[00:00:00] Hi, I'm Ed Slott and I'm Jeff Levine. And we're two guys who just love to talk about retirement and taxes. Look, our mission is simple to educate you, the saver, so that you can make better decisions because better decisions on the whole lead to better outcomes. And here's how we're going to do that. Each week, Jeff and I will debate the pros and the cons of a particular retirement strategy or topic.

With the goal of helping you keep more of your hard earned money. At the end of each debate, there's going to be one clear winner. You! A more informed saver who can hopefully apply the merits of each side of the debate to your own personal situation to decide what's best for you and your family. So here we go.

Welcome to the Great Retirement Debate. Okay, Jeff. Here's one for you. Alright. Two retirees walk into a bar. Okay. Because they're retired. They got time on their hands. Right. One has a traditional IRA. All right. The other has a Roth IRA. Should they invest [00:01:00] differently depending on where their money is? Or you could have somebody that has both.

Should they invest differently depending on where their funds are located? IRA, traditional IRA versus Roth. So effectively, the question is, should you change your investments because You have different types of accounts. Exactly. That's a good question. Well, only between those two, we're talking. Alright, so for me, I look at this and I say, the first step is probably figuring out what your investments should be.

Right? Not the other way around. Not determining your investments by the type of account you have. but first determining what investments you want and then figuring out where to place them in the account. Do you know what I mean? In other words, I think if you're, if you're deciding your investments based on whether you have traditional IRAs or Roth IRAs, you're sort of letting the, the tax tail, the uh, the so called tax tail wag the investment dog.

And that's probably not the right way to go. Well, I think there's a situation where that might have, have some [00:02:00] effect. For example, if you do something that's high risk, because you want high reward, why else would you do high risk? Uh, you might want that in You're an adrenaline junkie, man. You just like to live on the edge.

Well, there's a, there's a case for both. You might want that in the Roth if you think it's going to take off because that's all going to be tax free. Sure. But if it crashes because you took too much risk, you might wish that was in your traditional IRA because at least the government will share the pain.

That's true. There's no question about that, that the Roth gives you higher reward but there's higher risk, because it's effectively all your money. That's right. With the traditional IRA, you are sharing that in a sense that if you had a million dollars in a traditional IRA, you don't really have a million dollars.

You might have seven hundred thousand. If you lose it all, and your account goes from a million to zero, There's an argument to be made that you really didn't lose a million dollars. Right. I call that house money because that belonged to Uncle Sam anyway. Mm hmm. And then, of course, you get into even more.

I know we're not going to necessarily get into the weeds [00:03:00] here today, but you could add in taxable accounts as well where it's almost like a little bit of a hybrid. Right. That's why I said let's keep it to IRAs and Roth IRAs. Yep. Because taxable accounts are a whole different animal. They get step up in basis and all of that stuff.

Yeah. So, I think, to me, the very first step in the process is you figure out your appropriate asset allocation. Allocation. What we're talking about right now is asset location, right? Where would you put your investments? But, but to me, step one is get that allocation right, right? That's the, the, you know, the, the calculation of how much in stock should you have?

How much should you have? Uh, you know, do you want real estate? Do you want cash? All of your investments. And I think first you get that lined up. And then once you have that lined up appropriately, then you look at what accounts you how already have. You look and you say, well, I've got a $500,000 Roth IRA and I've got a million dollars in my 401k.

Okay. Well, now you just look and you start to figure out based on the investments I already decided I like because I like them from an investment [00:04:00] perspective. Now, here's the best place to locate those with my dollars. Well, if you're taking that approach, then we do have to factor in. the outside accounts, the taxable accounts, because you may have different investments there with higher risk or whatever.

And you say, well, I have enough, uh, stock market, for example, stock market exposure in my regular taxable brokerage account. So you have to take your full investment portfolio into account. Yeah. What I, what I typically say is there's priority investments I see for a Roth account and priority investments for a taxable account.

