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Roth Allocation
Old 01-27-2004, 06:55 AM   #1
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Roth Allocation

We have developed an overall allocation for our assets that feels pretty good. Am now thinking about specific Roth account allocation. Up until now, have allocated our Roths (approx 5% of total) to Total Stock Market Index. Thinking now that withdrawal strategy should incorporate keeping within 15% (currently) marginal federal tax bracket. For us that means probably beginning relatively small Roth withdrawals in 5-10 years.

Sooo, thinking about changing Roth allocation to something like 70-30 with the stock being Small Cap Value and the bond being either TIPS fund or Total Bond Market. Any thoughts?... Thanks, Bill
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Withdrawa question
Old 01-27-2004, 07:11 AM   #2
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Withdrawa question

I'm a little confused by your withdrawal comment; let me restate it to see if I understand it.

You'll be withdrawing enough money from other investments to put you at the top of the 15% tax bracket, but you'd like to withdraw additional money. Withdrawing additional money from other investments would put you into the 28% tax bracket so to avoid that you'll withdraw the extra from the Roth. Am I saying that correctly?

A Roth withdrawal would avoid a 28% hit on income, but would it be as effective if the tax was only 20% or 18% or 15%? Perhaps some of those other investment withdrawals would be taxed at those lower rates on cap gains, long-term cap gains, or dividends. Avoiding a Roth withdrawal would give it that much more time to continue tax-free compounding.


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Re: Roth Allocation
Old 01-27-2004, 07:41 AM   #3
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Re: Roth Allocation

Yes Nords, you got it right. This tax optimization approach to withdrawals is used in the www.i-orp.com withdrawal calculator. Note that Roth withdrawal would come AFTER taxable accounts dissipation which is where we can still take advantage of cap gain/dividend tax treatments.... Bill
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Re: Roth Allocation
Old 01-27-2004, 08:27 AM   #4
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Re: Roth Allocation

I agree with your direction. i-orp shows me the same general strategy - max out the 15% bracket, then avoid the higher ones as long as possible. And the financial advice seems to be to have some cash like instruments in accounts being drawn down. This, combined with rebalancing, evens out the draw on equities, by moving less to cash when equities are low.

For example, with a 50-50 portfolio (for illustration only, not my recommendation) with $50k in equity and $50k in cash or short term instruments, and a 4% draw on the account of $4k per year. After 1 year, the cash is 46k, and if the equities dropped to 40k, you do not redeem any equities. In fact rebalancing says to buy 3k worth. If you had redeemed equities for the next years 4k, the portfolio life would be shortened.

Wayne
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Re: Roth Allocation
Old 01-29-2004, 05:03 AM   #5
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Re: Roth Allocation

Let me try this a different way.

Assuming you have an otherwise diversifed portfolilo(large blend & value, small blend & value, International, REIT, bond/bond fund(s)), and you wanted to handle your Roth account as noted in the original post, what one stock and one bond fund would you select?

Thanks, Bill
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Re: Roth Allocation
Old 01-30-2004, 10:38 AM   #6
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Re: Roth Allocation

William,

I think SC value, REITs, and TIPS are good candidates as they're pretty tax inefficient. Are you holding anything currently in your taxable account that is not very tax efficient that you could move into the Roth?

- Alec
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Re: Roth Allocation
Old 01-30-2004, 11:10 AM   #7
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Re: Roth Allocation

From a personal standpoint, I try to hold the assets with the highest potential return in my Roth. In my case this is SV & foreign LV.

-Jay

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Re: Roth Allocation
Old 01-30-2004, 01:17 PM   #8
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Re: Roth Allocation

Thanks for the feedback Alec and Jay - you confirm my inclination to use small cap value in the Roth.

The major part of our already taxed monies is in I Bonds that we fortunately got a wad of when fixed rate was 3.4 and 3.6. Does the Vanguard TIPS fund still sound like a good choice to gradually begin adding to the Roth? We don't have it elsewhere.

Thanks again for your thoughts! Best regards, Bill
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Re: Roth Allocation
Old 01-30-2004, 02:40 PM   #9
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Re: Roth Allocation

A Roth would be a fine place to hold Vanguard's TIPS fund. It might be better if you have access to the fund in a pre-tax IRA or 401k, so that your Roth would be freed up for SV.

One place I would not hold TIPS is in a taxable account. You would be eaten alive in taxes.

Hope this helps.

-Jay
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Re: Roth Allocation
Old 01-30-2004, 03:48 PM   #10
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Re: Roth Allocation

Quote:
The major part of our already taxed monies is in I Bonds that we fortunately got a wad of when fixed rate was 3.4 and 3.6.
Lucky dog.

If you need more inflation protected exposure, I'd look to add a TIPS fund or individual TIPS (or even STRIPed TIPS) as fire5soon suggested before adding them to the Roth. If no room in the IRA or 401(k), then I'd put the TIPS in the Roth IRA.

- Alec
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Re: Roth Allocation
Old 01-30-2004, 05:42 PM   #11
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Re: Roth Allocation

Quote:
One place I would not hold TIPS is in a taxable account. *You would be eaten alive in taxes.
Eh, not so clear. TIPS, like all treasuries, are state-tax free. IRA distributions are taxed as income, including state taxes. So, it depends on your current tax rate, your future tax rate, your state tax rate, maturity of the TIPS, and how far you are from IRA distributions.
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Re: Roth Allocation
Old 01-31-2004, 07:59 PM   #12
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Re: Roth Allocation

[quote]
Eh, not so clear. *TIPS, like all treasuries, are state-tax free. *IRA distributions are taxed as income, including state taxes. * quote]

The problem with TIPS in a taxable account is the inflation adjustments are taxed each year whether you sell the bond that year or not. Some call this phantom income, a problem you don't have with nominal bonds. Plus, if WilliamG held these in a Roth then distributions are tax free.

Even if you were retired and needed the income for expenses, I'm not sure TIPS would be appropriate in a taxable account because of the "phantom income" situation. You're taxed now on appreciation you won't receive until you sell or the TIP matures.

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Re: Roth Allocation
Old 01-31-2004, 08:09 PM   #13
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Re: Roth Allocation

Quote:
Even if you were retired and needed the income for expenses, I'm not sure TIPS would be appropriate in a taxable account because of the "phantom income" situation. *You're taxed now on appreciation you won't receive until you sell or the TIP matures.
Right, but consider two points:

1) If you buy TIPS via a fund, the fund distributes both the real income and the "phantom" income. *So, you shouldn't be any more afraid of holding TIPS than any other bond fund in a taxable account.

2) There's no difference between "phantom" income and reinvested interest, so if you plan to reinvest part of the interest, don't let the phantom scare you.
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Re: Roth Allocation
Old 02-01-2004, 08:10 AM   #14
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Re: Roth Allocation

wabmester,
Those are good points. I guess it's just a matter of how far you want to take the tax efficiency issue into retirement... especially if you are in a low tax bracket.

-Jay
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