Author Topic: Asset Allocation questions  (Read 990 times)

lifeplus

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Asset Allocation questions
« on: March 10, 2021, 03:21:35 PM »
DW and I are nearing our FI target. We didn't learn about mega backdoor roths, backdoor roths and roth conversion ladders until about 5 months ago. We do not have a Roth as by the time we started investing we were already over the income limit to open one. Bummer I missed that opportunity and didn't take advantage sooner.

So here's my question:
We are shooting for a 90% stock 10% bond portfolio when we FIRE. Today we are 100% stocks. The amount in our 401ks combined would be 10% of our overall portfolio. My thought is to roll the 401k funds into a Traditional IRA when we FIRE and put them into VBTLX (Bonds). That would achieve our 90/10 ratio. This seems to make sense, but I'm curious if this is the best plan. This would mean that 90% of our portfolio is in a taxable brokerage fund and 10% in a taxable IRA fund. We'd have nothing in a Roth as we don't have one.

Or, would it make more sense to roll the 401k into a Traditional IRA then do a Roth Ladder to get that money into the Roth so we at least begin to have a Roth and can have our Bond fund there with no RMDs to worry about in the future.
« Last Edit: March 10, 2021, 03:24:47 PM by lifeplus »

swashbucklinstache

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Re: Asset Allocation questions
« Reply #1 on: March 10, 2021, 04:38:06 PM »
Hi,

I'm assuming you plan to retire this year.

Can you edit this into your post:
  • Your ages
  • Your raw $ amounts
  • Your planned expenses per year in retirement
  • Total amount of other income
  • Cost basis of your taxable investments, at least some info around it
  • (optional) the state you'll live in during retirement
  • (optional) anything atypical in your health as it relates to using ACA insurance

As a first step, and this is a bit ambiguous in your writeup so you may already well know this, if you plan on doing a Roth you will only roll from your 401k to IRA the amount you intend to convert each year. So maybe a first non-step =).

Ultimately I don't think this will make that much of a difference unless you're cutting things close. Trading in bonds in tax-advantaged space is easiest, but if you have capital gains space to burn due to low expenses you might be best served keeping high-growth stocks in the 401k while you ladder in Roth conversions. I think approximate total #s will help us give better answers!

jeroly

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Re: Asset Allocation questions
« Reply #2 on: March 10, 2021, 07:37:21 PM »
DW and I are nearing our FI target. We didn't learn about mega backdoor roths, backdoor roths and roth conversion ladders until about 5 months ago. We do not have a Roth as by the time we started investing we were already over the income limit to open one. Bummer I missed that opportunity and didn't take advantage sooner.

So here's my question:
We are shooting for a 90% stock 10% bond portfolio when we FIRE. Today we are 100% stocks. The amount in our 401ks combined would be 10% of our overall portfolio. My thought is to roll the 401k funds into a Traditional IRA when we FIRE and put them into VBTLX (Bonds). That would achieve our 90/10 ratio. This seems to make sense, but I'm curious if this is the best plan. This would mean that 90% of our portfolio is in a taxable brokerage fund and 10% in a taxable IRA fund. We'd have nothing in a Roth as we don't have one.

Or, would it make more sense to roll the 401k into a Traditional IRA then do a Roth Ladder to get that money into the Roth so we at least begin to have a Roth and can have our Bond fund there with no RMDs to worry about in the future.
Doing one does not preclude doing the other.  You could roll the 401(k) into a tIRA, put the funds into VBTLX for your 90/10 ratio.  Then continue to look over your taxation and post-retirement withdrawal strategy, and if it makes sense, each year do a year's worth of expenses (or some portion thereof) into a Roth ladder.  As far as what to invest the Roth $$$'s in - well, it's going to eventually be withdrawn tax-free, so the investment portion most likely to grow fastest, e.g. a tech sector fund or a growth fund, would be best to put there while keeping the slower-growing, bond portion of the portfolio, into the pretax fund.  You also allow your diversified portfolio of getting as much capital gains tax treatment as possible - if your tIRA has stocks, those gains when withdrawn get taxed as ordinary income.

lifeplus

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Re: Asset Allocation questions
« Reply #3 on: March 10, 2021, 09:40:32 PM »
@swashbucklinstache Here we go:

Your ages:
DW is 41 and I'm 46.

Your raw $ amounts:
Overall portfolio is just about $3M. Today it's 10% in Google Stock (where my wife works, it already has taxes taken out, not LTCG) 10% is in 401ks VTSAX and the rest is in a taxable brokerage account VTSAX. We also have 8 months of expenses in a high interest savings account.


Your planned expenses per year in retirement:
We live in CA. We own our home outright ($1.2M value), which we don't include in our networth. Our monthly expenses once FI, whith ACA estimates is about $8k.

Total amount of other income:
SS will come when we're older, or not, but we're not counting on it at all so it would be bonus. My wife may do consulting work and I'm sure I'll start another business or do some form of side hustle, but we're not counting on that income.

Cost basis of your taxable investments, at least some info around it:
I'm in the processs of selling a business I own. That will put us to our ideal FI number, but we're 2 years away if I don't sell it just based on a 62% savings rate that we have which goes into our taxable brokerage now. If I had to estimate total cost basis I would say it's about $1.9M original value.

