ER'd and need help with AA

[NanoSour]

I'm 2 months into ER and would appreciate some additional insight on how to set up my Taxable/Tax-Deferred accounts.

Currently withdrawing $3200/month from taxable account to cover expenses.

Assets are divided 54/46 taxable/tax-deferred.

According to Financial Engines, the overall AA is:

19% - Cash
17% - Large Cap
19% - Mid/Small Cap
22% - Bonds
23% - International

Taxable Account is all VG funds with the following AA:

26% - Cash
9% - Large Cap
20% - Mid/Small Cap
17% - Bonds
28% - International

Tax-Deferred is previous company 401K in a Pre-mixed fund with following AA:

11% - Cash
27% - Large Cap
18% - Mid/Small Cap
29% - Bonds
15% - International

I see a lot of discussion on tax efficient AA and how the assets should be divided between taxable/tax-deferred accounts. Recommendations would be appreciated taking into account that I'm withdrawing from the VG account on a monthly basis.

TIA....Nano

 

[pb4uski]

See Principles of Tax-Efficient Fund Placement - Bogleheads

Basically, investments that generate more income tax is taxable should be in tax deferred accounts and investment that generate less taxable income would be in taxable accounts.

Generally all your bonds would be in your tax deferred accounts, international in taxable (to take advantage of the foreign tax credit) and equities as well. In my case, my tax deferred accounts are large enough to hold all my bonds and some equities as well so my taxable and tax-free accounts are all equities.

Finally look at your AA across all accounts, not for each account.

 

[gcgang]

See Principles of Tax-Efficient Fund Placement - Bogleheads

Basically, investments that generate more income tax is taxable should be in tax deferred accounts and investment that generate less taxable income would be in taxable accounts.

Generally all your bonds would be in your tax deferred accounts, international in taxable (to take advantage of the foreign tax credit) and equities as well. In my case, my tax deferred accounts are large enough to hold all my bonds and some equities as well so my taxable and tax-free accounts are all equities.

Finally look at your AA across all accounts, not for each account.

+1. Well said.

 

[mickeyd]

One of the best books that I have read on the subject is "All about Asset Allocation". It was in our public local library collection. I recommend it.

 

[siamond]

See Principles of Tax-Efficient Fund Placement - Bogleheads

Basically, investments that generate more income tax is taxable should be in tax deferred accounts and investment that generate less taxable income would be in taxable accounts.

Generally all your bonds would be in your tax deferred accounts, international in taxable (to take advantage of the foreign tax credit) and equities as well. In my case, my tax deferred accounts are large enough to hold all my bonds and some equities as well so my taxable and tax-free accounts are all equities.

Finally look at your AA across all accounts, not for each account.

Very true. I would just point out that such strategy is really a must before retirement, while after retirement, it may not matter as much. The key point is that bonds generate a lot of (taxable) dividends, so if you reinvest it, you really don't want to pay taxes on such dividends. Now if you're retired and you actually spend those dividends (more precisely the sum of all dividends you're getting), then there is no issue.

First thing fist, I would suggest to rebalance with all international in taxable, and more bonds in tax deferred. Because of the tax credit. Then you may want to tune more, but only if you get too much aggregate dividends for your annual spend...

PS. Not too sure why you're keeping a sizeable amount of cash in your tax-deferred account. I'd suggest to invest it.

 

[pb4uski]

I would suggest that tax efficiency is as much of a must after retirement as before retirement, principally due to qualified dividends and LTCGs being taxed at 0% if your taxable income is in the 15% tax bracket. Also, having lower income investments in taxable accounts affords one more opportunity for Roth conversions while staying in lower tax brackets or beginning next year, under Obamacare MAGI limits for subsidies.

While I had a tax efficient portfolio while I was working, I pay a lot more attention to taxes in ER and have more flexibility to minimize taxes than I did when I was working.

 

[LOL!]

Asset allocation and asset location are basically two separate problems.

