Desperately Seeking Guidance

[mbnj77]

Hey all, here I am thinking I have a lot of this all figured out and then after reading some posts about tax efficiency and what should be kept in taxable vs. tax advantaged accounts, I realize I know nothing.

DW and I have three main buckets that we add money to regularly. Her 401(k), my 401(k), and a taxable brokerage account. For a while we had money with Edelman but what an absurdity to pay 2% for very little. But we thought we learned how to broadly diversify and I think we have done that in at all three buckets.

BUT now I guess to be the most tax efficient, we have to treat it as one big bucket; keeping the diversification but keeping certain types of funds in either the tax advantaged or taxable account, but not both.

Is there a thread that has these guidelines broken out? We are in a high tax bracket and maxing out everything including catch-up, (we make too much for an IRA), and I hate the thought of paying more in taxes that absolutely required. I also thought I need to be careful as the brokerage account needs to fund the gap to age 59 1/2 so our time horizon is much shorter. I thought I had to be more careful with those funds and hence a decision to put about 20% or so into Wellesley. I guess I got that wrong as well?

Any assistance would be greatly appreciated. Oh, we're both 51 and hope to be out by 56ish or so.

 

[Big_Hitter]

you can still do two backdoor roths annually. that should help


nothing wrong, imo with buying individual muni bonds in that brokerage account either.

 

[MBSC]

Here is the Bogleheads wiki on tax efficient investing.

https://www.bogleheads.org/wiki/Tax-efficient_fund_placement

I try to keep tax efficient equities in taxable accounts and fixed income in tax deferred accounts to the extent possible for my overall AA. However, due to my conservative AA and size of the accounts, I have "spillover" of fixed income into taxable accounts. The spillover is small enough that the interest earned is offset by deductions/exemptions so I do not owe tax. This interest and qualified dividends are covering expenses during my gap years.

 

[pb4uski]

See https://www.bogleheads.org/wiki/Principles_of_tax-efficient_fund_placement

In short, you want tax inefficient investments like bonds that produce ordinary income in tax-deferred accounts and tax efficient investments like stocks that produce tax advantaged income in taxable accounts. Typically, since for most people tax-deferred accounts are much bigger, you will likely have some stocks in your tax-deferred accounts but no bonds in taxable accounts.

You may wonder... if my taxable accounts are all stocks where does the money come to get me from ER to 59 1/2? You just sell stocks in the taxable accounts and if needed sell bonds and buy stocks in your tax deferred accounts as part of rebalancing. I also keep about 6% in cash in my taxable account that is our living expense and emergency fund and that cash gets replenished when I rebalance.

 

[pb4uski]

Ah MBSC.... you beat me to it by a minute!

 

[mbnj77]

Thank you very much for the guidance. So simply, if I understand you, if the stocks or stock funds that I own in my brokerage account doesn't spin off enough dividends to fund living expenses during the gap, then selling the shares themselves is what I must do, even if this diminishes the principle. Correct?

I guess I had expected this as well but just had thought bond funds would be part of that mix.

But what about safety? The bonds are going to be safer than stocks or stock funds. Don't I need to be much more conservative with that bucket since I'll need it in five years?

Thanks very much again.


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[travelover]

Thank you very much for the guidance. So simply, if I understand you, if the stocks or stock funds that I own in my brokerage account doesn't spin off enough dividends to fund living expenses during the gap, then selling the shares themselves is what I must do, even if this diminishes the principle. Correct? .......

Unreinvested dividends do spend down your principal. Did you notice that after a dividend is paid the value of the stock is lowered proportionately? So, if you just sold some of the stock to get the same amount of cash, you'd have the same principal as if you'd taken a dividend payment..

 

[Aerides]

I had a similar setup - max out both mine in DH's 401ks for post 59.5 life, and then build post-tax savings to last for the decade+ before that. All three are pretty much in 60/40 allocations, different funds, different investment firms (may consolidate and roll over 401ks early next year - just RE'd last month).

Presumably, during the next dozen years, we will eat into the post-tax principle, while the pre-tax side will continue to grow. That doesn't mean being overly conservative on the post-tax side - but we also keep about 2+ years of cash expenses separate from it so we are somewhat protected from short-term volatility.

Ideally, by the time we hit 59.5 the post-tax accounts will still be >0, so our income (calculated from sold shares) would be about the same as expenses, but the egg itself won't go down net-expenses assuming growth outpaces inflation, and assuming we avoid ****-storms.

One more pre-tax savings tip while you're still earning - if you have an HSA account, look into maxing that out as well. I ended up with a nice little bonus pre-tax account there.

 

[big-papa]

I'm not yet retired (age 55), but I originally had all of my bonds/fixed income in my 401K/rollover IRAs and equities in the taxable accounts. Then I realized that one goal I have is to hold off on SS and RMDs until 70 (if I can) and live on the taxable accounts only. Then it didn't make sense to withdraw only from taxable accounts if they are 100% equity as the size of the accounts and number of years remaining till age 70 might not support that. So at the moment, I am treating taxable accounts and tax deferred counts as individual investments separately with the taxable accounts having a more conservative AA than the tax deferred accounts. Over time, I'll bring the deferred accounts' AA down to where the taxable accounts are.


