Açor considers the high level of taxes that Bañuq pays. Açor will recommend changing the asset location of high-dividend-paying equities that Bañuq owns from a taxable account to a retirement account with tax-free earnings and withdrawals.
Açor’s recommendation regarding asset location in Bañuq’s portfolio is most
likely an example of tax:
A. deferral.
B. reduction.
C. avoidance
The answer is C. Why is that? Isn’t moving money to a retirement account tax deferrals or reduction? I understood location to mean the type of accounts not a physical location. Not sure what I might be missinghere.
Tax deferral means you pay LATER. Tax reduction means paying at a rate of x% instead of y%, where x>0 and y>0, but x<y. Avoidance is a special case of reduction where x=0%.
to add to breadmaker’s answer, the question specifies that the retirement account has tax-free earnings and withdrawals.
In the US there are 2 kinds of retirement account:
(i) accounts where you don’t pay income tax on the contributions. Funds (and earnings) in the account are taxed when withdrawn from the account. A traditional IRA is an example.
(ii) accounts where you don’t get a tax reduction for the contribution but do get tax-free earnings and withdrawals. A Roth IRA is an example.
The question is talking about accounts like a Roth IRA.
Tax avoidance strategies include holding assets in a tax-exempt account versus a taxable account, investing in an tax-exempt bonds instead of taxable bonds, holding assets long enough to qualify for long-term capital gain treatment, and holding dividend-paying stocks long enough to pay the more favorable tax rat.
The tax-deferral strategies include limiting portfolio turnover and the consequent realization of capital gains and tax loss harvesting.
Those descriptions are from R21 summary in the book.