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FIRE and tax-advantaged accounts
Old 07-16-2009, 11:46 AM   #1
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FIRE and tax-advantaged accounts

My partner and I are 50 and 55 and have been retired for about 4.5 years. We aren't rich, but our finances are so different from the norm that common financial advice is hard to apply. Some commonly accepted rules of thumb might even be dangerous for us. The controversy about the 4% SWR is an example and this board has been great for discussing such topics.

Another difference is in taxable vs. tax-advantaged accounts. My partner and I have less than half of our portfolio in tax-advantaged accounts, and I imagine that is true for most early retirees. The limits on 401(k) contributions required us to put our additional savings into taxable accounts. Proceeds from downsizing also had to go into taxable accounts.

Folks like us fund the first years of their retirements by withdrawing exclusively from taxable accounts.

This is very different from the conventional scenario wherein a couple retires at say, 65 and starts drawing immediately from an IRA. Almost all of the investment advice one hears is aimed at this scenario.

My question is: what do forum participants think about the best way to distribute stocks and bonds between taxable and tax-advantaged accounts. It seems to me that there are at least three broad approaches:

1. Don't worry about it and maintain the same asset allocation in both type of accounts.
2. Overweight bonds in your tax-advantaged accounts so that the interest compounds tax-free, and use qualifying dividends and sales of share to fund your expenses.
3. Keep more bonds in your taxable accounts and use the interest to fund your retirement, rarely or never having to sell equities in a down market.

Whadayathink?
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Old 07-16-2009, 12:27 PM   #2
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Here is what Vanguard thinks: http://www.vanguard.com/pdf/s556.pdf
Here is what Vanguard thinks about spending from a portfolio: https://institutional.vanguard.com/i...P_TotalRet.pdf Read page 5 of this VERY carefully.

My taxable portfolio contains VEU, VSS, SCZ, VBR, EEM and VWO --- none of which are fixed income.

My tax-advantaged accounts contain (among others) VFSUX, VFIIX, TIAA-traditional all of which are fixed income.

I am 52 years old. When I need to spend some VFSUX without withdrawal penalties, I can do a double trade as follows:
(a) Sell VFSUX in tax-advantaged to get cash.
(b) Sell VEU in taxable to get cash.
(c) Buy VEU in tax-advantaged with cash from (a).
In the end I have the same amount of VEU as I had before. If VEU was at a lower price from when I bought it, I get the tax deduction. If at a higher price, I pay LTCG taxes or no taxes because I have carryover losses.

Note: IF I SELL EQUITIES IN A DOWN MARKET THAT I AM BUYING SIMILAR (but "not substantially identical") EQUITIES IN ANOTHER ACCOUNT. The net effect is that I have no net sales of equities in a down market. Indeed, I will probably be rebalancing and have net buying of equities. Furthermore, a down market is when tax-loss harvesting present themselves, so you should be selling equities that have losses in a down market if they are in a taxable account.

So my answer is (4) which is something you didn't give as a choice. It means living off your taxable investments in a very
tax efficient way.

Here is a comment on the Bogleheads forum about this kind of strategy:
http://www.bogleheads.org/forum/viewtopic.php?t=13712
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Old 07-16-2009, 12:54 PM   #3
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I spend a lot of time trying to be as tax-efficient as possible in determining my asset allocations in taxable vs. non-taxable accounts. One of the great things I've discovered since I went from a fairly high tax bracket to a very low one is that most of my qualified dividends and long-term capital gains are either not taxed, or taxed at a very low rate now. I am in the process of reworking my taxable accounts to generate enough dividends and interest to live on (I still earn part-time income that I live on, though I anticipate fully retiring in a few years).

So, I keep high-yielding stocks, bonds, and TIPs fund (fund only, not TIPs themselves) in my taxable account. I also have some I-Bonds that are useful because I can control when I pay taxes on them (not until I cash them in). I do a very small amount of short-term trading, and when I do that, I do it in my non-taxable Roth account.

BTW, have you read the book "Buckets of Money" by Ray Lucia? It has some good discussions of tax considerations when withdrawing money for retirement.
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Old 07-16-2009, 02:21 PM   #4
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I would suggest that ksr might be missing some opportunities as described in those Vanguard papers that I linked. In particular, if they had no taxable bond income (including TIP income) and reduced high-yielding stock income, then they could use their 0% tax bracket (and other low tax brackets) to convert from traditional IRA to a Roth IRA while paying no taxes. This will benefit them down the road for many reasons.
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Old 07-16-2009, 05:46 PM   #5
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As I'm nominally all equities, I haven't been too concerned about sticking the less tax-efficient funds into the retirement accounts.

