surplus investing

[syd03]

Hi All

I wanted to get a feel for suggestions on investing aftertax monies, given the current economic mess. My wife and I both max out our company 401k plans. We are over the maximum income allowed to contribute to a Roth, so that is not an option. Up until this point we were focusing on a taxable account (T Rowe Price target retirement fund) that we would use to provide our income stream in early retirement before we would be able to access tax deferred savings. We have continued to contribute to the taxable account but it is getting more and more difficult to stomach. We keep telling ourselves we are buying more and more shares, but it is tough to see the statement balances continuing to retreat, despite our continued efforts.

What other investments do you all recommend with after tax money? We have trad'l IRAs through Vanguard too but again we are looking to have an account that could fund the first few years of our retirement with no strings attached. We are hoping to retire at 51. Any suggestions would be appreciated!

 

[crazy connie]

Are all debts paid off? Cars? Mortgage? How old are you and what do the expenses look like?

 

[syd03]

Both my wife and I are 41. We owe $36,000 on a home that was valued at $560K prior to real estate decline. Our area has not been affected greatly as we saw very little run -up during the peak of the market. Probably worth $470K presently. One car financed (owe $9K) and the other paid for. No other debt, credit card or otherwise.

 

[Urchina]

My $.02 (worth even less since October...):

1. Do you have an emergency fund of six months' expenses saved in a safe and liquid account? If not, I'd put this into place first.
2. Pay off the car. That's consumer debt.
3. Max out the traditional IRA (after maxing out the 401(k)s) because the money grows tax-deferred. ER is important, but not running out of money later on when you can't really go back to work is more important.
4. With anything you've got left over, why not stick it in a taxable account using a low-cost index fund? We currently use VTSMX in a Vanguard account. This will be the money we draw off of for ER should it ever happen. We are doing this especially because of the current economic mess, because we view stocks as being well-valued right now and buying a total-market index fund fits our asset allocation. Others here (many of whom are ER) may have different suggestions that seem more appropriate to your risk tolerance/situation.
5. Decide if you want to pay the mortgage off early or not. On the one hand, not having a mortgage payment at all can only make ER cash flow easier. On the other hand, you could refi the mortage and end up with a very small monthly payment, so maybe it doesn't matter that much.
6. I should have asked this first but, do you have an asset allocation mapped out? What does it tell you to do in this situation?

 

[Dennis]

Well I'm retired.. in 08' my Extra Taxable $ was in:
1. 3 yrs COH, it was: 1 yr in a VSGBX fund, 2 yrs in VFITX. ( For 09' it's A Bank MMkt and VFSTX)
2. Balanced Funds> OAKBX,PRPFX and HSTRX. It lost about a total of -6% in 08' and have owned them since 03' so they're still way ahead of owing individual Index funds for the same time..
3. When I was able to retire early, I also retired from Playing with over a dozen Index and other funds and just bought those Bal. Funds and let them play with it..seeing as it's not my primary Income for Retirement..although it could very well be if need be.
4. Wish I had Owned those BF's alot sooner, I could have retired at least 5 yrs sooner.Not since they did better than Indexing ( they did about +3% apy more) but I was my own worse Nemy on investing my own $.. I had Illusions of Grander I could do as well Investing it as I did making it in my Limo Business..boy was I wrong....My ego got the best of me...fortunately I learned just intime..2000 and made the switch..
5. And no they are not That Tax Effecient ( ave 2.5 out 5 rating) but their Tot. Rtns more than make up for it.. ( ave 18% taxes on them)

And I just tell others? "If you lost more than -20% last yr? You best reallocate into a more conservative portfolio with your Retirement $, into like a 50/50 or 40/60 or Just own Balanced Funds with the same Allocation and Only go Gamble with $ you don't need.."

My kids followed my lead and Switched In 2000 as well and have stayed in them ever since and are happy they did..since eventhough They're all educated and making 6 figures, they too would have lost over 30% of their $ in the last Bear ( 00-02') and another -30% in 08'...and were their own worse enemy on investing.

