Asset Location: A Tax-Smart Strategy for Retirement Planning
Your retirement savings are intended to fund the lifestyle you
envision, but taxes may have an impact. Consider ways to
diversify your retirement assets now to help maximize after-tax
returns and potentially manage the effect taxes could have on
your retirement assets.
If you’re concerned that future tax increases may be greater than anticipated, consider diversifying your retirement
assets among tax-deferred, tax-exempt and taxable strategies. Tax optimization may help improve your after-tax
returns and reduce your tax liability during retirement.
“Tax efficiency is always important, but never more than when taxes rise, as they recently have,” says Ken Jordan,
wealth planning director for Morgan Stanley. “In its simplest sense, tax efficiency is not about the returns on your
investments but the amount you actually keep. That’s a crucial distinction, but one that’s often overlooked.”
As you build your retirement savings, make sure you’re contributing the annual maximum to your tax-deferred
retirement accounts, such as Traditional IRAs and 401(k)s. “Since taxes aren’t taken out until the funds are withdrawn,
you give your savings the potential for greater growth year after year,” Jordan says.
Once you’re retired and move from saving to taking distributions, the same principle applies: “The idea is to withdraw
the funds you need to live on while leaving the bulk of your assets invested in the market,” Jordan says. “How you
accomplish that will depend on your investable assets, living expenses, time horizon and long-term goals, among other
factors. The common thread is tax diversification.”
Together, you and your Financial Advisor can review your portfolio and discuss tax-smart ways to build your nest egg
and plan for income in retirement.
Understanding Tax Diversification
Diversifying your portfolio by investing in multiple asset classes—your asset allocation—can be a way to mitigate risk.
The logic of tax diversification is similar. Asset location—investing your retirement assets in different types of
accounts—provides diversification, but the purpose is slightly different: “Tax diversification is geared toward
maximizing the returns you retain,” Jordan says.
To achieve tax diversification, you will want to consider dividing your assets among three different kinds of investment
vehicles: tax-deferred, tax-exempt and taxable.

Tax-deferred vehicles include the well-known IRAs and 401(k) plans, but the category extends to profitsharing plans, defined benefit plans, Keogh plans, ESOPs and annuities. These offer tax-deferred growth
potential and may help reduce current tax liabilities, but many of them have limits on how much you can
contribute. At withdrawal, assets are taxed at the ordinary income rate, which can be as high as 39.6%.

Tax-exempt vehicles include Roth IRAs, which generate tax-free income on the back end if certain
requirements are met but are funded with after-tax dollars. Interest on municipal bonds is generally taxexempt, subject to certain exceptions.
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
Taxable vehicles include conventional brokerage accounts. Earnings in
these are generally subject to capital gains and dividend taxes, the rates
of which are often significantly lower than for ordinary income—
generally, a maximum of 20% on long-term capital gains and qualified
dividends.¹ In addition; a new 3.8% Medicare tax on “unearned” net
investment income may apply.
Developing a Diversified Investment Strategy
Tax considerations grow in importance as you accumulate assets, and
diversification of those assets becomes crucial. Choosing which accounts to
hold, how to fund them and what types of assets to hold in each requires careful
consideration—so be sure to talk to your Financial Advisor about your long-range
goals and consult with your own independent tax advisor based on your
particular tax situation.
“First, you and your Financial Advisor should look at your endgame,” Jordan
says. “How much money will you need for the rest of your life—and how much
will you need at certain points along the way?”
You and your Financial Advisor can examine the different possibilities. For
example:



It could make sense for you to hold stocks that pay “qualified” dividends
in taxable vehicles. Those dividends will be taxed not as ordinary income
1
but at the long-term capital gains tax rate, which is not more than 20%.
(They may also be subject to the new 3.8% net investment income tax.)
Tax-exempt municipal bonds could also be appropriate.
Tax-deferred vehicles, on the other hand, could work best for holdings
that generate income taxed at the ordinary rate, such as taxable bonds.
And as part of a growth component for your retirement investing, you
might consider holding more aggressive or volatile assets in a taxdeferred vehicle, such as an annuity.
Roth IRAs and Roth 401(k)s, contributions to which have already been
taxed, could be a good place for active stock funds that produce a lot of
income.
There’s no assembly-line solution that fits all retirement goals and financial
scenarios. Your Financial Advisor and tax advisor can help you explore the
alternatives and pursue the set of strategies that make sense for your situation.
Developing a Tax-Smart Withdrawal Strategy in Retirement
Once your accumulated assets have been allocated with tax advantages in mind,
it makes sense to work with your Financial Advisor to devise a retirement income
strategy that also addresses tax issues. For example, suppose you fully retire at
age 65, and your primary concern is preserving the value of your assets rather
than investing for growth. From which account should you begin drawing the
funds for your living expenses to maximize tax efficiency?
