“Of all our findings, this one is the most interesting,” said Daniel Jacobs, the other co-author of both papers. “For U.S. investors, U.S. stocks will have a greater percentage of qualified dividend income (QDI) than ex-U.S. stocks, and QDI is taxed at a lower rate than other income. So you would think it would make sense to keep U.S. stocks in taxable accounts and ex-U.S. stocks in tax-advantaged accounts.
“But our calculations show that most investors may be better off the other way around. Often the foreign tax credit the investor gets from ex-U.S. stocks more than offsets the advantage of the higher proportion of QDI from U.S. stocks. Some investors could gain up to another 10 basis points in after-tax returns just by keeping ex-U.S. stocks in taxable accounts.”
The magnitude of the difference can vary widely, depending on the investor’s tax bracket, the overall allocation to equities in the portfolio (the glide path), the amount of foreign taxes withheld, and the proportion of QDI.
The charts below indicate which hypothetical portfolio—ex-U.S. equities in taxable accounts (signified by circles) versus U.S. equities in taxable accounts (signified by triangles)—provided higher after-tax returns across a variety of scenarios.