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Taxable Account Investing
Old 11-18-2012, 10:39 AM   #1
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Taxable Account Investing

I am totally clueless about investing in a taxable account. All of our investments have been in retirement accounts. However, we just sold some property that we owned that had no debt on it and have refinanced our home to do some improvements. We will be using some of it for home improvements, but will have about $100k cash left over.

I am uncertain how to best invest it to limit income taxes. We have a 55/45 allocation with DH's IRA at Vanguard (which we do draw from) and my 401(k) at Fidelity (which we don't draw from).

DH is retired (he is 65) and I'm semi-retired, working very part-time. Ordinarily to make big purchases (car, major home improvement, etc) we need to withdraw from his IRA which we don't love doing since a large withdrawal is taxable.

I expect that in 2013 we will be in the 25% tax bracket.

I sort of plan to take the $100k that is in taxable accounts and put it in Vanguard and just have it sit there but it will be available for those kinds of large withdrawals in the future. For example, we may want to buy a car in a couple of years and we could part of it for that. Or we might use it for major home repairs, etc. (Nothing really planned for any time soon.)

I'm uncertain where to put the money at Vanguard from a tax standpoint. I just don't know that much about how taxes work on investments since we have never had to pay taxes on any given that everything has been in retirement accounts.
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Old 11-18-2012, 10:47 AM   #2
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Hi,

Boggleheads has a good artical in the library on what asset class to put in your taxable vs non taxable accounts.

basically you want bonds , reits and balanced funds in the non tax account.

best

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Old 11-18-2012, 11:37 AM   #3
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Depending on what you invest in you will pay taxes on interest payments or dividend payments. If you are investing in mutual funds, you may encounter year-end distributions of capital gains.

What to invest in depends on your overall asset allocation, considering all of your accounts. The $100K could be a part of your cash allocation, and depending on your investment policy, might make up a part of your designated cash reserves.

For example, I maintain a two-year cash reserve in addition to my short-term bond allocation.

I can't advise on Vanguard investments, as I don't have an account with them, but would suggest that you consider EFTs as an investment vehicle as the potential for capital gains is reduced.

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Old 11-18-2012, 11:51 AM   #4
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I don't put anything in cash frankly (well a little in my bank account but not part of my asset allocation).

Basically what I am struggling with is whether to put this in an equity fund or a bond fund.

All of my 401(k) is in an S&P 500 fund

At Vanguard we have our money currently in

Extended Market fund
High Yield Corporate fund
Short Term Investment Grade Fund
Total Bond
Total International
Wellesley

Our overall allocation is 55/45.

I am happy with what our investments are in Vanguard so would probably invest this 100k in one of the funds I'm already invested in. The closest we have to cash investment is the short term investment fund which is where we draw regular IRA withdrawals from.

I don't want to use this 100k for that so the choices would be to invest it in the Extended market fund, high yield fund, total bond, total international, or Wellesley. Just not sure which would be better from a tax standpoint.
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Old 11-18-2012, 11:55 AM   #5
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Have you considered a municipal bond fund?
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Old 11-18-2012, 12:07 PM   #6
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Quote:
Originally Posted by Katsmeow View Post
I don't put anything in cash frankly (well a little in my bank account but not part of my asset allocation).

Basically what I am struggling with is whether to put this in an equity fund or a bond fund.

All of my 401(k) is in an S&P 500 fund

At Vanguard we have our money currently in

Extended Market fund
High Yield Corporate fund
Short Term Investment Grade Fund
Total Bond
Total International
Wellesley

Our overall allocation is 55/45.

I am happy with what our investments are in Vanguard so would probably invest this 100k in one of the funds I'm already invested in. The closest we have to cash investment is the short term investment fund which is where we draw regular IRA withdrawals from.

I don't want to use this 100k for that so the choices would be to invest it in the Extended market fund, high yield fund, total bond, total international, or Wellesley. Just not sure which would be better from a tax standpoint.
If you want to keep the same 55/45 allocation, using the $100K for equities in the taxable account has some advantages. If equities do decline you can use the loss for tax loss harvesting. If equities increase in value you can sell them a preferred, capital gains rates (under current tax law). Also under current tax law, qualified dividends are subject to preferred rates.

Most of the funds you mention are not tax-efficient and are better in the IRA. One exception is the International fund. Your investment there is subject to foreign taxes, but because it is tax deferred you do not get the credit. If you sell that in the IRA and buy it in the taxable account you will get benefit. You could then use the cash in the IRA to buy a combination of Wellington and fixed income to get back to your target allocation.
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Old 11-18-2012, 12:34 PM   #7
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Well there are many roads you can go down some better than others. One idea you could stop taking from the IRA and spend the taxable money down. Another idea put this in your portfolio bonds in IRA/401k stocks in taxable (something like total stock market). You might have to leave some total stock market in IRA/401k to get your desired overall allocation. Just some ideas you will have to run your own numbers and do what is best. Hard to tell what would be best tax wise. What is your income? If you want an answer from the pro's go over to Bogleheads.org
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Old 11-18-2012, 12:39 PM   #8
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Since you already own Vanguard Total Int'l in your tax-advantaged account, I would suggest the following:

Use your taxable account to hold only up to 3 funds. Namely
a. Vanguard Total Int'l Stock Index fund
b. Vanguard Total Stock Market Index fund
c. (I won't name this one yet.)

The first two are very tax efficient, but the Total Int'l is probably more tax efficient in that one can claim the foreign tax credit that it generates on their tax return. Also, if the fund drops in value, one will be able to tax-loss harvest and save even more money on taxes.

