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How Should You Allocate Investments Among Your Various Accounts?

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If you're like many Americans who are diligently saving for retirement, your nest egg is spread among a number of different accounts such as a 401(k), individual retirement account (IRA), Roth IRA, or even a Health Savings Account (HSA). Keeping these funds in separate accounts can make sense for both financial and logistical reasons, but you may be at a loss when it comes to allocating your investments within each account. What can you do to make these funds as tax-efficient as possible? Read on to learn more about the factors you'll want to consider when deciding whether to place certain investments in tax-advantaged or taxable accounts.

Tax efficiency

The tax structure of many individual investment options, from municipal bonds to stocks to ETFs, can vary widely. This makes it important to evaluate the tax treatment of each investment in each account to ensure you're not inadvertently being taxed twice on certain investments. For example, the interest generated by bond funds can be subject to taxation at your marginal rate, making it a bad idea to invest your entire Roth IRA (an otherwise tax-free account) in bonds.

By that same token, investing your HSA in bonds can also be a bad idea; although HSA funds are deposited pre-tax, making them a generally tax-efficient account, they're also exempt from taxation (along with earnings) when withdrawn and used for qualifying medical expenses. Generating any bond interest will subject these funds to taxes from which they would otherwise be exempt, so you're better off loading up your traditional IRA or 401(k) with bonds instead. 

However, tax laws can and do change, so you'll want to take a few additional factors into account rather than basing your entire asset allocation on the tax efficiency of certain investment vehicles. You may also find it useful to diversify the tax treatment of your retirement accounts by alternating contributions to a traditional and Roth IRA or prioritizing pre-tax savings like a 401(k) if most of your current retirement assets have already been taxed. 


Your own risk tolerance can also impact the placement of investments in certain accounts. You may feel more inclined to take risks with funds in a Roth IRA, as the potential for higher (tax-free) returns is then greater; however, more conservative investors (knowing that long-term losses in a Roth IRA can't be deducted) may be reluctant to invest in anything that has the potential to lose value and lead to a non-deductible loss. 

You may want to seek the services of an investment advisor to help you determine your own risk tolerance prior to making any sweeping investment changes. Staying invested for the long term is the key to growth, and investing in a way that's too risky for your preferences could lead you to pull out funds in a panic during a dip, losing money in the process. Once you've reached an asset allocation you're comfortable with, you'll be in a great position to begin buying and selling funds in each account.


Another factor to consider when allocating your investments is your timeline. Most often, this will be your timeline to retirement, as most accounts designed for retirement savings have specific fees and penalties associated with withdrawal before the age of 55 or 59.5; but in situations where you're also saving in an HSA or other non-retirement-specific vehicles, you may be able to dip into some of these accounts sooner than expected. 

As a result, it can be prudent to map out your timeline toward use of each of these funds -- especially if you're planning to retire well before the age at which you'd qualify for Social Security or Medicare. For example, you may want to spend a few years frontloading your Roth IRA or HSA so that you'll be able to withdraw your contributions (without penalty) for payment of retirement living expenses or medical costs until you've bridged the gap between and the age at which you can begin taking distributions from your 401(k). Talk to a investment service for more direction.