You might say, what about the IRA? Come back to that in a little bit. But when we're looking at where you want to place investments, I think there's value for the most part in trying to locate investments that have a high return and that are also tax inefficient, if you will, in your Roth. Like the Roth has two things going for it, right?

It has tax deferral [00:05:00] and it has tax free growth. So if you have inefficient investments, meaning investments that produce a lot of capital gains or interest or dividends each year, it's good to have those inside a tax deferred wrapper so that you're not paying tax on those dollars each and every year.

And of course, if something is growing quite rapidly, you know, if you expect it to have long term appreciation, well, where else would you rather have that long term appreciation than an account where it's all tax free. So to that extent, the Roth. in my opinion, should generally be prioritized for those types of investments.

High return, highly inefficient. Now, when we look at the What do you mean by highly inefficient in a Roth? Meaning like a lot of what would create a lot of tax each year if it were inside a regular account. Because that's a non issue in a Roth IRA. Exactly. And then I look at, let's say, a taxable account Right?

And there, there's two things for priority there. So this is now not the, not the Roth, not the traditional, but a regular [00:06:00] brokerage account. Right. There, you want generally lower returns, and you want things that are more tax efficient. Now, if it's ultra tax efficient, it really doesn't matter what the return is, right?

If you think about a municipal bond, for instance. If you had a municipal bond earning 2%, or 3%, or 20%, it really doesn't matter because it's tax free. Right. But most things in life other than municipal bonds are not tax free. So then if there's some tax that's going to be owed on that investment, it really comes down to a multi, uh, like a multi factor approach of analyzing both the actual return and the tax rate applied to that return.

Right. Because if you look at something that has a small return, but that's taxed really poorly, like at ordinary income tax rates, It might be more important to shield that in a retirement account than it would be if something had a higher return but was taxed at more preferential rates. It's sort of, you got to look at both together.

But most [00:07:00] people, I don't know about most people, and you may know more about this than me, in a brokerage account, usually as, towards the end of the year, you do the loss harvesting and they offset the losses and the gains so it doesn't have as much tax impact on the stock. Well, certainly, you're right. On the capital gains portion, if you're looking at good tax loss harvesting, that is an option.

Although some people, they've, they've held investments for so long, they really don't have that much in losses. You know, they may have a lot of gain going forward. And plus, things like interest or dividends, you don't have the ability to offset. Right. You don't have much of a shelter there. Exactly. So, so to me, I look at it and I say the Roth IRA, we prioritize high return, inefficient investments.

Right. The taxable account generally is going to be for lower return. Efficient investments. And then we get to the traditional IRA. Right. To me, the traditional IRA is the Danny DeVito of accounts. You remember the movie Twins, Ed? Oh, yeah, yeah. Yeah, with Arnold Schwarzenegger. Arnold is the Roth, I guess.

Well, yes. Danny DeVito is the leftovers. You [00:08:00] remember? Like Oh, right, the leftover on the floor. That's right. He says, you know, Julius was Arnold. He got all the good stuff. Yeah. And uh, that was a great movie. It was a great movie. And Danny DeVito, he says, I got stuck with all the left, you know, the, the, the doctor It says you were all the leftovers.

Yeah, well the ta, the IRA is basically all the leftovers. So what you do is you start by saying, what are the most important investments that I already decided I want to own? And I put those in my Roth. And then what are the most efficient things I own with the low returns? Those go to the taxable account 'cause you don't have a lot of tax drag is the name or there.

And then everything that's left over. We've already filled up those other two accounts, just ends up in your traditional IRA. And do you take beneficiaries into account too? Because if we're including a taxable, they get the step up in basis. So that's a big deal. It is. It's a huge deal. Yeah. When we're looking at beneficiaries, actually, you know, a little bit different, but a related note, sometimes I actually think that people should consider treating their beneficiaries unequally.