A Role for Annuities
Traditional IRAs and employersponsored accounts
(considered “qualified
accounts”) are popular taxdeferred options for your
retirement portfolio. A
nonqualified annuity is another
tax-deferred option and can
serve to supplement a qualified
account.
A nonqualified annuity is a
powerful—and complex—
investment, so it’s important to
understand the specifics of the
contract you’re purchasing and
what you want to achieve by
making an annuity part of the
tax-deferred portion of your
portfolio. Some of those
benefits could include:
•Tax-deferred growth
•No limit on
contributions (the
issuing insurance
company may impose
contribution limits)
•No required
withdrawals in
retirement (the issuing
insurance company
may require the owner
to annuitize the
contract once the
annuitant reaches the
maximum maturity
date, generally age
95)
•The option to create a
guaranteed income
stream that can
supplement other
sources of guaranteed
income such as Social
Security or a pension
(if you qualify for them
in the first place)
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You may prefer to withdraw from a tax-deferred account, such as a Traditional IRA, in the early years of retirement
rather than waiting until you have to take required minimum distributions (RMDs) starting at age 70½. “In that way, you
won’t have depleted all the lower-tax potential of your taxable account early on,” Jordan explains. “So you can begin
tapping it when you’re older to meet expenses and support your lifestyle with a relatively light tax bite.”
But, according to Jordan, the better option may be to tap your taxable assets first. “Most of that withdrawal would
presumably be in the form of capital gains or dividends on equities, which are taxed at the long-term capital gains rate,
which is generally subject to a maximum rate of 20%¹ (but may also be subject to the new 3.8% net investment income
tax if your modified adjusted gross income exceeds certain thresholds), or free of federal income taxes (and possibly
state income taxes) in the case of interest on municipal bonds,” he says. “In contrast, withdrawals from a tax-deferred
account would be taxed as ordinary income—and the rate could be as high as 39.6%.”
But make sure to keep a sharp eye on the holding periods of taxable assets, Jordan cautions. “In order to qualify for
the lower, long-term capital gains rate, you need to hold a stock for more than one year.”
If you were to continue drawing income from your taxable account at that relatively lower tax rate, you would be giving
the assets in your tax-deferred account even more time to remain invested in the market, free of taxes on any growth
until withdrawn.
Whether you dip into your taxable or tax-deferred account first depends on your particular circumstances and
numerous variables. “There’s no across-the-board, right-or-wrong approach,” Jordan says. “Both strategies can meet
the definition of tax-efficient planning.”
In all cases, it’s essential to discuss your situation, needs and goals with your tax advisor as well as your Financial
Advisor.
Tax Efficiency for Legacy Planning
In all likelihood, your aspirations go beyond achieving a secure and rewarding retirement. You may already be thinking
about ways to create a legacy for your children and the generations that follow. And you may want to support charities
and causes you care about. Here, too, tax efficiency matters.
“It’s not uncommon for philanthropically minded individuals to sell stock and write a check with the proceeds,” Jordan
says. “The problem is that by doing that, they incur capital gains tax.” A more tax-efficient option would be to gift
appreciated stock directly to the charity. This way, you avoid paying any applicable capital gains taxes on the
appreciation, and you may qualify for a potential income tax deduction.
In creating a legacy for your family, potentially tax-exempt vehicles such as Roth IRAs can be useful. With a Roth IRA,
you use post-tax funds to make contributions or pay taxes on eligible funds that you convert to a Roth at the time of
conversion, rather than paying taxes when you withdraw the funds in retirement (subject to certain conditions).
If you won’t need it to fund your retirement, a Roth IRA can be an effective wealth planning tool. Since there is no
contribution cutoff at age 70½ and no required distributions during the Roth IRA owner’s lifetime (note, however, that
the required distribution rules apply after the death of the Roth IRA owner), you can leave as much of your money in
the account as you wish. “Withdrawals you take in retirement are generally tax-free,” Jordan points out, “and any
²
money remaining in the account may pass income tax-free to your heirs.”
Income limits restrict who can contribute to a Roth IRA, but anyone can convert funds from a Traditional IRA or
employer-sponsored retirement plan to a Roth IRA. Taxes will be due on the funds at the time of conversion. It’s smart
to pay those taxes with funds outside the IRA to keep the account’s assets intact and, if you’re under 59½, avoid the
10% penalty tax on early distributions.
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And again, because Roth IRAs are not subject to RMDs during your lifetime, the assets can stay invested. “If you have
the money to pay the income tax on a Roth conversion—and you won’t need those funds for your retirement—it’s an
excellent, tax-efficient way to pass assets to your children,” Jordan says.
Simple Ways to Start
As we’ve seen, making tax-smart choices about where to hold certain assets will depend on numerous factors and
should be a key consideration of your overall retirement strategy.
Holding different types of retirement accounts can give you more flexibility in planning your income during retirement.
But combining some of them could result in more efficient management of your assets and help align your investments
with your overall financial strategy.
You should also review your existing retirement accounts with your Financial Advisor to see whether consolidating
some of them might make sense. Possible benefits include less paperwork, lower costs, clearer RMDs and greater
investment flexibility.