(optional) the state you'll live in during retirement:
We'll be in the Bay Area, California to start as that's where we're at, where our daughter (9 years old) is going to school and friends, etc. We may change where we live, but today the plan is to stay here until she's through high school.

(optional) anything atypical in your health as it relates to using ACA insurance:
We're all healthy. Nothing atypical.
« Last Edit: March 10, 2021, 09:44:46 PM by lifeplus »

lifeplus

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Re: Asset Allocation questions
« Reply #4 on: March 10, 2021, 09:48:55 PM »
@jeroly
Thanks for breaking it down. I think I'm hearing, if we do roll our 401ks into a tIRA (bonds) we could then roth ladder some of our yearly expenses into a high growth stock/s index via the Roth, and in 5 years, use that as living expenses tax free, is that correct?

jeroly

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Re: Asset Allocation questions
« Reply #5 on: March 11, 2021, 03:40:24 AM »
@jeroly
Thanks for breaking it down. I think I'm hearing, if we do roll our 401ks into a tIRA (bonds) we could then roth ladder some of our yearly expenses into a high growth stock/s index via the Roth, and in 5 years, use that as living expenses tax free, is that correct?
The tax would have been already paid upon conversion so it's not exactly tax free, but there would be no additional tax or penalty upon withdrawal of the rolled over amounts.

swashbucklinstache

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Re: Asset Allocation questions
« Reply #6 on: March 11, 2021, 06:23:33 AM »
@swashbucklinstache Here we go:

Your ages:
DW is 41 and I'm 46.

Your raw $ amounts:
Overall portfolio is just about $3M. Today it's 10% in Google Stock (where my wife works, it already has taxes taken out, not LTCG) 10% is in 401ks VTSAX and the rest is in a taxable brokerage account VTSAX. We also have 8 months of expenses in a high interest savings account.


Your planned expenses per year in retirement:
We live in CA. We own our home outright ($1.2M value), which we don't include in our networth. Our monthly expenses once FI, whith ACA estimates is about $8k.

Total amount of other income:
SS will come when we're older, or not, but we're not counting on it at all so it would be bonus. My wife may do consulting work and I'm sure I'll start another business or do some form of side hustle, but we're not counting on that income.

Cost basis of your taxable investments, at least some info around it:
I'm in the processs of selling a business I own. That will put us to our ideal FI number, but we're 2 years away if I don't sell it just based on a 62% savings rate that we have which goes into our taxable brokerage now. If I had to estimate total cost basis I would say it's about $1.9M original value.

(optional) the state you'll live in during retirement:
We'll be in the Bay Area, California to start as that's where we're at, where our daughter (9 years old) is going to school and friends, etc. We may change where we live, but today the plan is to stay here until she's through high school.

(optional) anything atypical in your health as it relates to using ACA insurance:
We're all healthy. Nothing atypical.
Thanks!
Okay, so in CA and spending 96k per year in spending needs.

At a federal level, you'll pay $0 in capital gains until your income crosses 80k. https://www.nerdwallet.com/article/taxes/capital-gains-tax-rates. I'm not sure about California state taxes. Your basis is approx. 1.9 million, and since the 80k is only the gains not return of principle as I understand it. I'm assuming you'll take dividends as income instead of reinvesting them, for simplicity. A sale of a business or consulting income will mess this up, but only for the given year and "mess it up" by giving you more money at any rate =).

I would treat your consulting income as your bond allocation. If that's $0 or you're not comfortable with that, I'd do things in this order:
1) withdraw the 96k you need to live each year from your taxable account, either Google stock or vtsax, by selling via spec ID to sell the lots with the least amount of long term gains
2) continue selling taxable up to the 80k limit of capital gains and put the proceeds into taxable bonds
3) repeat the above two each year until you hit 90/10, minding that you will be able to convert a little less each year (lower basis + you now have taxable bond income)
4) for years after that, if you're still under 59.5, do #1 first. Then, instead of #2, roll over the amount that'll get you to 80k from your 401k to your IRA, then convert it to Roth. Of course, this will be a lower # than you see in #2 because it all counts towards the 80kb limit not just the gains.
5) once your 401k is empty and all IRA is Roth, your default is to use taxable for everything until it's gone. Of course, if you have a year that costs you $300,000 or something you can definitely use the Roth to lower that amount to minimize taxes

Note: to repeat above, do not roll your entire 401k into your IRA now, because that messes up the pipeline via pro rata rules.

I'm not a tax expert and I don't know California rules. My belief is to prioritize allocation over Roth conversions especially as you have lots of years available and not that much in your 401k, but you could switch the order of #2 and #4 or immediately change your 401k to bonds then otherwise follow the plan above, and once $ is in Roth putting it back in vtsax..

I'm assuming 96k in spending needs off that taxable basis is too high for ACA or covered California subsidy consideration but I'll defer to the experts. This would lower that 80k number and possibly reorder 2 & 4.

At 3 million and 96k expenses you probably have enough for none of this to matter. You might consider paying an expert to come up with a plan, and check out the iorp calculator. Definitely model anything I say here for every year forward with different assumptions.

Also, congrats!

cool7hand

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Re: Asset Allocation questions
« Reply #7 on: March 11, 2021, 06:59:17 AM »
+1 on the congratulations! You might not have used the most tax efficient way to build a stash, but you've more than enough!