Since that time, however, I've run across a few articles that discuss withdrawing from both simultaneously (if you ER before age 70) as having long-term tax benefits, especially if you're in the situation where the RMDs at age 70 would otherwise push you into a higher tax bracket because of the total amount of money invested. I suspect that also means a different AA split between what's in the taxable accounts and the tax advantaged accounts as well and exactly how much is withdrawn from each account each year. Lots of moving parts to figure out.

 

[Options]

Hey all, here I am thinking I have a lot of this all figured out and then after reading some posts about tax efficiency and what should be kept in taxable vs. tax advantaged accounts, I realize I know nothing.

DW and I have three main buckets that we add money to regularly. Her 401(k), my 401(k), and a taxable brokerage account. For a while we had money with Edelman but what an absurdity to pay 2% for very little. But we thought we learned how to broadly diversify and I think we have done that in at all three buckets.

BUT now I guess to be the most tax efficient, we have to treat it as one big bucket; keeping the diversification but keeping certain types of funds in either the tax advantaged or taxable account, but not both.

Is there a thread that has these guidelines broken out? We are in a high tax bracket and maxing out everything including catch-up, (we make too much for an IRA), and I hate the thought of paying more in taxes that absolutely required. I also thought I need to be careful as the brokerage account needs to fund the gap to age 59 1/2 so our time horizon is much shorter. I thought I had to be more careful with those funds and hence a decision to put about 20% or so into Wellesley. I guess I got that wrong as well?

Any assistance would be greatly appreciated. Oh, we're both 51 and hope to be out by 56ish or so.

I second the suggestion to visit the Bogleheads site. For any question you have regarding your particular situation, you can type key words into the searh box. You'll then come up with a number of links that will help you figure out whatever it is you're working on.

I personally wouldn't be overly concerned about the idea of "I know nothing". Even though I thought I had everything figured out, it wasn't until after I retired that I had the time to drill down into the weeds of optimizing every aspect of my PF, including taxes. For me anyway, this has taken lots of reading (in many cases reading the same thing many times!). In time, it will grow less daunting--at least it has for me. Still, I continually look for ways to optimize all aspects of retirement as it's become a part-time hobby of sorts now.

Bottom line, your knowledge and confidence will increase with time.

 

[sengsational]

It took a while for me to "get it" because I thought I didn't want stocks in my after-tax bucket since they were more volatile. But the volatility doesn't matter because the same day you sell in your after tax to get living expenses, you buy the same thing in your tax deferred account. You didn't "sell low" (or even "sell high"), you just kept the same thing you had before, just in a different account.

 

[2017ish]

It took a while for me to "get it" because I thought I didn't want stocks in my after-tax bucket since they were more volatile. But the volatility doesn't matter because the same day you sell in your after tax to get living expenses, you buy the same thing in your tax deferred account. You didn't "sell low" (or even "sell high"), you just kept the same thing you had before, just in a different account.

I took a while to get this through my thick head as well, but finally the light came on. (Not yet retired, but keeping this in mind as I locate the asset allocation among accounts in preparation.)

 

[pb4uski]

Thank you very much for the guidance. So simply, if I understand you, if the stocks or stock funds that I own in my brokerage account doesn't spin off enough dividends to fund living expenses during the gap, then selling the shares themselves is what I must do, even if this diminishes the principle. Correct?

I guess I had expected this as well but just had thought bond funds would be part of that mix.

But what about safety? The bonds are going to be safer than stocks or stock funds. Don't I need to be much more conservative with that bucket since I'll need it in five years?

Thanks very much again.


Sent from my iPhone using Early Retirement Forum

Correct... see this post that elaborates on how it works. http://www.early-retirement.org/forums/f28/need-aa-advice-78920.html#post1641483

Safety is a function of your AA and your AA is measured across your tax deferred and taxable accounts combined. Think of it this way... if someone has 60 of stock in a taxable account and 40 of bonds in a tax-deferred account is their overall portfolio any riskier than someone who has 40 of bonds in a taxable account and 60 of stock in a tax-deferred account? In both cases they are 60/40 so the risk is the same... but the first account is much more tax efficient.

 

[target2019]

It took a while for me to "get it" because I thought I didn't want stocks in my after-tax bucket since they were more volatile. But the volatility doesn't matter because the same day you sell in your after tax to get living expenses, you buy the same thing in your tax deferred account. You didn't "sell low" (or even "sell high"), you just kept the same thing you had before, just in a different account.

+1

 

[Newventurer]

It took a while for me to "get it" because I thought I didn't want stocks in my after-tax bucket since they were more volatile. But the volatility doesn't matter because the same day you sell in your after tax to get living expenses, you buy the same thing in your tax deferred account. You didn't "sell low" (or even "sell high"), you just kept the same thing you had before, just in a different account.