Balanced funds are a Alternative for Hiring a Firm and they already have a Track record that most Firms won't share with you.. but both kinds are a risk and you just hope for the best.. But Paul Merriman and Some others Just came out with Saying a 50/50 Bal. Port as done just about as well as the S&P for the past some 40 yrs.. or about 9% apy.. and that's more than good enough for me and others like myself with HNW $.

If you like devoting the time and do better than them? More Power to you..

 

[syd03]

My $.02 (worth even less since October...):

1. Do you have an emergency fund of six months' expenses saved in a safe and liquid account? If not, I'd put this into place first.
2. Pay off the car. That's consumer debt.
3. Max out the traditional IRA (after maxing out the 401(k)s) because the money grows tax-deferred. ER is important, but not running out of money later on when you can't really go back to work is more important.
4. With anything you've got left over, why not stick it in a taxable account using a low-cost index fund? We currently use VTSMX in a Vanguard account. This will be the money we draw off of for ER should it ever happen. We are doing this especially because of the current economic mess, because we view stocks as being well-valued right now and buying a total-market index fund fits our asset allocation. Others here (many of whom are ER) may have different suggestions that seem more appropriate to your risk tolerance/situation.
5. Decide if you want to pay the mortgage off early or not. On the one hand, not having a mortgage payment at all can only make ER cash flow easier. On the other hand, you could refi the mortage and end up with a very small monthly payment, so maybe it doesn't matter that much.
6. I should have asked this first but, do you have an asset allocation mapped out? What does it tell you to do in this situation?

Thank you so much for your insight!

1 Yes, and we just added another $10K to it. We would be OK for a year with both of us out of work, never having to touch any savings other than that emergency fund to get by
2 I agree with you about the car, in the past we always either paid cash for cars (not Mercedes or BMWs mind you) or financed them but then paid them off within a year. Now with stocks being cheap (At least I'm hoping they are), I'm wondering if taking $9K and paying off a car with a loan rate of 4% makes sense. Maybe I should plop more money into the market instead
3/4 OK. Our IRAs are with Vanguard. Any particular funds you recommend? Maybe we ought to switch. Wellsley and a bunch of others we hold in them are doing poorly. At least they are low cost through Vang to buy though. We have VTSMX in a separate rollover IRA
5 The mortgage we have now is 5.2% fixed. We should have it paid off in about 2 years based on xtra principal curtailment each month. The interest deduction is minimal. Although my wife and I really struggle with getting any deductions anymore. Seems like everytime we get a promotion or raise we give everything right back to U Sam. We're too conservative to buy another property, although some have told us we should. Just to afraid
6 We do. It was always around 65 to 70% stock funds, 20% bonds, 10% cash. It needs rebalanced now due to the slamming we've taken but I haven't done it yet. Still hoping stocks will fall a little more before I shift out of bonds/cash

Thanks Again

 

[travelover]

........<snip>.........3/4 OK. Our IRAs are with Vanguard. Any particular funds you recommend? Maybe we ought to switch. Wellsley and a bunch of others we hold in them are doing poorly. At least they are low cost through Vang to buy though. We have VTSMX in a separate rollover IRA..........<snip>........

I think the VTSMX was recommended for the taxable account. For tax efficiency you want index stock funds in taxable accounts, funds with bonds (Wellsley) in tax sheltered accounts.

 

[DblDoc]

You shouldn't hold a target fund in taxable as the bond and cash portion are tax inefficient. I'm in a similar situation and hold index ETF's for domestic and foreign equities in my taxable account and Vanguard bond index funds in my IRA's and 403b. I adjust as needed to maintain my AA. You are also in an expensive target fund with an ER of 0.65 compared to 0.16 for Vanguard equivalents...

DD

 

[harley]

I agree with Urchina on everything except the IRA advice. I think the money would be better off invested in after tax investments. I guess it's a bit of a gamble, but with the economy going the way it's going I think tax rates will be significantly higher in the future. And since you obviously make enough not to qualify for the Roth and are saving mightily, I doubt you'll be in a significantly lower tax bracket in the future than you are now. I guess it wouldn't hurt to max out the IRAs since it's not that much money, but if it was me I'd save the money this year and use it to pay the taxes next year when I moved my traditional IRAs into Roths. But that's me.