[00:09:00] To to leave them. Each a little bit more. You know to, to make sure that or to consider leaving a higher income tax beneficiary more of a Roth account. And a lower income tax beneficiary, more of a traditional account. This way overall. Fewer dollars are taken by the IRS. And if there's fewer dollars, still equalize the net of tax inheritance.

That's right. I always, what I tell people is if you have a traditional IRA, a 401k or similar type of account, you have N plus one beneficiaries and being the number of people you name on your beneficiary form. Plus one and the plus one is the IRS, right? You do something to minimize the plus ones share of your inheritance or you know without algebra I just tell people you know, who are your beneficiaries and they'll say well, I have John and Jim.

Oh, so you have three Right. What? No, I said I only have two. No, you didn't put Uncle Sam on there. Yep. He's, uh, he's an interesting beneficiary. Uh, we [00:10:00] know what a beneficiary is. They get the funds after they inherit, after somebody dies. Uncle Sam is an unusual beneficiary. He gets it while you're alive and after death.

It's good to be the king. Yeah, right. So, uh, You always have that. I always tell people, you know, you have an extra beneficiary. If you split it over less people, obviously your beneficiaries will get more. So I don't use the N plus one. All right. But I get what you're saying. Nobody wants the extra beneficiary.

That's right. You cut out the IRS's share. It means there's more left over for the other people. He comes with the account, except in a Roth. That's true. Alright, so back to our initial, you know, or our main topic of discussion today, should you invest differently in a Roth or a traditional IRA? You know, when we look at this, we say there are definitely some tax advantages to doing so, right?

Putting your higher appreciating investments inside a Roth account. Can be great. Uh, you know, from a tax perspective, putting your most efficient investments inside a [00:11:00] taxable account because if they are efficient, you don't need the tax deferred wrapper as much right? That can be valuable. But there are some downsides to this approach too that people should be aware. For instance, not every couple, right? If you're if you're looking at a household, If you're looking Right? With, uh, uh, uh, you know, let's say, uh, husband and wife's accounts. Maybe the husband has more of the traditional IRAs and the wife has more of the Roth IRAs. Oh, right. Yeah. If you're locating your investments, like we just talked about, You know, they may see their own accounts fluctuate much differently from one another and that may, you know, they may Understand it or they may not, right?

Sometimes that can be very difficult to explain Like well, why did your account go up so much? I'm going down and plus in some cases blended families and things like that. The accounts may go to different beneficiaries That's exactly right, which again must be taken into consideration. It also means that That, um, you know, to your point, there is a little bit of a benefit in some cases, a little bit of defense, if you will, of having those risky investments [00:12:00] inside the traditional IRA where someone could take, you know, where, where the IRS effectively absorbed some of that loss.

That said, over time, you hope that your higher appreciating assets, the riskier assets, look, like you said, the only reason you take the risk is because you believe long term it's going to have the reward to, you know, in, And in life, you play your odds over and over and over again, right? You do the best you can with the information you have at the moment, and you go forward from there.

Most times, those higher risk investments have a higher expected return. That's again, why you're willing to take the risk. If you hold on to it long enough, you hope to see that return. And if you do it inside the Roth, you You, you know, you can, you can enjoy those returns tax free, but there's no guarantee.

And so someone might say, well, I'd rather have all my accounts be the same, uh, you know, it, it, this way I have a little bit in each bucket. There's, there's an argument to be made for that too. Well, except that the Roth, anything in a Roth, uh, always does better [00:13:00] because that's, that's the single best account.

I mean, everything in there grows income tax free for the rest of your life. You never have to take it out. And even 10 years beyond to beneficiaries, they don't have to worry about income tax. You notice I said income tax always because people say, what about a state, you know, they think estate tax too.

They're all included in your estate, but anything in a Roth, it's Even alternative investments, uh, like real estate for example, uh, real estate, the best place to have it is in the Roth because it's absolutely income tax free. But the worst place is your traditional IRA because now you've just stripped it of all the great benefits of real estate.

