Asset Location

A is correct. Corporate bonds generate ordinary income (interest) taxed at ordinary income rates up to 37%. Holding all $400,000 in bonds in the IRA shelters this highly-taxed income from current taxation. The stocks generate qualified dividends (taxed at 15-20%) and long-term capital gains (taxed at 15-20%), which are tax-advantaged even in taxable accounts. Since David needs $600,000 in stocks total, he can hold $300,000 in the taxable account and $300,000 in the IRA. The key is getting the tax-inefficient bonds (all $400,000) entirely into the tax-deferred IRA.

B is backwards and creates the worst possible tax outcome: bonds in taxable accounts generate ordinary income taxed up to 37% annually, while stocks in the IRA waste the preferential qualified dividend and long-term capital gains rates. C is incorrect because it places $300,000 of tax-inefficient corporate bonds in the taxable account where the interest will be taxed at ordinary rates every year. This wastes tax-deferred space in the IRA. D splits assets randomly without considering tax characteristics, missing the opportunity to shelter the tax-inefficient bond income.

B is correct. Asset location is the strategic placement of different investment types across taxable and tax-advantaged accounts to minimize the overall tax burden. The goal is to hold tax-inefficient investments (those generating ordinary income like bonds and REITs) in tax-advantaged accounts where growth is tax-deferred or tax-free, and hold tax-efficient investments (those generating qualified dividends and long-term capital gains like stocks and index funds) in taxable accounts.

A describes asset allocation (determining percentage mix), not asset location (account placement). While related, these are different strategies. C describes security selection for performance, which is unrelated to asset location. Asset location is about tax efficiency, not picking winning investments. D describes diversification strategy, which is also separate from asset location. You can be well-diversified but poorly located from a tax perspective.

B is correct. REITs are required to distribute at least 90% of their taxable income to shareholders, and these distributions are typically taxed as ordinary income (not qualified dividends). For a client in the 35% tax bracket, REIT distributions in a taxable account would be taxed at 35% annually. Holding the REIT in a Traditional IRA shelters these distributions from current taxation, allowing tax-deferred growth. This is a classic example of a tax-inefficient investment that belongs in a tax-advantaged account.

A ignores tax efficiency entirely. While REITs do provide diversification, the question asks specifically about tax optimization through asset location. The diversification benefit exists regardless of which account holds the REIT. C is factually incorrect: REIT distributions are NOT qualified dividends and do NOT receive the preferential 15-20% tax rate; they are taxed as ordinary income. D makes no sense from a tax perspective: splitting the same tax-inefficient investment between accounts does not create any tax benefit and actually makes half the investment tax-inefficient.

C is correct (the EXCEPT answer). Asset location does NOT determine the percentage allocation between stocks, bonds, and cash. That is the definition of asset allocation. Asset location determines WHERE (in which account type) each investment is held, not WHAT percentage of the portfolio is allocated to each asset class. These are complementary but distinct strategies.

A is accurate: Tax-inefficient assets generate ordinary income (taxed up to 37%) or short-term capital gains, so sheltering them in tax-advantaged accounts (IRA, 401(k), Roth IRA) minimizes current tax burden. Bonds pay interest taxed as ordinary income; REITs distribute non-qualified dividends taxed as ordinary income. B is accurate: Tax-efficient assets generate qualified dividends (taxed at 15-20%) and long-term capital gains (taxed at 15-20%), which are already tax-advantaged. Index funds have low turnover, minimizing taxable events; growth stocks held long-term generate long-term capital gains only when sold. D is accurate: Asset location is purely about account placement, not changing the overall portfolio mix. A client with 60/40 stocks/bonds can maintain that allocation while optimizing WHERE each asset type is held for tax efficiency.

D is correct. All four statements represent sound asset location principles.

Statement 1 is TRUE: Municipal bonds generate tax-free interest at the federal level (and often state level for in-state bonds). Holding them in a tax-advantaged account like a Roth IRA wastes valuable tax-sheltered space on an asset that is already tax-free. They belong in taxable accounts. This is an exception to the "bonds in tax-advantaged accounts" rule because munis are already tax-advantaged.

Statement 2 is TRUE: Corporate bonds generate interest taxed as ordinary income (up to 37%). Holding them in a Roth IRA completely eliminates taxation on this income through tax-free qualified withdrawals. This is optimal placement for tax-inefficient fixed income.

Statement 3 is TRUE: Roth IRAs provide tax-free qualified withdrawals, making them ideal for the highest-growth investments. Since growth stocks are expected to have the highest long-term appreciation potential, placing them in a Roth maximizes the value of tax-free compounding. A $10,000 investment that grows to $100,000 over 30 years generates $90,000 in gains. In a Roth, all $90,000 is tax-free; in a taxable account, selling would trigger capital gains tax.

Statement 4 is TRUE: Qualified dividends from value stocks are taxed at preferential 15-20% rates (much lower than ordinary income rates of up to 37%). These stocks are tax-efficient enough for taxable accounts, especially if the client is in a lower capital gains bracket. The preferential rate makes them suitable for taxable holding.