Good luck, you appear to be doing great on your path to ER.

 

[Urchina]

I agree with Urchina on everything except the IRA advice. I think the money would be better off invested in after tax investments. I guess it's a bit of a gamble, but with the economy going the way it's going I think tax rates will be significantly higher in the future. And since you obviously make enough not to qualify for the Roth and are saving mightily, I doubt you'll be in a significantly lower tax bracket in the future than you are now. I guess it wouldn't hurt to max out the IRAs since it's not that much money, but if it was me I'd save the money this year and use it to pay the taxes next year when I moved my traditional IRAs into Roths. But that's me.

Good luck, you appear to be doing great on your path to ER.

Harley, thanks for clarifying what I meant to say. I'd max out the traditional IRA this year with the intent to roll it into a Roth in 2010. (assuming, of course, that you've got the cash to pay the taxes on the conversion).

 

[syd03]

I agree with Urchina on everything except the IRA advice. I think the money would be better off invested in after tax investments. I guess it's a bit of a gamble, but with the economy going the way it's going I think tax rates will be significantly higher in the future. And since you obviously make enough not to qualify for the Roth and are saving mightily, I doubt you'll be in a significantly lower tax bracket in the future than you are now. I guess it wouldn't hurt to max out the IRAs since it's not that much money, but if it was me I'd save the money this year and use it to pay the taxes next year when I moved my traditional IRAs into Roths. But that's me.

Good luck, you appear to be doing great on your path to ER.

I know this is probably the dumbest question asked on this forum....you're saying I can move my trad'l IRA into a Roth in 2010? So our household income won't factor into the equation at all at that point? Sorry, I missed this one

Thanks!

 

[harley]

Correctamundo. The way things are right now you will be allowed to convert a traditional IRA to a Roth in 2010, no matter what your income is. You will have to pay the taxes on it, but if the market is still in this general vicinity that may not be too much of a burden. Of course, the gov't can always change the rules. This is one of the remainders from the Bush tax cuts (I think). I'm planning to do it, if it's still available.

 

[syd03]

Harley,

Is there an upper-end cap on rollover amount (ie $5000) or could you roll $50,000 or more from the trad'l IRA into a Roth in 2010?

Thanks again!

 

[harley]

There's no limit, but there are some things to keep in mind. Here's a fairly good article about it. Converting IRA Money to a Roth IRA in 2010 - InvestorGuide University

Pay particular attention to the part about having to figure out the total of ALL your IRAs and determining which part is subject to tax and which parts are after tax. There's plenty of information about this out on the web, so research it and make sure it's the right thing for you. And don't get your hopes up too high. There's a good chance they'll cancel this before it ever gets to happen. I hope not, but you know the gov't.

 

[jIMOh]

T Rowe has some tax managed balanced funds (which use muni bonds+stocks) and also has some pure muni bond funds you may want to consider.

If you are within 10-15 years of retirement, using a taxable account before a traditional IRA MIGHT make sense. You can still access the traditional IRA early using rule 72t (substantially equall periodic payments) prior to age 59.5. If you have 15+ years to retirement, I would do the traditional because the tax savings on the compounded growth would be tough to beat over long periods of time.

You have 401ks maxed
Do you have access to an HSA?
Do you have a 6 month emergency fund set up?
I would pay off the car to remove consumer debt
I would then direct a substantial sum (at least the amount of the car payment) into a "car replacement fund" for your next vehicle.
Once the EF is at 6 months expenses I would then get another 6-18 months expenses in a muni bond fund as a secondary emergency fund. You mentioned you could live a year on current savings? Is all that in cash? Why?
Once you get 24 months total in taxable accounts and conservative investments, consider increasing risk a little more- I use PRPFX (Permanent Portfolio) for alternative to cash. Total market index could also work. Dividend stock fund would be a third suggestion.

 

[harley]

If you have 15+ years to retirement, I would do the traditional because the tax savings on the compounded growth would be tough to beat over long periods of time.

