Before I reply, I want to stress that we're optimizing among great choices here. Making the "wrong" choice in how to deal with a target date fund (especially the low-cost Vanguard ones) is far from a terrible situation.
Not sure I agree about the taxes, GreenGuava. Since Vanguard's target date funds are index funds-of-funds, you should not have a heavy tax burden from them whether you hold them in or out of a retirement plan. That said, I do agree that most people hold them inside retirement accounts.
Let me explain some tax issues: first, they maintain the desired asset allocation by selling some of one and using it to buy the other in order to re-balance. This can produce capital gains taxes that might not be present if one were to re-balance by new contributions (whether actual new money, while in the accumulation phase, or by adjusting where some dividends are re-invested at any time). Second, bond payments are generally treated as income for tax purposes (that is, at your marginal rate), while qualified dividends are typically taxed at a lower rate. This makes it more advantageous to use your IRA space to fill with bonds and put some stocks in taxable (if one is going to split among these) rather than maintaining a matching allocation in each account (e.g., 30% bonds in both taxable and IRA). On top of this, if you
are going to have bonds in taxable, you might want to consider something other than total bond market, in order to take advantage of favorable tax treatment of other types of bonds (depending on one's current or expected tax brackets). The target date funds don't do this. Lastly, some international stock funds are eligible for a foreign tax credit (offsetting some taxes paid on dividends from companies based in other countries); this tax credit isn't available if the stocks are held in a fund-of-fund, nor if they're held in a tax-advantaged account.
It's still far better than having a wrap of actively managed funds (which are far worse, tax-wise).
One other, non-tax consideration: the target date funds
never promote to Admiral shares. If you hold enough in a target date fund, even if it's all in a tax-advantaged account, you're paying more in expenses than you would if you rolled it yourself. Whether or not the difference is worth the extra effort is not a decision I can make for anyone. If you're in, say, the 2055 fund (10% bonds, 70/30 split domestic to foreign in stocks), this threshold is just under $16,000. But even the more expensive version of Vanguard funds are better than most other things out there, so it's not like this is disastrous.
