There are many options when it comes to choosing a strategy to manage financial assets and make investment decisions. For the most part, your strategy should be specifically tailored to meet your financial objectives. This will include balancing risk of loss with potential reward.
However, effective personal financial planning will also take into consideration taxes. Failure to take taxes into consideration may be detrimental to being able to build generational wealth as well as ensuring that there is enough capital to fund a comfortable retirement lifestyle. A householding strategy is geared towards minimizing tax liabilities and other costs while fulfilling your wealth management goals.
One method of doing this is through a portfolio management strategy known as householding.
What is householding?
This strategy may utilize all banking and investment account types that you have in order to achieve the best possible after-tax outcomes. A householding investment strategy will allocate certain types of assets to the most tax-efficient type of account rather than having multiple types of accounts holding the same type of assets.
Essentially, the various types of accounts are used as the building blocks to potentially achieve the overall risk and reward objectives of your portfolio. Categorize your various investment accounts into three groups with specific tax structures: taxable accounts, traditional retirement accounts and Roth accounts. Allocate asset holdings among these accounts in a strategic way that takes into consideration how tax laws treat these different categories of accounts.
These types of accounts are standard investment accounts that are subject to straightforward income and capital gains tax liabilities. When utilized a householding strategy, should hold stocks in taxable accounts since stocks are taxed as capital gains on selling which is favorable to being treated as ordinary income. Taxable accounts should also be used to hold municipal bonds since they are tax-exempt at the federal level.
Traditional retirement accounts
This category of account refers to qualified accounts such as IRAs, 401ks, 403b and other qualified retirement accounts. It may be beneficial to use traditional retirement accounts to hold investments that generate taxable interest since these would be taxed as ordinary income if held outside of a retirement account. You can also use your traditional retirement account to hold other assets in order to reach your overall asset allocation strategy.
These types of accounts are funded by after-tax dollars but are not taxed upon withdrawal of funds. This will include Roth IRAs, Roth 401ks, Roth 403bs and more. Since Roth accounts are not taxed on growth it may be beneficial to hold more aggressive funds and assets in these accounts.
Customizing your householding strategy
Although householding investment strategies do have certain overall principles that aim to provide you with better after-tax outcomes, each individual has their own specific financial profile and wealth management objectives. A customized householding strategy may better fit your individual needs and parameters. Working with an experienced financial professional can help you craft a householding strategy specifically for you.