Author Topic: Which parts of a portfolio do you want in your tax-sheltered accounts?  (Read 5839 times)

peace99

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Having found this website a few weeks ago Iím quickly getting up to speed with an investment mentality. I have a basic idea of what I am going to invest in:

US stocks
Foreign stocks
Bonds
(Possibly REITís and Gold)

(Still have to decide the %).

The question I have is which ones of these are best in my 401K / HSA and Roth IRA? E.g. tax sheltered and why?

(I expect to put 1/4 of my yearly investments in tax sheltered (maxing out) and 3/4 of my yearly investments in non tax sheltered)

Thanks

mxt0133

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Re: Which parts of a portfolio do you want in your tax-sheltered accounts?
« Reply #1 on: September 03, 2014, 03:03:18 PM »
The ones you want to put in tax deferred accounts are ones that generate the most taxable events, like bonds, or high turnover funds.  Index funds with low turnover and low yields would be ideal in your taxable accounts.

beltim

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Re: Which parts of a portfolio do you want in your tax-sheltered accounts?
« Reply #2 on: September 03, 2014, 03:18:20 PM »
The ones you want to put in tax deferred accounts are ones that generate the most taxable events, like bonds, or high turnover funds.  Index funds with low turnover and low yields would be ideal in your taxable accounts.

Unfortunately it's not this simple.  The goal IS NOT to minimize taxes paid.  The goal is to maximize the after-tax dollar amount.  This depends on the return of the investment and the type of investment as well as the investor's current tax bracket, future tax brackets, and the particular retirement vehicles involved.

Philociraptor

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BooksAreNerdy

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Re: Which parts of a portfolio do you want in your tax-sheltered accounts?
« Reply #4 on: September 04, 2014, 10:12:41 AM »
Using the link provided above, we decided to put REIT and bonds into a Roth, and our stock index funds go into trad IRA, 401k, and taxable accts.

peace99

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Re: Which parts of a portfolio do you want in your tax-sheltered accounts?
« Reply #5 on: September 04, 2014, 10:38:23 AM »
Thanks for the info. Its a very good link (its a complicated topic).  Just put Bonds into a Roth IRA.

beltim

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Re: Which parts of a portfolio do you want in your tax-sheltered accounts?
« Reply #6 on: September 04, 2014, 10:42:37 AM »
Thanks for the info. Its a very good link (its a complicated topic).  Just put Bonds into a Roth IRA.

You expect your after-tax return in bonds to be higher than your after-tax return in stocks?  Bold prediction.

Beric01

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Re: Which parts of a portfolio do you want in your tax-sheltered accounts?
« Reply #7 on: September 04, 2014, 11:07:49 AM »
You expect your after-tax return in bonds to be higher than your after-tax return in stocks?  Bold prediction.

This is really confusing to me. I put my bonds (and my international TSM fund) in my 401k about 3 months ago, and my US TSM funds in my Roth IRA and taxable account, based on my reading of the previously linked Bogleheads article on tax efficiency. Did I do wrong?

beltim

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Re: Which parts of a portfolio do you want in your tax-sheltered accounts?
« Reply #8 on: September 04, 2014, 11:11:27 AM »
You expect your after-tax return in bonds to be higher than your after-tax return in stocks?  Bold prediction.

This is really confusing to me. I put my bonds (and my international TSM fund) in my 401k about 3 months ago, and my US TSM funds in my Roth IRA and taxable account, based on my reading of the previously linked Bogleheads article on tax efficiency. Did I do wrong?

Maybe.  The Bogleheads article optimizes based on tax efficiency, and minimizes taxes paid.  But it doesn't really take into account expected returns (see the "Criticisms of this tax placement strategy" section on that page).  Therefore, it doesn't optimize based on ending up with the most money at the end, which is what I care about.

beltim

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Re: Which parts of a portfolio do you want in your tax-sheltered accounts?
« Reply #9 on: September 04, 2014, 11:16:54 AM »
See my post at http://forum.mrmoneymustache.com/ask-a-mustachian/asset-allocation-blues/msg237934/#msg237934 for one example of how putting bonds in an IRA can be worse than putting stocks in an IRA. 

Beric01

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Re: Which parts of a portfolio do you want in your tax-sheltered accounts?
« Reply #10 on: September 04, 2014, 11:25:55 AM »
You expect your after-tax return in bonds to be higher than your after-tax return in stocks?  Bold prediction.

This is really confusing to me. I put my bonds (and my international TSM fund) in my 401k about 3 months ago, and my US TSM funds in my Roth IRA and taxable account, based on my reading of the previously linked Bogleheads article on tax efficiency. Did I do wrong?

Maybe.  The Bogleheads article optimizes based on tax efficiency, and minimizes taxes paid.  But it doesn't really take into account expected returns (see the "Criticisms of this tax placement strategy" section on that page).  Therefore, it doesn't optimize based on ending up with the most money at the end, which is what I care about.

Ah, I think I understand now! I read that section before but didn't really "get" it.

Quote
Due to higher returns, equities have the potential to expand tax-advantaged space, leading to higher tax savings later on despite higher tax bills in the present.