“Consolidation simplifies reporting and gives you a clearer picture of your finances,” Jordan says. “It also makes it
easier for your Financial Advisor to help you manage your potential for asset allocation risk as well as taxation risk—
and to bring your financial resources into closer alignment with your overall strategy.”
Also consider making use of OneView from Morgan Stanley, which can help you organize all your financial information
in one place, regardless of where your accounts are held. When you enroll your accounts, OneView provides
convenient and secure online access to a holistic view of your financial life. “This puts you and your Financial Advisor
in a better position to carry out your retirement strategy,” Jordan says.
However you structure your retirement portfolio, the important thing is to have a strategy. “Tax efficiency is really about
your life and what you want for yourself and your family,” Jordan says. “You can’t just pick ideas out of the air and
hope they’ll work. A strategy is essential.”
Consider discussing with your Financial Advisor:
 How to further optimize your retirement savings for tax purposes
 How consolidating retirement accounts may help you align your financial resources
with your retirement goals
 How OneView can give you a current, comprehensive picture of your financial life
1
Federal tax rate; state and local income taxes may also apply.
2
Distributions of earnings are tax-free if made (a) after the five-tax-year holding period, which begins on January 1 of the first tax year for which a
regular contribution (or in which a rollover or conversion contribution) is made to any of the taxpayer’s Roth IRAs (other than inherited Roth IRAs),
and (b) after age 59½ or due to death, disability or for a first-time home purchase. Withdrawals of contributions are not taxed.
Tax laws are complex and subject to change. Morgan Stanley Smith Barney LLC (“Morgan Stanley”), its affiliates, and Morgan Stanley Financial
Advisors and Private Wealth Advisors do not provide tax or legal advice and are not “fiduciaries” (under ERISA, the Internal Revenue Code or
otherwise) with respect to the services or activities described herein except as otherwise provided in a written agreement with Morgan Stanley. This
material was not intended or written to be used for the purpose of avoiding tax penalties that may be imposed on the taxpayer. Individuals are
encouraged to consult with their tax and legal advisors (a) before establishing a retirement plan or account and (b) regarding any potential tax,
ERISA and related consequences of any investments made under such plan or account.
Asset allocation and diversification do not ensure a profit or protect again loss in declining financial markets.
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Equity securities’ prices may fluctuate in response to specific situations for each company, industry, market condition and general economic
environment.
Companies paying dividends can reduce or cut payouts at any time.
Some bonds may be subject to the alternative minimum tax (AMT).
Interest in municipal bonds is generally exempt from federal income tax. However, some bonds may be subject to the AMT. Typically, state tax
exemption applies if securities are issued within one’s state of residence, and local tax exemption typically applies if securities are issued within
one’s city of residence.
Bonds are subject to interest rate risk. When interest rates rise, bond prices fall; generally, the longer a bond’s maturity, the more sensitive it is to
this risk. Bonds may also be subject to call risk, which is the risk that the issuer will redeem the debt at its option, fully or partially, before the
scheduled maturity date. The market value of debt instruments may fluctuate, and proceeds from sales prior to maturity may be more or less than
the amount originally invested or the maturity value due to changes in market conditions or changes in the credit quality of the issuer.
Consolidating into a single IRA may not be right for everyone. There may be a number of options available to you. Each option offers advantages
and disadvantages, depending on your particular facts and circumstances (including your financial needs and your particular goals and objectives).
The decision of what option to select is a complicated one and must take into consideration your total financial picture. To reach an informed
decision, you should carefully consider your alternatives, the related tax and legal implications, fees and expenses, and the differences in services,
and discuss the matter with your own independent legal and tax advisors.
Insurance products are offered in conjunction with Morgan Stanley Smith Barney LLC’s licensed insurance agency affiliates.
All guarantees are based on the financial strength and claims-paying ability of the issuing insurance company.
Withdrawal and distributions of taxable amounts from annuities and tax-qualified retirement accounts (e.g., IRAs) are subject to ordinary income tax
and, if made before age 59½, may be subject to an additional 10% federal income tax penalty. Early withdrawals from annuities will reduce the
death benefit and cash surrender value. Optional benefits, such as living benefits and enhanced death benefits, are available for an additional fee.
If you are investing in an annuity through a tax-advantaged retirement plan such as an IRA, you will get no additional tax advantage from the
annuity. Under these circumstances, you should consider buying an annuity only because of its other features, such as lifetime income payments
and death benefit protection.
CRC 886356 (04/14)
Tax laws are complex and subject to change. Morgan Stanley Smith Barney LLC (“Morgan Stanley”), its affiliates and Morgan Stanley Financial Advisors or
Private Wealth Advisors do not provide tax or legal advice. This material was not intended or written to be used for the purpose of avoiding tax penalties that
may be imposed on the taxpayer. Individuals are urged to consult their personal tax or legal advisors to understand the tax and related consequences of any
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