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Allocate wisely to save taxes

By Jennie L. Phipps · Bankrate.com
Thursday, July 7, 2011
Posted: 2 pm ET

Taxes can really punish anyone whose retirement planning includes saving a significant amount of money in tax-advantaged and taxable retirement savings accounts. If you're not careful, Uncle Sam will take an unnecessarily big bite out of your nest egg.

Here's some savvy advice on how to allocate wisely between taxable and nontaxable savings accounts. It comes courtesy of Kevin Feldman, managing director of U.S. iShares at BlackRock, a global investment firm.

Feldman said in a column he wrote for SeekingAlpha.com, which aggregates investment advice of all sorts, that he was asked at a weekend barbecue how he chooses to place an investment inside or outside his tax-deferred accounts. He wrote that he was grateful for that question because he thought it was a much better query than the ones he usually gets from people hoping for a little free investment advice.

When I read this and asked him for clarification, he graciously explained further.

In general, Feldman said he puts municipal bonds and most index ETFs -- both of which he considers very tax-efficient -- in accounts that aren't part of his IRA. Here's why:

You generally don't pay federal taxes on municipal bonds and often, you don't pay state taxes either. ETFs, he said, have had a good track record of paying minimal capital gains distributions ("BlackRock's equity iShares ETFs haven't distributed any capital gains in the past 10 years," Feldman says.) and most of the dividends they generate have qualified for the lower qualified dividend income (QDI) tax rate of 15 percent (zero percent in some cases).

Investments that he puts inside his IRA are things like high-yield bonds that distribute income regularly and don't qualify for the lower QDI tax rates. He also places actively managed mutual funds that unpredictably distribute capital gains in his IRA. And he puts investments there that require complex tax or calculations or must meet exacting filing requirement like REITs and U.S. government TIPS. He says putting them inside an IRA makes owning them less of a hassle.

If this kind of tight management sounds daunting to you, be reassured that even if you're Feldman, deciding on these kinds of allocations isn't a slam-dunk. He advises getting help from somebody who regularly manages these transactions, so you meet all the right requirements when you move your money around.

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