However, because I do plan to draw from taxable accounts first and end up with just retirement accounts in 10-15 years, I have tried to maintain at least a token amount for all accounts in some of the funds that tend to close to new investors.
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Old 07-16-2009, 05:55 PM   #6
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Quote:
Originally Posted by LOL! View Post

I am 52 years old. When I need to spend some VFSUX without withdrawal penalties, I can do a double trade as follows:
(a) Sell VFSUX in tax-advantaged to get cash.
(b) Sell VEU in taxable to get cash.
(c) Buy VEU in tax-advantaged with cash from (a).
In the end I have the same amount of VEU as I had before. If VEU was at a lower price from when I bought it, I get the tax deduction.

Note: IF I SELL EQUITIES IN A DOWN MARKET THAT I AM BUYING SIMILAR (but "not substantially identical") EQUITIES IN ANOTHER ACCOUNT. The net effect is that I have no net sales of equities in a down market. Indeed, I will probably be rebalancing and have net buying of equities. Furthermore, a down market is when tax-loss harvesting present themselves, so you should be selling equities that have losses in a down market if they are in a taxable account.
If selling at a loss, isn't this a wash sale (unless you wait >30days to buy)
and you never get to take a loss because the reduced basis replacement shares are in IRA?
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Old 07-16-2009, 06:14 PM   #7
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Originally Posted by kaneohe View Post
If selling at a loss, isn't this a wash sale (unless you wait >30days to buy)
and you never get to take a loss because the reduced basis replacement shares are in IRA?
It is if you buy substantially identical replacement shares as in:
Sell VEU at a loss, buy VEU in IRA. <-- wash sale
I didn't go into the minor detail of avoiding the wash sale since it is discussed in the Vanguard papers. For example, to avoid the wash sale: buy something that is not substantially identical (I mentioned that). In the case of VEU, VEA would not be substantially identical but is still the same asset class (large cap international). So ...
Sell VEU at a loss, buy VEA in IRA. <-- not wash sale
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Old 07-16-2009, 06:40 PM   #8
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I think investors who want TIPS should probably keep them in a tax-deferred account so that they don't have to pay taxes on imputed interest. And I think cash (CDs, money markets) should be kept in taxable accounts for easy withdrawal if urgently needed.

I think it's a real PITA to put real estate in IRAS, but I can understand why some investors would want to do that and feel it's worth the effort.

Otherwise I don't think it matters what assets are in which accounts. Rebalancing seems easily done among them without regard to what's being taxed. If taxes are a concern then there are plenty of tax-efficient mutual funds, ETFs, & stocks to help out.

Quote:
Originally Posted by LOL! View Post
My tax-advantaged accounts contain (among others) VFSUX...
Does Vanguard have a Department of Acronyms (DoA)?

Would they let fund managers use letters standing for "Vanguard #$%^in' sucks"?
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Old 07-16-2009, 06:44 PM   #9
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Originally Posted by LOL! View Post
It is if you buy substantially identical replacement shares as in:
Sell VEU at a loss, buy VEU in IRA. <-- wash sale
I didn't go into the minor detail of avoiding the wash sale since it is discussed in the Vanguard papers. For example, to avoid the wash sale: buy something that is not substantially identical (I mentioned that). In the case of VEU, VEA would not be substantially identical but is still the same asset class (large cap international). So ...
Sell VEU at a loss, buy VEA in IRA. <-- not wash sale
ok, thanks, I know you used the words (not substantially) but I got confused by the symbols in your first post which were the same(might want to edit?)

btw..what is the difference between VEU and VEA that makes them different? Thanks.
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Old 07-16-2009, 06:54 PM   #10
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...And I think cash (CDs, money markets) should be kept in taxable accounts for easy withdrawal if urgently needed.
I now keep zero cash in taxable except for the monthly cash-flow in our checking account. It might not matter to Nords, but when you are getting $40K in taxable bond income and that makes your 85% of your SS benefits taxable you should take a second look. You should have $40K return of capital (tax-free, from selling losing positions) and none of your SS benefits would be taxed. Yet you would have the same income to spend. That scenario would leave more 0% tax bracket space for conversion of traditional IRA to Roth IRA as well.

And getting the cash and doing the double trade is trivial.

