Author Topic: Which account do the bonds go in?  (Read 1139 times)

mntnmn117

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Which account do the bonds go in?
« on: December 13, 2021, 05:06:57 PM »
I can't seem to find a simple/straight answer for this. I'm targeting 90/10 Equities/Bonds, probably 7-10 years from FIRE. Accounts are roughly Taxable Brokerage $400k, Roth IRA $150k, Trad 401k - $450k. Right now the Bonds BND and soon to be TLT are in the trad 401k and the taxable account.

If those are the bond funds I'm holding, which account should be holding them?

If I was to pick one account to do the rebalancing in, which account should it be done in? This would be regular exchanging of VTI for the Bonds and vise versa.

Glenstache

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Re: Which account do the bonds go in?
« Reply #1 on: December 13, 2021, 05:36:56 PM »
I can't seem to find a simple/straight answer for this. I'm targeting 90/10 Equities/Bonds, probably 7-10 years from FIRE. Accounts are roughly Taxable Brokerage $400k, Roth IRA $150k, Trad 401k - $450k. Right now the Bonds BND and soon to be TLT are in the trad 401k and the taxable account.

If those are the bond funds I'm holding, which account should be holding them?

If I was to pick one account to do the rebalancing in, which account should it be done in? This would be regular exchanging of VTI for the Bonds and vise versa.
Once FIRED, the value of bonds is in part the ability to sell something with a fixed value during downturns instead of equities. Therefore, I'd say make sure that they are in your taxable as you approach FIRE assuming you won't be over 65 at FIRE.

EvenSteven

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Re: Which account do the bonds go in?
« Reply #2 on: December 13, 2021, 05:48:39 PM »
I can't seem to find a simple/straight answer for this. I'm targeting 90/10 Equities/Bonds, probably 7-10 years from FIRE. Accounts are roughly Taxable Brokerage $400k, Roth IRA $150k, Trad 401k - $450k. Right now the Bonds BND and soon to be TLT are in the trad 401k and the taxable account.

If those are the bond funds I'm holding, which account should be holding them?

If I was to pick one account to do the rebalancing in, which account should it be done in? This would be regular exchanging of VTI for the Bonds and vise versa.

Bond interest is taxed at your top nominal rate, whereas dividends and capital gains are taxed at a lower rate, so the typical advice is bonds in tax deferred accounts and do your rebalancing there. With yields so low right now it probably doesn’t make a huge difference.

maizefolk

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Re: Which account do the bonds go in?
« Reply #3 on: December 13, 2021, 06:04:29 PM »
Once FIRED, the value of bonds is in part the ability to sell something with a fixed value during downturns instead of equities. Therefore, I'd say make sure that they are in your taxable as you approach FIRE assuming you won't be over 65 at FIRE.

I wouldn't worry that putting bonds where they are going to get the best tax treatment (in a retirement account) would create problems during retirement. Remember that dollars are fungible.

If the market is down a lot and you want to sell bonds to cover living expenses but your bond allocation is entirely in 401k/IRA investment space and your taxable investments are all in stocks just:

1) sell the amount of bonds you want to withdraw inside your retirement account.
2) sell an equivalent amount of stocks outside your retirement account.
3) use the proceeds of step #1 to buy stocks inside your retirement account.

Viola, you've sold bonds, have net zero change in your stock investments, and didn't need to take on extra tax liability to be able to do so (it just took two extra clicks on your computer).

mntnmn117: To the extent possible hold bonds in your tax preferred space (401k/IRA) so that you can avoid the higher income tax rates on bond interest vs dividends and international stocks in taxable space so you can benefit from the foreign tax credit on the automatic tax withholding of foreign dividends. Domestic stocks can go in either.

If you're rebalancing because one part of your portfolio has increasing in value faster than another it's better to do that in a tax preferred account (to avoid capital gains) and if you're rebalancing become one part of your portfolio has declined in value slower than another it is better to do that in a taxable account (to harvest capital losses).

Beach_Bound

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Re: Which account do the bonds go in?
« Reply #4 on: December 13, 2021, 07:43:21 PM »
Once FIRED, the value of bonds is in part the ability to sell something with a fixed value during downturns instead of equities. Therefore, I'd say make sure that they are in your taxable as you approach FIRE assuming you won't be over 65 at FIRE.

I wouldn't worry that putting bonds where they are going to get the best tax treatment (in a retirement account) would create problems during retirement. Remember that dollars are fungible.