Sorry to be dense here - is what you describe an attempt to satisfy wash sale rules primarily? This strategy seems to assume then that you have cash, maybe from dividends (?), sitting in the pre-tax account to purchase shares with?

 

[COcheesehead]

I am in a high tax bracket as well. Some things to consider:
Look at muni and high yield muni in your taxable account for bond positions without the tax issues. MUB and HYD are two ETF's to consider. One yields about 2%, the other about 4.5%. Different risk profiles.
You may also want to look at a retirement deferred annuity. Fidelity offers them for about a .25% charge which is cheap and they function like an IRA. No limits on what you can invest and since the money is post tax, you can take out all your principle without penalty. Earnings will be taxed. There are also no minimum required distributions at 70.5, so the money can ride tax deferred as long as you want.

 

[Terryjm51]

Great thread, to be completely honest, I am in the same position.
I didn't understand a word, agreed must read and read again for clarity.
Still working and producing a great income and saving all I can, I don't understand how I can have a ROTH with the income I make. Something about back door, but that doesn't make much sense to me. I just save after tax money and have talked to the plan administrator that when I retire I can roll all of it to a ROTH.
Thanks for the great information.
Where do you all find these bogle threads that is attached ??


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[pb4uski]

Sorry to be dense here - is what you describe an attempt to satisfy wash sale rules primarily? This strategy seems to assume then that you have cash, maybe from dividends (?), sitting in the pre-tax account to purchase shares with?

No, what is described is not an attempt to satisfy wash sale rules.... check out the example in the linked thread in post #13.

It is true that if one is selling equities at a loss then you need to be cognizant of the wash sale rules in rebalancing because if you sell in your taxable account at a loss and buy substantially the same security in your tax-deferred account then that would be a wash sale. But it is relatively easy to sidestep the wash sale by selecting a different security or just waiting for the required time.

Since you are living off taxable account funds, it would be rare that you would be buying equities in your taxable account. In most cases, once you retire you take taxable account dividends in cash rather than reinvesting.

 

[COcheesehead]

Great thread, to be completely honest, I am in the same position.
I didn't understand a word, agreed must read and read again for clarity.
Still working and producing a great income and saving all I can, I don't understand how I can have a ROTH with the income I make. Something about back door, but that doesn't make much sense to me. I just save after tax money and have talked to the plan administrator that when I retire I can roll all of it to a ROTH.
Thanks for the great information.
Where do you all find these bogle threads that is attached ??


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Backdoor contributions are still taxed at your income rate which is usually not an attractive option when you are in the high tax brackets already. When you retire and your taxes fall, that is a different story.

 

[sengsational]

This strategy seems to assume then that you have cash, maybe from dividends (?), sitting in the pre-tax account to purchase shares with?

It does assume that you have some fraction of your asset allocation in something stable (i.e. cash). This is your buffer so you don't have to "sell low" when you need money. If you had this cushion in after-tax funds, you'd just spend it. But since, in this scenario, you don't (it's "tied-up" in an equity), you do the sell/buy maneuver and your asset allocation stays the same (cash goes up in after-tax, and down in tax-deferred, leaving the percent of assets in the cushion the same).

 

[ESRwannabe]

mbnj77,

Here are some good rules of thumb for someone that has enough income that they can max out retirement accounts and still have plenty for taxable investments.

Your 401k is the best spot for fixed income (i.e. bonds).

Your Roth IRA is the best place for REITs.

Your taxable account is the best place for stocks, especially when you can get the foreign tax credit.

 

[DawgMan]

OP, can relate. I'm still a few yrs from deciding if I want to RE, but have started thinking many of the same things. Being in the top tax bracket while currently working, my focus has always been about minimizing my taxes. For those that are self-employed as I am, there is nothing better than a Defined Benefit Plan. Without getting into the details, this can effectively allow you to put multiple hundreds of thousands of $$s away in any given year (straight deduction off your income into tax differed accounts). Not for every one, but ideal for high income producers who live below their means. They max out at around $2M (in terms of getting max benefit) which is where I am which thus creates the liquidation strategy challenges in RE. Great vehicle to minimize taxes while working, but then formulating the best tax efficient withdrawal strategy in RE is my next dilemma.@

 

[walkinwood]

Like someone already said.. "I know nothing" is way too strong.

The Safe Withdrawal Studies all base their results on treating your portfolio as a whole & using total return (dividends + appreciation) to fund retirement. Yes, sometimes you will sell stock rather than just live on dividends.

We've been retired for 8 years now and I don't think of "principal" any more. I track my total portfolio value and see how it is stacking up versus an inflation (CPI) adjusted value of the original portfolio value. The nominal portfolio value fell way below the inflation adjusted value of the initial portfolio in 2008 and 09, but has slowly recovered.

Take tax implications into account as you move to a more tax efficient portfolio. There shouldn't be any big gotchas, but keep it in mind.

Good luck.