So basically, this is saying that because your total available "space" (meaning contribution limits each year) in tax-advantaged accounts is limited, if you put your fast-growing money in those accounts, the total amount of money will grow rapidly, and you'll have a much larger amount of money you aren't paying taxes on (as compared to bonds)?

This is interesting, but I'm not sure how one would calculate the difference for one's specific situation. It's not a simple calculation, to be sure.

anisotropy

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Re: Which parts of a portfolio do you want in your tax-sheltered accounts?
« Reply #11 on: September 04, 2014, 11:28:04 AM »
I've always thought it should be Bonds but Beltim's idea is interesting, I am going to think about it.

beltim

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Re: Which parts of a portfolio do you want in your tax-sheltered accounts?
« Reply #12 on: September 04, 2014, 11:44:13 AM »
Here's an example to perhaps make it clearer.  From 1993 to 2013, the S&P 500 returned 9.1% annually and long-term treasuries returned 5.4%.  Let's assume the most pessimistic case for tax efficiency: that the gains on bonds are taxed every year and for stocks there's no taxation until the end (I know this isn't true because of dividends, but it makes the math easier and it's an even more extreme case than reality).  Now, let's invest $10,000 in each and look at two cases:

1) Bonds in Roth IRA, Stocks in Taxable:
$10,000 invested in bonds in 1993 becomes $28,600.
$10,000 invested in stocks becomes $57,100 before taxes, but assuming a 15% capital gains tax, becomes about $50,000 after taxes.
Total: $78,600

2) Stocks in Roth IRA, Bonds in Taxable:
$10,000 invested in stocks becomes $57,100.
$10,000 invested in bonds becomes (assuming, let's say, a 25% tax bracket) $22,100
Total: $79,200

Now, in this case there's not much of a difference, but that's because the difference in returns between stocks and bonds over 20 years is one of the smaller ones in history. 

mxt0133

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Re: Which parts of a portfolio do you want in your tax-sheltered accounts?
« Reply #13 on: September 04, 2014, 11:59:23 AM »
Very interesting point of view beltim, one of my assumptions is that I will be in a lower tax bracket when I FIRE.  So for 2014 for incomes between $18,150   to $73,800 for married filing joint the Tax Rate on Qualified Dividends and Long Term Capital Gains is 0%.  http://www.irs.gov/taxtopics/tc409.html

So based on those assumption and my projected post FIRE income I will not be paying taxes on long term capital gains.  Again this assumes that the current laws don't change and I can keep my post FIRE income below 73K.

Which I would assume most people on this site would fall under.  For a concrete example go read http://www.gocurrycracker.com/never-pay-taxes-again/ and http://www.gocurrycracker.com/the-go-curry-cracker-2013-taxes/.

Dodge

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Re: Which parts of a portfolio do you want in your tax-sheltered accounts?
« Reply #14 on: September 04, 2014, 12:18:03 PM »

Very interesting point of view beltim, one of my assumptions is that I will be in a lower tax bracket when I FIRE.  So for 2014 for incomes between $18,150to $73,800 for married filing joint the Tax Rate on Qualified Dividends and Long Term Capital Gains is 0%.  http://www.irs.gov/taxtopics/tc409.html

So based on those assumption and my projected post FIRE income I will not be paying taxes on long term capital gains.  Again this assumes that the current laws don't change and I can keep my post FIRE income below 73K.

Which I would assume most people on this site would fall under.  For a concrete example go read http://www.gocurrycracker.com/never-pay-taxes-again/ and http://www.gocurrycracker.com/the-go-curry-cracker-2013-taxes/.

Good explanation mxt0133.  My yearly expenses should be much less than $73,800 when I'm in my withdrawal phase, so I went with the standard advice.

Thanks for showing us the other side beltim!

beltim

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Re: Which parts of a portfolio do you want in your tax-sheltered accounts?
« Reply #15 on: September 04, 2014, 12:20:10 PM »
Very interesting point of view beltim, one of my assumptions is that I will be in a lower tax bracket when I FIRE.  So for 2014 for incomes between $18,150   to $73,800 for married filing joint the Tax Rate on Qualified Dividends and Long Term Capital Gains is 0%.  http://www.irs.gov/taxtopics/tc409.html

So based on those assumption and my projected post FIRE income I will not be paying taxes on long term capital gains.  Again this assumes that the current laws don't change and I can keep my post FIRE income below 73K.

Which I would assume most people on this site would fall under.  For a concrete example go read http://www.gocurrycracker.com/never-pay-taxes-again/ and http://www.gocurrycracker.com/the-go-curry-cracker-2013-taxes/.

Yes, you definitely have to use your individual tax situation to figure out the best path for you.  That's why I said it's not that simple, and the best path "depends on the return of the investment and the type of investment as well as the investor's current tax bracket, future tax brackets, and the particular retirement vehicles involved."

Ybserp

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Re: Which parts of a portfolio do you want in your tax-sheltered accounts?
« Reply #16 on: September 04, 2014, 12:38:17 PM »
It would be interesting to see the results for other decades if indeed 1993-2013 should be considered abnormal.

