Should I keep my bond allocation in my 401k and Roth accounts?

[nico08]

Hi:

I have about 50 percent of my investment portfolio in taxable accounts, 30 percent is on my 401k and 20 percent is in Roth accounts. I have a 60 percent stock 40 percent bond allocation. I am 43 and hope to retire within 2 years. Since I have a long time between retirement and when I can receive social security and a small government pension, I will need to withdraw a considerable amount from my investment portfolio. If I want to minimize taxes when I enter retirement, does it make sense for me to keep my bond allocation in my 401k and Roth, so I can use long term capital gains and qualified dividends as a source of income from my taxable accounts early in my retirement? Any other ideas for someone who is potentially going to retire rather early? Thanks.

[mathjak107]

Roths would make sense for equities since they would grow the most tax free.

401k's and traditional ira's should hold with income generating stuff. They get taxed at regular income rates regardless.

Equities should go in the taxable account if not a roth. That way you get lower long term capital gains rates, can write off losses and pass tax free to heirs at a stepped up basis.

You can increase your bottom line by 20% getting the right investments in the right vehicles.

[LOL!]

You should slowly convert that 30% in 401(k) into Roth while paying no taxes on it.

Yes, it does make sense to not pay income taxes. You do that by having no income and/or keeping your taxable income below all your deductions and exemptions.

[Ready]

You could also consider municipal bond funds for your taxable accounts. If your tax bracket is reasonably high, their after tax yield is pretty attractive.

[pb4uski]

I would make the 401k all fixed income it there are stable value funds or decent bond funds available. That covers 30% of your 40% bond allocation. I would make half of the Roth accounts fixed income or alternately use 10% of the taxable account portfolio fixed income using munis.

Put you international equities in your taxable accounts so you can use the foreign tax credit.

Also see Principles of tax-efficient fund placement - Bogleheads

[nico08]

Quote:

Originally Posted by LOL! You should slowly convert that 30% in 401(k) into Roth while paying no taxes on it.

Does anyone know how I could slowly convert the 30 percent in the 401 into Roth while paying no taxes on it? What are the steps to do that?

[pb4uski]

It depends on what other income you have. I would think it would be hard to do substantial Roth conversions and pay NO taxes, but to pay low taxes is very possible.

I do Roth conversions to the top of the 15% bracket and my incremental federal and state income taxes were about 10% of the conversion, which is a lot lower than my marginal tax rate when I deferred the income.

If I cut my Roth conversions in half my federal tax would be nil but I would still have state taxes.

[nico08]

Quote:

Originally Posted by pb4uski It depends on what other income you have. I would think it would be hard to do substantial Roth conversions and pay NO taxes, but to pay low taxes is very possible. I do Roth conversions to the top of the 15% bracket and my incremental federal and state income taxes were about 10% of the conversion, which is a lot lower than my marginal tax rate when I deferred the income. If I cut my Roth conversions in half my federal tax would be nil but i woudl still have state taxes.

Oh ok, so I do these conversions when I have entered into early retirement? My current marginal tax rate while I employed is 25%. I predict when I am in early retirement my marginal tax rate may reach 25% but my retirement income would be at the beginning of the 25% rate, and I may be able to budget myself so that I stay within the 15% rate.

[pb4uski]

Quote:

Originally Posted by nico08 Oh ok, so I do these conversions when I have entered into early retirement? My current marginal tax rate while I employed is 25%. I predict when I am in early retirement my marginal tax rate may reach 25% but my retirement income would be at the beginning of the 25% rate, and I may be able to budget myself so that I stay within the 15% rate.

When I was working I was in the 25% tax bracket, so when I saved this money I avoided paying ~30% in federal and state income taxes.

I'm living off taxable savings from ER (at 56) to SS and pensions start (planning on 70). With no Roth conversions my tax rate would be very low. With Roth conversions to the top of the 15% tax bracket, it is about 10%. So the way I figure it on the money I deferred I have saved 20% (30% avoided less 10% paid).

If I don't do Roth conversions now, once SS, my pension and RMD's kick in, I would be back into the 25% tax bracket and paying 30%, so it is better to accelerate the income now and pay 10% than be forced to take it in the form of RMDs later and pay 30%.