So if you don't have a Roth, you're probably better off in a regular taxable account to own it personally, for example, or outside of your traditional IRA, because you get the step up in basis, the depreciation, all the big tax benefits of owning real estate. And if you do it in a Roth, obviously [00:14:00] you don't have to worry about any of that.

It comes with it. It's like Roth, everything comes with it. You get the Roth, it's like when they have the, uh, the, The step ups in, uh, products. I can't even think of one. You get this, you, you know, for this money, they get this, and you get this. You buy one knife and you get 75 for free, right? It's got everything.

You get the holder. It's got all the benefits. Yeah. I should know that from PBS. You know, you get this package, oh, you get one more and 10 more CDs and 10 more CDs. That's the roth. It comes with every possible benefit. That's the best place to own. Uh, but, uh, if you don't do well, let's even with real estate, you lose money.

It's all your loss. Yep. Yeah, so I can make a, I can make the argument maybe that you'd want to have real estate inside a taxable account, but it kind of brings me to a point that I want to make before we wrap up our discussion here, which is, you know, a lot of times I get the question, hey, I have real estate.

Should I own it in my traditional IRA? Should I own it in my Roth? Should I own it in my taxable account? Or, hey, I have this foreign stock. Where [00:15:00] should I own this? Well, you can't look at these things in isolation, at least not if you buy into my theory that first you pick your investments and then you pick the location.

Because what it really comes down to when you're, when you're figuring out where you should own your investments is what else do you own, right? Should I have it in my traditional IRA? The answer is compared to what? Right? Should I have it in my taxable account compared to what? Oh, and I just want to stop you there.

We were, we're saying things and I'm realizing some people might say, so you can just put real estate in your IRA? No. You can use your IRA or Roth IRA funds to buy real estate. You can't contribute it. I just want to make that clear. Right, right. Right. Yes. You can't like take your house and put it in. Yeah.

Yeah. Right. You could go and, and most of these times you'd need a self directed IRA custodian too in order to uhh. But you buy it with the funds in the Roth IRA, for example. Which creates a whole set of other parameters and whatnot that you need to be aware of. Prohibited transaction rules and so forth. No, there a [00:16:00] risk, and that's not what we're talking about.

We're just talking about where's the best location for these kind of assets. Yeah, so ultimately to me, again, it boils down to create your list of investments. And then you prioritize them based on your specific list of investments, and it's just ranking them. So we would start with your Roth account and say, what are the things I most want in here?

And if you have 10 investments, you rank them 1 to 10 and say, this is the thing I want most in the Roth. OK, if you put all of it in and there's still money left in your Roth, then you go down to number 2 on your list. Invest it. If you still have money left, you go down to number 3. Then you do the same thing for your taxable account.

You say, if looking at my 10 investments, what are the things that I want most in the taxable account? Well, you start on the list with one, go down until that's full. At the end of the day, what you're going to be left with is the leftovers, the Danny DeVito of your investments, and you put them right back into your traditional IRA.

And now you have appropriately, in my opinion, at least, asset located. You now have not only your good asset [00:17:00] allocation, which you decided before you set apart on where you put the investments, but then you have taken the next step, which is figuring out where with the investments you already know you want to have, you should place them.

Right. All right, Ed, always a meaningful discussion with you. Lots of good feedback, I think, today, uh, for our listeners to take into consideration as they plan for their own retirement and figure out where to locate their own investments. Thanks so much, as always, for a great discussion. See you next time.

Jeffrey Levine is Chief Planning Officer for Buckingham Wealth Partners. This podcast is for informational and educational purposes only and should not be construed as specific investment, accounting, legal, or tax advice. Certain information mentioned may be based on third party information which may become outdated or otherwise superseded without notice.

Third party information is deemed to be reliable but its accuracy and completeness cannot be guaranteed. The topic discussed in corresponding arguments are those of the speakers and may not accurately reflect those of Buckingham Wealth [00:18:00] Partners.