I needed to pay off a large 0%-interest credit card loan last month. I was able to easily retrieve the necessary cash from my 401(k) using the double-trade idea. I sold a fund in my taxable to get the cash (no taxes on the gain since I have net cap losses this year from tax loss harvesting) and bought a similar fund in my 401(k) by exchanging from the stable value fund. It took 3 days for the trade in my taxable account to settle and allow that cash to be used for billpay on the CC, but I did plan for that.

kaneohe, VEU contains ~20% emerging markets stocks, while VEA has 0% emerging markets stocks. If one wanted to keep the exact same asset allocation one could replace VEU with 80% VEA and 20% VWO.
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Old 07-16-2009, 07:02 PM   #11
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if they had no taxable bond income (including TIP income) and reduced high-yielding stock income, then they could use their 0% tax bracket (and other low tax brackets) to convert from traditional IRA to a Roth IRA while paying no taxes. This will benefit them down the road for many reasons.
This is an excellent point about converting IRA to Roth IRA when in a no-tax or low-tax bracket. Since my part-time work income uses up my entire 0% tax bracket, I've chosen to delay the conversions. I figure I'm only going to work, even pt, for a few more years. After that, I'll start converting IRA to Roth IRA to the extent that I can keep it in the 0% tax bracket. What can I say, I'm miserly about paying taxes.

Of course tax laws could change, but at least that's my plan for now.
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Old 07-16-2009, 07:08 PM   #12
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I think investors who want TIPS should probably keep them in a tax-deferred account so that they don't have to pay taxes on imputed interest.
I'm not sure if this has already been mentioned, but there is a fairly important difference between holding TIPs and holding TIPs funds in a taxable account. When you own actual TIPs, you pay taxes on even the "phantom income" that isn't paid until the TIP matures (this is the inflation adjustment). When you own a TIPs fund, although you still pay taxes on both the interest and the inflation-adjusted income, you actually receive the inflation adjustment from the fund each year. So, although you are still paying taxes, at least in a fund you are paying taxes on something you received.

And one other thing I like about TIPS is the that the income is generally exempt from state income taxes (depends on the state, but I think this is true in most states).
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Old 07-16-2009, 11:32 PM   #13
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Originally Posted by LOL! View Post
I now keep zero cash in taxable except for the monthly cash-flow in our checking account. It might not matter to Nords, but when you are getting $40K in taxable bond income and that makes your 85% of your SS benefits taxable you should take a second look. You should have $40K return of capital (tax-free, from selling losing positions) and none of your SS benefits would be taxed. Yet you would have the same income to spend. That scenario would leave more 0% tax bracket space for conversion of traditional IRA to Roth IRA as well.
Good point; you're right that I wouldn't think of that. No bonds in our ER portfolio and too many zeros in our earnings records for SS to matter much.
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Old 07-21-2009, 01:06 PM   #14
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So my answer is (4) which is something you didn't give as a choice. It means living off your taxable investments in a very
tax efficient way.
Sorry to bump my own thread, but I wanted to say thanks. Following LOL's advice I ran the numbers and found that we could reduce our annual tax bill by about a month's living expenses. Today we made the fund exchanges and our IRAs are now entirely in bonds.
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Old 07-21-2009, 06:30 PM   #15
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Originally Posted by IndependentlyPoor View Post
My question is: what do forum participants think about the best way to distribute stocks and bonds between taxable and tax-advantaged accounts. It seems to me that there are at least three broad approaches:

1. Don't worry about it and maintain the same asset allocation in both type of accounts.
2. Overweight bonds in your tax-advantaged accounts so that the interest compounds tax-free, and use qualifying dividends and sales of share to fund your expenses.
3. Keep more bonds in your taxable accounts and use the interest to fund your retirement, rarely or never having to sell equities in a down market.

Whadayathink?
This is not an easy question. I have about 2/3 taxable, 1/3 tax deferred. I have never hit a down market that I didn't have enough taxable income or cash balances to fund my life. If that did happen, I would prefer to take money from fixed income in the IRA than to sell good stocks when they were undervalued-if my tax situation allowed this without putting me in a much worse tax position.

Ha
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Old 07-21-2009, 06:56 PM   #16
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Sorry to bump my own thread, but I wanted to say thanks. Following LOL's advice I ran the numbers and found that we could reduce our annual tax bill by about a month's living expenses. Today we made the fund exchanges and our IRAs are now entirely in bonds.
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