Taxes Have a Role in Asset Allocation

Once you begin taking distributions from your 401(k) or IRA account during retirement, your investments earnings -- whether from bond interest or stock capital gains -- will be taxed at your ordinary income tax rate. (The exception is the Roth IRA, whose earnings are tax free.)

However, many investors don't take this into consideration. One previous study has shown, for example, that 48% of investors who own bonds in taxable accounts also own equities in tax-deferred accounts. "People don't do the right thing," says Dammon.

Morris Armstrong, CFP, ChFC, head of Armstrong Financial Strategies in New Milford, Conn., says he has worked with clients for years to help them understand this concept.

"It is human nature to look at an 'account' as opposed to a portfolio," he says. "That is why many people choose to ignore the work required to allocate between taxable accounts and nontaxable accounts. But a portfolio is your entire holdings."

While each client's situation is of course different, he says, it doesn't make sense to stuff a retirement account with stocks that generate capital gains and dividends that enjoy preferred tax rates, only to be taxed at higher ordinary income rates upon withdrawal.

Apply that thinking to some of the big growth stocks of the last decade or two, which have split repeatedly while their prices have surged -- Microsoft (MSFT Quote), Dell (DELL Quote), Cisco (CSCO Quote), Intel(INTC Quote), Southwest Airlines (LUV Quote) -- and the savings, or loss, depending on how you look at it, is considerable.

Another reason to place stocks in taxable accounts, Armstrong notes, is that you cannot declare a loss in retirement accounts to offset any gains.

In addition, taxable accounts offer a potentially lucrative estate-planning feature. Upon your death, your heirs won't owe taxes on the capital gains on your appreciated assets. Instead, they start fresh with a new basis, or value for tax purposes, which is the market value as of the date of death.

Withdrawing money from an inherited IRA, in contrast, generates an income tax bill. So it makes sense, from an estate planning perspective, when possible, to put bonds -- whose value increases more slowly than equities -- in a retirement plan and faster-growing stocks in taxable accounts.

Not everyone has the luxury of having both kind of accounts. Most people need to look first to their workplace retirement plan, particularly if their employer offers matching funds.