor must consider tax costs.  For example, a tax savvy advisor decides to reposition holdings by placing REITs in the IRA and municipal bonds in the taxable account (rather than holding taxable bonds in the IRA).  Thus, the REITs must be sold in the taxable account. If the REIT holdings have appreciated, the client will recognize capital gains. Clearly, the tax cost on material short-term gains would outweigh the benefit of changing asset location. But, if it's a long-term gain, would the location savings be worth the tax bill? To answer this question, the advisor must consider:

-          How material is the gain?

-          Does the client have capital losses to offset and/or are they in a low tax bracket?

-          How old is the client? (With a young investor, appreciation will likely be taxed at some point anyway.  However, an older client might never pay tax on the appreciation. Thus, recognizing gain for an older client could make the tax cost too steep.)

-          Will the reduction in the investment income surtax be greater than the tax on recognized gain?

 

Bottom line: To maximize tax benefits for clients, advisors should revisit their bond decisions, considering municipal bond yields vs. taxable yields as well as individual client circumstances.

This Website Is For Financial Professionals Only


A Strategically Focused CE Curriculum

With classes approved for over a decade by the CFP Board, IWI, and NASBA, Advisors4Advisors CE classes are an optimal knowledge stream for CFP®, CIMA®, CPA, CPA/PFS®, CFA®, and other practitioners. It's not a grab bag of speakers willing to sponsor CE content. Nor is it a one-man CE course. It's a group of subject matter experts with amazing communication skills and a history of thought leadership that, together, give advisors a well-rounded knowledge system for running a professional practice ethically and intelligently.

CE Since October 2008

A4A CE classes for financial professionals began in October 2008, the week Lehman Bros. collapsed. Initially billed as “The Financial Crisis Webinar Series,” A4A connects advisors with authoritative sources on investing, tax, and financial planning, chosen by A4A Editor Andrew Gluck, a veteran financial reporter. A4A members get a stream of CE classes for an advisor who: 

  • holds a CFP®, CIMA®, CPA, CPA/PFS, CFA or other designation requiring CE annually 
  • values monthly CE classes by Fritz Meyer, Craig Israelsen, Bob Keebler, Frank Murtha, or Andrew Gluck
  • diversifies a core of client portfolios in low-expense funds
  • invests based on MPT and economic fundamentals
  • advises on tax and financial planning as well as investing
  • needs financial counseling skills
  • wants the Certified Financial Counselor™ designation 
  • is building a brand as a thought leader locally or in a niche
  • wants the facts when bad news breaks
  • wants CE aligned with a content marketing system
  • wants 24/7 access to CE on-demand
  • insists on objective evidenced-based tax and investment planning analysis
MEMBER REVIEWS 
William Desormeau, Jr.  
It is not possible for me to overstate the cumulative value that Craig, Bob and Fritz have added for over 10 years to my investment advisory practice, as well as for personal and family financial planning. A4A gets my highest recommendation
Lynn Najman, CFP®
I’ve subscribed to A4A since its inception, and always find it intellectually stimulating and on point. It’s one of the few CE solutions out there that doesn’t waste my time by pushing product or talking down to me.

PeteDeacon-CPA-CFP

Pete Deacon, CPA, CFP®
A4A has had a profound effect on my business. Since 2009, I’ve relied on the consistent messaging and updates to run my business successfully. Being able to present the information from Bob, Fritz, and Craig's ongoing CE webinars has been a significant benefit.

fredericMayersen-phd-cfp

Fredric Mayerson, MBA, PhD, CFP®
I've been a financial professional and professor of finance for 35 years and find Fritz Meyer and Robert Keebler to be among the most engaging, incredibly knowledgeable, and experienced presenters I’ve encountered. They deliver an extraordinary amount of information in an extremely interesting way — sequentially and developmentally, utilizing pedagogical tools and techniques that few possess.  A4A to is the most consistently excellent CE program available.  
Ron Roge, MS, CFP®
I’ve been attending A4A many years because the CE classes are outstanding, and my time is valuable. Though I have over 35 years of experience, I’m always learning something new on A4A. I attend fewer conferences now because the CE is generally not advanced. If you want to learn from the best, in a faster, easier, and less expensive way, I highly recommend A4A.

John R. Day, CPA/PFS®

I’ve been a member since 2011 and never miss the monthly webinars with Fritz Meyer. I appreciate Fritz’s independent views on the economy and markets and Bob Keebler keeps me updated on excellent tax planning ideas. A4A is a great value!

NormanPolitzinerCFP

Norman Politziner, CFP

I wouldn't miss a Fritz Meyer webinar unless my pants were on fire. I've relied on Andrew Gluck's knowledge systems --client communications and CE -- for two decades. It's simply the best solution for tax, financial, investment, and risk-management professionals.®   

Dan Hawley, CFP® 

A4A, for over a decade, has been a great resource for useful and accurate information and CE. A4A and Advisor Products are bargains for an advisory practice. 

KevinBrosious-CFP-CPA-PFS

Kevin Brosious, MBA, CFP®, CPA/PFS®

I get CPA CE credit and CFP credit for the webinars.  But not only that, the A4A content is terrific