The benefits of tax-deferred compounding are so great that investors are usually told to put the maximum allowed into these accounts first. If you've done that and have more to invest, the rest would have to go into a taxable account. Investors are often told that tax-deferred accounts are best used for investments such as bonds. That's because the semiannual coupon payments made on corporate and government bonds held in a taxable account are subject to annual income tax at rates as high as 39.6 percent. That tax can be postponed if these bonds are held in tax-deferred accounts.
Common wisdom says stocks are better suited to taxable accounts.
Tax on profits realized from a gain in price is not triggered until the stock is sold. Putting such a stock in a tax-deferred account gains the investor nothing, because the tax is deferred until sale. The same gain is subject to a maximum capital gains tax of only 20 percent if the profit is realized in a taxable account. But MIT's James M. Poterba and his colleagues found, after looking at data from 1962 through 1998, that typical investors do better reversing the traditional approach and putting stocks in the tax-deferred accounts and bonds in taxable ones. The reason is that most ordinary investors now own stocks through managed mutual funds that make capital gains distributions each year.