The Right Investment in the Wrong Place

Sometimes you can make the right investment in the wrong place. How so?

Example 1: An annuity or tax-free bond being purchased with qualified retirement funds

At times there may be a case for this, but generally I do not recommend it. The reason is that an IRA or other retirement account is already tax-deferred, so you will not be paying taxes on any growth in that account until you withdraw the money.

An annuity or municipal bond offers the same tax-deferral benefit, so there is little point in having them within a qualified account. They can be suitable investments, but in my opinion, they are a better fit for nonqualified funds.

Example 2: Too many conservative investments in a qualified retirement account or annuity

While I am actually a conservative investor myself, in some situations I believe that qualified funds may be more aggressively invested. This is again due to the fact that qualified accounts and annuities are tax-deferred. So any growth on trading and aggressive investments is not taxed until you withdraw them, which is often many years later. Whereas if you have realized capital gains on funds outside of qualified or annuity accounts, you immediately pay taxes. Conservative investments, which are usually those that you intend to buy-and-hold, might be better made with nonqualified money.

Example 3: Life insurance outside of a trust

A trust is not for everyone, especially as many people have assets well under the Federal Estate Tax limit of $5.25 million single, $10.5 million joint. But a little known fact is that the STATE Estate Tax threshold may be much lower — for example, New Jersey is at $675k. So anything over that will be taxed at a 4-16% rate before being passed on to heirs. So for many, funding a life insurance policy inside an ILIT (Individual Life Insurance Trust) makes sense, and can result in the full death benefit reaching family members instead of being bitten off by Uncle Sam!

Example 4: Funding a mortgage or joint property through inheritance money

While no one likes to think of divorce, sometimes it’s better to be safe than sorry. Inheritance money is not subject to splitting between husband and wife in a divorce in most states, unless it has been used to fund joint property, or comingled with other marital assets in some way. Instead, it is better to keep inheritance money invested in separate, individually-owned accounts. The principal remains intact and segregated, and any earnings or dividends can still be used towards marital obligations if needed.

Example 5: Money invested in a child’s name

Not only is the Kiddie Tax limiting in terms of the benefits of investing for a minor, but assets in your child’s name can possibly count against them when it comes time to college funding and scholarships. Make sure you know the consequences of setting up a college savings plan, or other account in your child’s name.

There are many more examples of where the right investment can be made in the wrong place. So remember, it’s important to consider ALL aspects of your portfolio when putting it together, including tax, college, retirement, insurance, and estate planning consequences!