As already mentioned, figure out the asset allocation that you want: equities, fixed income, cash; US vs international; large-cap vs small-cap. Then once that is decided figure out how to lay that asset allocation down on the locations that you have. Some folks also worry about which accounts (locations) they are withdrawing from, but I believe that is just a tertiary consideration because money is money.

As for tax efficiency, I don't want any income in Schedule B in the top half (interest in taxable) because it gets taxed heavily. I also only want qualified dividends in the lower half of Schedule B. I don't want unqualified dividends to appear on Schedule B because they are taxed heavily as well. So how does one accomplish this? Simple: 1. No bonds, no REITs, no actively-managed funds in taxable. 2. No CDs, no cash, no money markets in taxable. 3. The only thing in taxable that makes sense are tax-efficient index funds like a total US stock market index fund and a total int'l stock market index fund.

Now one can't always achieve tax nirvana, but they sure can try.

A common lament is "But I am withdrawing from taxable now, so I need some cash there. I don't want to sell equities when they are down." The solution is to keep only equities in taxable and sell them when they are down, up, or sideways. Then in tax-deferred buy similar (if not identical) equities by exchanging from bonds to equities if needed to maintain one's asset allocation. Just watch out for the wash-sale rule if you sell equities at a loss in taxable.

It's like in chess where you sacrifice a queen in order to promote a pawn to a queen.

 

[pb4uski]

...A common lament is "But I am withdrawing from taxable now, so I need some cash there. I don't want to sell equities when they are down." The solution is to keep only equities in taxable and sell them when they are down, up, or sideways. Then in tax-deferred buy similar (if not identical) equities by exchanging from bonds to equities if needed to maintain one's asset allocation. Just watch out for the wash-sale rule if you sell equities at a loss in taxable.

It's like in chess where you sacrifice a queen in order to promote a pawn to a queen.

+1 This is a popular misconception that people often have trouble getting their heads around so an illustration may be helpful.

Mr. ER has a target AA of 60/40 and has 70% of his nestegg in tax-deferred accounts and 30% in taxable accounts when he retires on 1/1/yy and he has a 5% WR since he has not yet started drawing SS or his pension. He has a nestegg of $1 million.

So at the beginning of his retirement he has deployed his $1 million as follows:

Taxable account:$250k in stocks and $50k in cash = $300k in total
Tax-deferred account: $350k in stocks and $350k in bonds = $700k in total
Combined: $600k in stocks and $400K in bonds/cash = $1,000k in total

During the year, Mr. ER's portfolio earns nothing (just to make this example simple) so at the end of the year he has spent the $50k of cash on living expenses and has $950k left and needs $50k for the upcoming year as inflation has been benign.

Mr. ER then sells $50k of stocks in his taxable accounts to raise the cash he needs for the upcoming year, leaving him with $200k of stocks and $50k of cash. He looks at his AA, and it is now 58/42 as a result of the stock sale, different from his 60/40 target AA.

So Mr. ER then exchanges $20k of bonds for $20k of stocks in his tax-deferred account, leaving his tax-deferred account with $370k of stock and $330k of bonds.

So after these transactions, Mr. ER has:

Taxable account:$200k in stocks and $50k in cash = $250k in total
Tax-deferred account: $370k in stocks and $330k in bonds = $700k in total
Combined: $570k in stocks and $380K in bonds/cash = $950k in total

Note that Mr. ER's portfolio after these transactions has returned to his 60/40 AA target.

One nuance is that if the sale of stocks in the taxable portfolio results in a loss, Mr. ER needs to be careful not to buy the same stock in his tax deferred portfolio if the buy is within 30 days if he wants to take the loss on his tax return, but he can buy a similar stock.

 

[sengsational]

A common lament is "But I am withdrawing from taxable now, so I need some cash there. I don't want to sell equities when they are down."

so an illustration may be helpful

It was. Thanks.

Although some of us have $3000 per year as far as we can see into the future, if equities happen to be down when you need cash, it's a nice way to get uncle sam to help you out with your loss.