The Money Mustache Community
Learning, Sharing, and Teaching => Investor Alley => Topic started by: TheGibberingPotato on February 18, 2015, 05:17:31 PM
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I've read the bogleheads guides and understand that bonds are taxed higher than long term capital gains, and so therefore they should go into your Roth/401k first. But.... I'm still confused, because the stocks will grow faster over a long horizon, and so wouldn't that lead to larger capital, and eventually more to be taxed?
Can anyone help clarify this for me? There should be a cross-over point, right? Comparing two identical balances, at first, iit would be better to have bonds in the tax advantaged accounts since they are taxed at a higher rate. But eventually, as the stocks outpace the bonds, they now are such a larger sum that it makes up for the difference?
Throw in that when I start withdrawing from the accounts i'll be in a low income bracket and so my bonds will be taxed lower for that reason. And also, if the stocks have tax free growth they will grown even faster, and thus have even more potential tax savings (if in a roth/401k)?
Is my line of thinking correct? It really seems to me that I should my tax-advantaged accounts be 100% stocks!
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How much do you have in taxable vs. tax advantaged?
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Your basic thought is correct. There is a crossover point (or many, potentially), based on current tax rates, years to retirement, tax rate in retirement, and returns on both stocks and bonds. I did some detailed calculations on this a while ago that you could search for. But yes, in order to figure out whether it's better to put bonds or stocks in a tax-advantaged account, you have to consider a bunch of factors.
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You only realize capital gains when you sell. If you are taking an indexing approach and really only plan on selling in retirement, your tax rate on capital gains is very likely 0% (75K for MFJ under today's rules) if your costs are mustachian levels. The only realized income you should be receiving is dividends and interest while you are employed. During your accumulation phase, reinvesting qualified dividends will be superior to reinvesting interest or ordinary dividends due to the tax bill. In this case, it doesn't make sense to carry taxable bonds in a taxable account.
But this isn't the only factor and context is important. If the money is basically for retirement, taxable accounts are probably where you will initially draw from. In retirement you rebalance by selling appreciated assets (rather than accumulation where you buy the depreciated asset) and if you only have stocks, this might not be ideal. So at some point you would need to shift your allocations. You also might have other shorter term goals that the money would be used, or you may do more active investing that incurs more capital gains than the passive approach.
The tax rules can change, but it is hard to recommend an approach that is agnostic to change when you don't know what form the changes would take.
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<oops>
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You only realize capital gains when you sell. If you are taking an indexing approach and really only plan on selling in retirement, your tax rate on capital gains is very likely 0% (75K for MFJ under today's rules) if your costs are mustachian levels. The only realized income you should be receiving is dividends and interest while you are employed. During your accumulation phase, reinvesting qualified dividends will be superior to reinvesting interest or ordinary dividends due to the tax bill. In this case, it doesn't make sense to carry taxable bonds in a taxable account.
But this isn't the only factor and context is important. If the money is basically for retirement, taxable accounts are probably where you will initially draw from. In retirement you rebalance by selling appreciated assets (rather than accumulation where you buy the depreciated asset) and if you only have stocks, this might not be ideal. So at some point you would need to shift your allocations. You also might have other shorter term goals that the money would be used, or you may do more active investing that incurs more capital gains than the passive approach.
The tax rules can change, but it is hard to recommend an approach that is agnostic to change when you don't know what form the changes would take.
Your basic thought is correct. There is a crossover point (or many, potentially), based on current tax rates, years to retirement, tax rate in retirement, and returns on both stocks and bonds. I did some detailed calculations on this a while ago that you could search for. But yes, in order to figure out whether it's better to put bonds or stocks in a tax-advantaged account, you have to consider a bunch of factors.
How much do you have in taxable vs. tax advantaged?
Thanks all. For background, the purpose of the investing is to retire early, where the target is 10 years from now. I have a low COL, and probably in retirement I'll have be a in a low tax bracket, although maybe I'll do even better than planned and will get above 75k in investment returns some years.
I have some number crunching to do, and it seems like in the end it's going to be somewhat nebulous anyways. I'm probably going to default to stocks in tax advantaged accounts until I am more confident.