Asset Location Advanced: Should Bonds Go in Your IRA? (The Math Has Changed)
Asset Location Advanced: Should Bonds Go in Your IRA? (The Math Has Changed)
EXECUTIVE SUMMARY
- The Debate: Old school advice says “Bonds in IRA, Stocks in Taxable.” Why? Because bond interest is taxed at high ordinary rates. Shielding it seems logical.
- The Counter-Argument: If bond yields are low (e.g., 2%), you are wasting valuable IRA space on a low-return asset. You should put your highest growth asset (Stocks) in the IRA to maximize the tax-free compounding.
- The BMT Verdict: It depends on yields. When bond yields are high (>5%), put them in the IRA. When yields are low (<3%), put them in Taxable (Muni Bonds) and save the IRA for stocks.
For decades, financial planners blindly followed the rule: “Bonds go in the IRA.” But mathematics cares about Magnitude, not just Rate. If stocks grow at 10% and bonds grow at 2%, shielding the bonds saves you pennies while paying taxes on the stocks costs you dollars. Team BMT Protocol suggests a dynamic approach. Your Asset Location should shift based on the interest rate environment. Source: Kitces.com / Asset Location Decisions
Scenario: $100k of Stocks (10% return) vs. $100k of Bonds (5% return). Tax Rates: 30% Ordinary, 20% Cap Gains.
- Strategy A (Standard): Bonds in IRA.
Bonds (IRA): Earn $5k. Tax $0. (Save $1.5k).
Stocks (Taxable): Earn $10k. Tax $2k. (Pay $2k).
Total Tax Cost: $2,000. - Strategy B (Aggressive): Stocks in IRA.
Bonds (Taxable): Earn $5k. Tax $1.5k. (Pay $1.5k).
Stocks (IRA): Earn $10k. Tax $0. (Save $2k).
Total Tax Cost: $1,500. - Verdict: In this high-growth scenario, putting Stocks in the IRA saved more money ($500).
Tax Cost Comparison (Annual)
| Strategy | Total Tax Liability |
|---|---|
| Bonds in IRA (Standard) | 2000 |
| Stocks in IRA (Aggressive) | 1500 |
*Chart Note: Values represent annual tax liability in dollars. Lower is better. Placing high-growth stocks in the IRA minimizes the total tax bill when equity returns outpace bond yields significantly.
CRITICAL SCENARIO: The “Roth” Exception
Never put bonds in a Roth IRA.
| Account | Primary Goal | Ideal Asset |
|---|---|---|
| Traditional IRA | Tax Deferral | Bonds (High Yield) or REITs |
| Roth IRA | Tax-Free Growth | 100% Equities (Highest Return) |
Execution Protocol
Look at the 10-Year Treasury or AGG yield. If it’s above 4.5%, prioritize moving bonds into your Traditional IRA/401(k). The ordinary income tax drag is too high to ignore.
If your IRA is full (or you want to save it for stocks), buy Municipal Bonds (MUB) in your taxable account. The interest is federally tax-free, solving the “Asset Location” problem without using IRA space.
If you hold Stocks in Roth and Bonds in Traditional, you can’t just sell one to buy the other (different accounts). You must rebalance by adjusting new contributions or by holding a “swing asset” (e.g., a balanced fund) in your largest account.
Fail Condition: Ignoring RMDs. If your Traditional IRA grows too huge (because you filled it with stocks), your RMDs at age 73 will be massive. Putting bonds in Traditional helps suppress RMD growth.
WEALTH STRATEGY DIRECTIVE
- Do This: Follow the hierarchy: Roth = Stocks Only. Traditional = Bonds/REITs (if yields are high). Taxable = Stocks/Muni Bonds. This is the optimal “Tax Efficient Frontier.”
- Avoid This: Buying “Tax-Exempt” Municipal Bonds inside an IRA. You get lower yields for a tax benefit you can’t use. It is a mathematical error.
Frequently Asked Questions
What about REITs?
REITs (Real Estate Investment Trusts) generate “Ordinary Income” dividends which are taxed heavily. They are the #1 candidate for your Traditional IRA, regardless of bond yields.
Does this apply to 401(k)?
Yes. Most 401(k) plans are “Traditional” (Pre-Tax). They are excellent places to hold your bond allocation, leaving your Roth IRA and Taxable Account free for pure equity growth.
What if I have no Bonds?
If you are 100% Equities, Asset Location is simpler: Put highest growth in Roth, standard growth in Taxable/Traditional. See Asset Location Basics (#405).