An Opportunity to Maximize Tax-Favored Growth in Your Investment Account

Workplace open enrollment tends to kick in during late fall. It’s when workers sign up for the new year’s health and dental benefits. But it’s also a prime time to check in on contributions to and the underlying investments in 401(k) plans, individual retirement accounts and health savings accounts, which can offer a bevy of tax benefits. Enter asset location, which involves positioning the assets with the highest growth prospects and yield for growth and tax efficiency.

Tax Diversification and Asset Location

Investors ought to have a combination of tax-deferred, tax-free, and taxable accounts, as this will help them tailor their income and manage levies paid as they draw down in retirement. Keeping the appropriate investments in the right accounts can also help enhance your after-tax return — what you get to pocket after you pay Uncle Sam.

• Tax-deferred accounts, such as your traditional 401(k) plan and your individual retirement account, can be a great place to store assets that are generating lots of income. This would include corporate and high-yield bonds and funds holding these assets. This way, you’re capturing growth and pushing out the taxes due into the future.
• Tax-free accounts should be primed for growth. You use after-tax dollars to fund Roth 401(k)s and Roth IRAs, so that your investments can grow free of tax and be withdrawn free of taxes in retirement, subject to certain conditions. Invest aggressively here.
• In contrast, taxable accounts could be a good place to hold assets such as Treasury bills if you’re going to use the money soon, as well as municipal bonds.

Health Savings Accounts

For workers who choose a high-deductible health plan, a triple-tax advantage awaits in the form of a health savings account. So-called HSAs allow you to put away pretax or tax-deductible dollars into an account, which can grow tax-free and can be tapped free of taxes as long as you’re using the money for qualified medical expenses. The benefit of the HSA is that you can use it to cover health-care costs in the present and future, and you can take it with you even if you change employers. There is no “use it or lose it” provision.

High deductible plans make the most sense for young workers with low medical expenses and employees who can cover health-care expenses out of pocket, and thus minimize tapping the HSA. First, make sure that you’re funding the account such that you can cover the deductible, then invest the rest.

What you can invest in will depend on the service provider handling your HSA, though even now, money market funds available in these accounts could be paying attractive yields.

“Times are different in this enrollment period, versus two years ago,” Glassman said. “I can see people dialing down the risk and saying we have a safety net that’s paying 5% that’s not taxable.”