I hear this all the time, but I'm just not convinced. When you withdraw the money it will all be taxed at your current (future) tax bracket. I can see using a traditional IRA to hold certain tax-inefficient investments (bonds, cash, etc), but in general I just don't see how they would beat an after-tax LTBH equity investment. Am I missing something?

 

[jIMOh]

I hear this all the time, but I'm just not convinced. When you withdraw the money it will all be taxed at your current (future) tax bracket. I can see using a traditional IRA to hold certain tax-inefficient investments (bonds, cash, etc), but in general I just don't see how they would beat an after-tax LTBH equity investment. Am I missing something?

10 years is my over/under on traditional IRAs vs taxable.
In general I am suggesting 15 years of tax free compounding will beat higher taxes on the earnings than to take a bet on tax code and 5%/15% taxes on dividends every year.

Here are some things to consider:
1) the tax rates on dividends and capital gains has only been at 5%/15% for a short time (6-8 years?). I am not going to lock in rates this low as a long term plan. I will take advantage of them when I could, but rates this low will not last long (IMO).
2) You can withdraw $86.6k from a traditional IRA before the current tax bracket is higher than 15% ($67900 bracket cap, plus $11400 std deduction, plus $3650*2 exemptions=86.6k)
3) If a person needs more than 86.6k, in expenses, that is where I would also start to consider a taxable account to save on taxes. If expenses are lower than 86.6k, then the IRA will be favored considerably- even over shorter time periods.
4) If a person needs more than 86.6k (25% bracket) the 15% rate on dividends is what is in effect, and this situation is probably where the IRS decides to increase the 15% (meaning we are more likely to see the 5% rate in 15% bracket stay than the 15% rate in the 25%+ bracket stay.
5) rebalancing within the IRA will be easier than taxable accounts.

 

[harley]

OK, I can understand that. I guess it all comes down to individual situations. I doubt they'll increase capital gains beyond 20%, but nobody really knows. I do have high dollar expenses, so I suspect my tax bracket will be significantly higher (gov't increases again) than the cap gains rate. I guess the best thing is to balance pre and post tax accounts, and use the pre tax accounts to hold the less efficient funds. No matter what, this is a better problem to have than the alternative.

 

[syd03]

T Rowe has some tax managed balanced funds (which use muni bonds+stocks) and also has some pure muni bond funds you may want to consider.

If you are within 10-15 years of retirement, using a taxable account before a traditional IRA MIGHT make sense. You can still access the traditional IRA early using rule 72t (substantially equall periodic payments) prior to age 59.5. If you have 15+ years to retirement, I would do the traditional because the tax savings on the compounded growth would be tough to beat over long periods of time.

You have 401ks maxed
Do you have access to an HSA?
Do you have a 6 month emergency fund set up?
I would pay off the car to remove consumer debt
I would then direct a substantial sum (at least the amount of the car payment) into a "car replacement fund" for your next vehicle.
Once the EF is at 6 months expenses I would then get another 6-18 months expenses in a muni bond fund as a secondary emergency fund. You mentioned you could live a year on current savings? Is all that in cash? Why?
Once you get 24 months total in taxable accounts and conservative investments, consider increasing risk a little more- I use PRPFX (Permanent Portfolio) for alternative to cash. Total market index could also work. Dividend stock fund would be a third suggestion.

Thanks for the insight. The 'PRPFX' you mention you hold....who is it through? All our funds are through Vanguard, American, Fidelity, and T Rowe. We always liked Vanguard and the others were the only choice we had in 401ks. What fund company do you recommend for our outside investments? You mentioned T Rowe at the beginning, any others?

Thanks!

 

[jIMOh]

Thanks for the insight. The 'PRPFX' you mention you hold....who is it through? All our funds are through Vanguard, American, Fidelity, and T Rowe. We always liked Vanguard and the others were the only choice we had in 401ks. What fund company do you recommend for our outside investments? You mentioned T Rowe at the beginning, any others?

Thanks!

My IRAs are with T Rowe Price.

PRPFX is in an account with permanent funds- you can invest with them directly if you choose, or use an online broker.