Tax location: why the same investment in two accounts ends up as two different amounts

The question nobody asks in time

You choose a fund. You put in the same money. Then someone asks which account to hold it in: a workplace retirement plan, a Roth, or a plain brokerage account. It sounds like paperwork.

It is not. Where an investment sits can change how much of it you keep by tens of thousands of dollars, without changing the investment at all [1].

Morningstar’s retirement research puts a number on it. For someone reaching retirement with a $1 million portfolio, choosing which account held which holding raised the final amount left behind by an average of $112,000. Morningstar puts that at as much as 30 basis points a year of extra return - 0.3 percentage points - with no cut to yearly spending [1].

The trade calls this asset location. It is one letter away from asset allocation, and often confused with it. Allocation is what you own - the mix of stocks and bonds. Location is which account it sits in [1][2].

Three kinds of account, three moments of tax

Almost every account you can hold an investment in falls into one of three buckets [2].

Tax later. A traditional 401(k) or IRA. Money goes in before tax, so your taxable income drops this year. Nothing is taxed while it grows. Every dollar taken out later is taxed as ordinary income [6][5].

Tax now. A Roth 401(k) or Roth IRA. You pay tax before the money goes in, so there is no deduction. After that, growth and qualifying withdrawals come out tax-free [4][7]. “Qualifying” carries a rule: for a Roth you generally need to be 59 and a half, and to have held the account five years [8].

Tax as you go. A plain brokerage account. No break going in, none coming out. Every year the dividends and interest it throws off are taxed, and so is any gain you lock in by selling [2].

A Morningstar interview with Baird’s Tim Steffen puts the first two plainly. They are, he says, “mirror images of each other” [3].

The arithmetic that surprises people

Take $1,000 of earnings, a tax rate of 22%, and an investment that grows to 2.95 times its starting value. That is roughly 7% a year for sixteen years. These figures are illustrative, not a forecast.

Tax later: the whole $1,000 goes in. It grows to $2,950. You withdraw, pay 22%, and keep $2,301.

Tax now: you pay the 22% first, so $780 goes in. It grows 2.95 times. You keep $2,301.

Identical. Not close - the same number. Multiplying by 0.78 and multiplying by 2.95 give the same answer whichever order you do them in.

So if your tax rate is the same going in and coming out, the choice between those two accounts changes nothing whatsoever.

What breaks the tie is the rate moving. Hold everything else still and drop the later rate to 12%: tax-later returns $2,596, tax-now still returns $2,301. Raise the later rate to 32% and it flips - $2,006 against $2,301. The swing is exactly $295 each way, because ten percentage points of $2,950 is $295.

That is the whole question. Not how fast the money grows. Not how long you hold it. Those cancel out completely.

The third account leaks

The plain brokerage account is a different problem. It is not about order.

Dividends and interest are taxed in the year they arrive, so less is left to reinvest, and that shortfall compounds. Investopedia calls it tax drag [9]. Qualifying dividends are taxed at 0%, 15% or 20%; the rest at ordinary rates as high as 37% [10]. Long-term capital gains - profits on things held over a year - carry the same 0/15/20 structure. Anything sold inside a year is taxed as ordinary income [11][12][26].

Run the same $780 through a plain account where tax takes about 7% of each year’s growth, on the same illustrative figures. The money reaches roughly $2,195 rather than $2,301. Sell, pay 15% on the $1,415 gain, and you keep about $1,982 - some $319 short, near 14% less, from an identical investment.

Hence the placement rule. Morningstar’s version has two halves. Put the highest-growth holdings in the tax-free Roth, where decades of compounding come out untaxed. Put the lower-growth income holdings, such as bond funds, in the tax-deferred account, where the annual interest is not taxed each year [1]. One adviser quoted by Kiplinger reduces it to a sentence: put the least tax-efficient assets where the tax authorities cannot reach them [23]. The emphasis shifts with age - in working years the aim is avoiding gains you have to declare; in retirement it becomes drawing income with the least tax friction [24].

Where the plain account wins

It would be dishonest to stop there. The taxable account has advantages the sheltered ones cannot match [13].

There is no contribution limit and no withdrawal rule. The money is reachable at any age, for any reason. You can also harvest losses: sell something below what you paid, and the loss offsets gains, or up to $3,000 of ordinary income [13]. That is impossible or awkward inside a sheltered account.

Put plainly: when an investment loses money, the plain account is the only one that shares the loss with the tax authorities.

Four traps

Phantom gains. Inside a mutual fund, other people’s selling can trigger a tax bill for you. In 2022 the Growth Fund of America fell about 25% and still paid shareholders $3.71 a share in long-term capital gains that December [14].

The wrapper decides. Brookings finds a mutual fund and an ETF holding identical portfolios can produce very different tax outcomes, purely from how each meets withdrawals. It argues this breaks a basic principle - that otherwise identical investors should be taxed alike [15].

A deferred balance is not all yours. The statement includes tax not yet paid. Required minimum distributions begin at 73, rising to 75 in 2033, and force money out whether you want it or not [18]. That can lift Medicare premiums and drag more Social Security into tax [19].

Early access costs. Take money from a 401(k) before 59 and a half and there is generally a 10% penalty on top of income tax [20]. Rule 72(t) is the escape: at least five substantially equal annual payments, penalty-free, though still taxed [21].

What varies

The limits move every year. For 2026 the IRS set the 401(k) limit at $24,500 and the IRA limit at $7,500, with catch-up amounts of $8,000 and $1,100 [16]. Savers aged 60 to 63 get a higher catch-up of $11,250 [4].

From 2026, workers aged 50 and over whose prior-year wages from that employer topped $150,000 must make catch-up contributions to a Roth rather than pre-tax [17]. The statute’s base figure is $145,000, adjusted upward for inflation [4]. State tax varies too: state capital gains rates run from zero to just over 14% [25].

The names change by country; the shapes do not. Britain has ISAs and pensions rather than Roths and 401(k)s. Pension tax relief there is worth more than 50 billion pounds a year and ISA relief more than 10 billion. Higher-rate taxpayers (40%) and additional-rate taxpayers (45%) are the biggest gainers, while those on low incomes who cannot save are excluded altogether [22].

The one thing to carry

The order of two multiplications cannot change the answer. Tax before growth, or growth before tax, leaves exactly the same money. So the only live question in the now-or-later choice is whether your rate will move - and that is a guess about a law nobody has written yet.