Beric01

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Re: Which parts of a portfolio do you want in your tax-sheltered accounts?
« Reply #17 on: September 04, 2014, 02:51:27 PM »
Very interesting point of view beltim, one of my assumptions is that I will be in a lower tax bracket when I FIRE.  So for 2014 for incomes between $18,150   to $73,800 for married filing joint the Tax Rate on Qualified Dividends and Long Term Capital Gains is 0%.  http://www.irs.gov/taxtopics/tc409.html

So based on those assumption and my projected post FIRE income I will not be paying taxes on long term capital gains.  Again this assumes that the current laws don't change and I can keep my post FIRE income below 73K.

Which I would assume most people on this site would fall under.  For a concrete example go read http://www.gocurrycracker.com/never-pay-taxes-again/ and http://www.gocurrycracker.com/the-go-curry-cracker-2013-taxes/.

Ah, this is what I was looking for. Thanks!

I'm going to ask a very specific question. I have only Vanguard total stock market index (Admiral - VTSAX) in my taxable account. If I withdraw that money 10 years from now (so only long term capital gains) and my income is very low, will I pay any taxes at all? I'm not sure how to figure this out.

mxt0133

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Re: Which parts of a portfolio do you want in your tax-sheltered accounts?
« Reply #18 on: September 04, 2014, 11:11:10 PM »
Ah, this is what I was looking for. Thanks!

I'm going to ask a very specific question. I have only Vanguard total stock market index (Admiral - VTSAX) in my taxable account. If I withdraw that money 10 years from now (so only long term capital gains) and my income is very low, will I pay any taxes at all? I'm not sure how to figure this out.

So if your income plus long term capital gains is less than $36,900*, standard deductions and personal exemption already deducted, for 2014, then no, you will not be paying any long term capital gains tax. 

To give a concrete example say you had income of 20k from any source, earned income, social security, interest, dividends, ect.  minus your standard deductions and personal exemption which is 6.2k and 3.9k respectively.  So that leave you with taxable income at 9.9k, this means that you can realize up to 27k in long term capital gains and not pay and capital gains taxes on it.  Any amount above that will be taxed at 15% until your taxable income plus capital gains goes above 406k, which I don't think we will be worrying about right now.

Use this tool to help you play with some scenarios, https://turbotax.intuit.com/tax-tools/calculators/taxcaster/.




If you put in single, and income of 36.25k**, notice your taxes will be $3,495.  Now put in 10k in capital gains which will put you at 36.25k of taxable income (minus standard deduction and personal exemption of 10k) and you still owe $3,495 in taxes.  Because this puts you in the 15% tax bracket you do not pay any long term capital gains.  Now increase capital gains to 1.1k, your taxable income will go up to $3,495 + $15 (15% of 100) = $3,510.  Your taxes went up $15 because you went over $100 dollars in long term capital gains which is taxed at 15%.

* Ref: http://www.schwab.com/public/schwab/nn/articles/Taxes-Whats-New

**Note these are 2013 numbers of tax brackets

Beric01

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Re: Which parts of a portfolio do you want in your tax-sheltered accounts?
« Reply #19 on: September 05, 2014, 12:54:13 AM »
Ah, this is what I was looking for. Thanks!

I'm going to ask a very specific question. I have only Vanguard total stock market index (Admiral - VTSAX) in my taxable account. If I withdraw that money 10 years from now (so only long term capital gains) and my income is very low, will I pay any taxes at all? I'm not sure how to figure this out.

So if your income plus long term capital gains is less than $36,900*, standard deductions and personal exemption already deducted, for 2014, then no, you will not be paying any long term capital gains tax. 

To give a concrete example say you had income of 20k from any source, earned income, social security, interest, dividends, ect.  minus your standard deductions and personal exemption which is 6.2k and 3.9k respectively.  So that leave you with taxable income at 9.9k, this means that you can realize up to 27k in long term capital gains and not pay and capital gains taxes on it.  Any amount above that will be taxed at 15% until your taxable income plus capital gains goes above 406k, which I don't think we will be worrying about right now.

Use this tool to help you play with some scenarios, https://turbotax.intuit.com/tax-tools/calculators/taxcaster/.




If you put in single, and income of 36.25k**, notice your taxes will be $3,495.  Now put in 10k in capital gains which will put you at 36.25k of taxable income (minus standard deduction and personal exemption of 10k) and you still owe $3,495 in taxes.  Because this puts you in the 15% tax bracket you do not pay any long term capital gains.  Now increase capital gains to 1.1k, your taxable income will go up to $3,495 + $15 (15% of 100) = $3,510.  Your taxes went up $15 because you went over $100 dollars in long term capital gains which is taxed at 15%.

* Ref: http://www.schwab.com/public/schwab/nn/articles/Taxes-Whats-New

**Note these are 2013 numbers of tax brackets

Wow, this is awesome! Really helped me understand the concept. I can also now see how I can pay zero taxes ;-)

Now I need to figure out how to control my capital gains to specific amounts when I withdraw money from a taxable account.