If the market is down a lot and you want to sell bonds to cover living expenses but your bond allocation is entirely in 401k/IRA investment space and your taxable investments are all in stocks just:

1) sell the amount of bonds you want to withdraw inside your retirement account.
2) sell an equivalent amount of stocks outside your retirement account.
3) use the proceeds of step #1 to buy stocks inside your retirement account.

Viola, you've sold bonds, have net zero change in your stock investments, and didn't need to take on extra tax liability to be able to do so (it just took two extra clicks on your computer).

mntnmn117: To the extent possible hold bonds in your tax preferred space (401k/IRA) so that you can avoid the higher income tax rates on bond interest vs dividends and international stocks in taxable space so you can benefit from the foreign tax credit on the automatic tax withholding of foreign dividends. Domestic stocks can go in either.

If you're rebalancing because one part of your portfolio has increasing in value faster than another it's better to do that in a tax preferred account (to avoid capital gains) and if you're rebalancing become one part of your portfolio has declined in value slower than another it is better to do that in a taxable account (to harvest capital losses).

Not the OP, but does this advice change as you get closer to FIRE? If I plan to have 5 years of living expenses in taxable accounts while I fund a Roth ladder, I would think the taxable accounts should be fairly conservative since I'm relying on them for short term use. I can accept more risk and volatility in my retirement accounts because I'm 5+ years away from touching them. Obviously if the taxable balance is much higher than 5x annual expenses, this becomes less important. I'm starting to think about how asset allocation/location might look different in FIRE than in accumulation, and the optimal way to transition between the two...

maizefolk

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Re: Which account do the bonds go in?
« Reply #5 on: December 13, 2021, 08:18:55 PM »
Not the OP, but does this advice change as you get closer to FIRE? If I plan to have 5 years of living expenses in taxable accounts while I fund a Roth ladder, I would think the taxable accounts should be fairly conservative since I'm relying on them for short term use. I can accept more risk and volatility in my retirement accounts because I'm 5+ years away from touching them. Obviously if the taxable balance is much higher than 5x annual expenses, this becomes less important. I'm starting to think about how asset allocation/location might look different in FIRE than in accumulation, and the optimal way to transition between the two...

Once you're FIREd you (hopefully, in the absence of extremely FatFIRE) are in a really low income tax bracket, so the consequences of not optimizing fund placement for tax purposes matters are a much smaller than during the accumulation phase.

That said, personally I'd be inclined to leave well enough alone*. I ran the numbers on a person who retired in 2007 in the worse case scenario (exactly 25x retirement expenses; the bare minimum of 5x expenses in non-retirement accounts; 100% stocks in both buckets) and they'd still only end up paying about 0.4% of their savings in early withdrawal penalties because they ran out of taxable assets before their Roth conversion pipeline started to mature.

But I could understand someone else choosing to be more risk adverse, particularly if they wanted to pair it with implementing an overall bond tent around their FIRE date.

*Fair disclosure, for me this question is purely hypothetical. Even with access to an IRA, a 403b, a 457 AND a 401a over the past seven years, I've still only managed to squeeze 60% of my net worth into tax advantaged accounts.

boarder42

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Re: Which account do the bonds go in?
« Reply #6 on: December 14, 2021, 11:28:01 AM »
should the bonds be in traditional or roth accounts?  i tend to lean traditional as my roth accounts growth is worth more long term since there are less taxes.

JoePublic3.14

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Re: Which account do the bonds go in?
« Reply #7 on: December 14, 2021, 11:37:25 AM »
should the bonds be in traditional or roth accounts?  i tend to lean traditional as my roth accounts growth is worth more long term since there are less taxes.

Correct, you’d want the asset with highest potential/expected growth in Roth. Just as you stated.


OP, The little 'trick' mentioned upthread is a great thing to keep in mind. It sounds a little weird until it clicks.

mntnmn117

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Re: Which account do the bonds go in?
« Reply #8 on: December 14, 2021, 05:22:15 PM »
This makes sense, updating the investment plan. With the bond dividend taxed at regular rate you don't want that in a normal taxable account. International you want in taxable account since it's dividends get preferred treatment. Lastly the Roth should be 100% equities, and likely your highest growth equities.

I'd also been thinking like Glenstache that easy access was a benefit to having that in the taxable account.  I see now you don't really need to do that.

MDM

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Re: Which account do the bonds go in?
« Reply #9 on: December 15, 2021, 04:36:58 AM »
Tax-efficient fund placement - Bogleheads goes into this in some detail, but other posters have already given the short version.