So if you have $100K of the Total Int'l in tax-advantaged accounts, I'd just buy $100K of Total Int'l in your taxable and use the $100K of Total Int'l in tax-advantaged to rebalance back to your overall desired asset allocation. Maybe you will buy a bond fund and a Total US Stock index fund with the money?
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Old 11-18-2012, 12:55 PM   #9
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I'd use the $100k to buy Total Stock Market, Total International or to increase you cash allocation; how much of each you buy will depend on the AA you want to maintain and the amount of cash you want to have on hand, I'd certainly want to keep a year's worth of expenses on hand in cash.
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Old 11-18-2012, 01:56 PM   #10
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I'd keep it in cash.

You are withdrawing from an IRA now. You could withdraw less to stay under the 25% tax bracket and fill in the rest of your income needs with the taxable money, saving on taxes.

You can also characterize the IRA withdrawal as a Roth conversion. Again, cover your expenses normally paid with that IRA withdrawal with funds from your taxable account instead. Effectively, you end up transferring most of your taxable account value into a Roth IRA Rollover account. Then it is tax free after that, including bulk withdrawals to cover a new car. It also can allow you to continue withdrawing from your IRA only to the bottom of the 25% tax bracket while covering the rest of your needs from the Roth. That will maximize the amount of the IRA that you pull out at 15% instead of 25%. And you can invest it the same way you're used to in the traditional IRA. Watch out for the Roth 5 year rules, they may restrict your access to the Roth IRA.

You must complete a Roth conversion within the calendar year, but there's no reason you have to do it this year if your income is already into the 25% tax bracket. I'd probably wait until you've studied all the tax consequences and planned it out. Then execute the plan next year. You don't want to screw it up.

If you're already into the 25% tax bracket you probably won't have the taxable account hanging around for long. That's why you can just leave it in cash for now. That's your next year's expenses.
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Old 11-18-2012, 02:06 PM   #11
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My approach is similar to what others have recommended. I look at AA across all my taxable, tax-deferred and tax-free accounts.

The first priority for my tax-deferred accounts is my bond allocation. If my total bond allocation were to exceed my tax-deferred account, then the excess would go into the tax-free accounts and and lastly to the taxable account; in all cases since bond funds pay a lot of dividends and are not tax efficient.

In actuality, my tax-deferred accounts exceed by bond allocation, so my taxable and tax free accounts are all equities.

But I did learn one thing from this thread about the foreign tax credit that I'll need to chase. Right now, I have some Roth invested in international equities and it sounds like I would be better off to make those domestic equities and keep all my international equities in my taxable accounts.

Since you have Vanguard, you can run a Portfolio Watch report across all your accounts given your target AA and then use Portfolio Tester to evaluate how to invest the $100k. Alternatively, you probably have enough at Vanguard to have them do a financial planning session for you and get additional ideas on how to place the $100k.

Good luck.
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Old 11-18-2012, 02:55 PM   #12
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I'd keep it in cash.

You are withdrawing from an IRA now. You could withdraw less to stay under the 25% tax bracket and fill in the rest of your income needs with the taxable money, saving on taxes.

You can also characterize the IRA withdrawal as a Roth conversion.
Yep I like this plan. I wouldn't necessarily leave all the money in cash. I might put it in some dividend producing funds, but using it for expenses so you can do IRA to ROTH conversions is a good plan.
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Old 11-18-2012, 08:16 PM   #13
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I have zero interest in keeping the money entirely in cash. I've read enough to be convinced that large cash holdings are not advisable. So, I don't want to do that. Our intent with this money was to keep it for those large expenses that you know you will have but don't know when (car, major home repair like a new roof, etc.). The kind of thing where I wouldn't want to have to withdraw from the IRA due to the taxes. The hope is that we keep this money invested in the meantime and hope we don't need to do anything with it for a couple of years. It may not make sense to anyone else for us to do this instead of just spending it...but it's what we want to do.

On asset allocation.

We used to have total stock market in Vanguard. However, my 401k at Fidelity has limited choices, particularly those with low expenses. So I am in an S&P fund at Fidelity. To get to the desired allocation and have the right balance of types of equities we sold the total stock market at Vanguard and bought the extended market fund which basically is equities other than those in the S&P 500. Between that and what I have in my 401(k) we have the right balance among types of equities. If it wasn't for my 401(k) we probably would have total stock market but it isn't in the cards for now.

Next year and as long as I work part time, I expect us to be in the 25% tax bracket. We live in a state with no income tax. I don't know how long I'll continue to work part time (as long as I like it basically). When I stop we will be probably be in the 15% bracket. Oh, we can't withdraw less to stay under the 25% tax bracket while I'm working part-time. I will get us there on my income alone and even if my income went down with DH's SS we would certainly get there..

Most of our living expenses in 2013 will be paid from my part-time income. DH does receive SS and we will have some withdrawals from his IRA (about 25% of our total income will come from those).

I want to do something with this money that is relatively simple and easy to account for from a tax standpoint. While I'm an attorney, taxes are not my area. I do our own taxes using Turbo Tax so I don't want to do anything so complicated I would have hire someone to do taxes.
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Old 11-18-2012, 08:30 PM   #14
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So just put the money in some index funds and adjust your retirement account allocations to keep your AA where you want it to be. Although if you want to keep this money around for emergency expenses I'd still argue that putting some in a saving account is a good idea and why not look at I-Bonds or putting some of it into a CD ladder. They won't give you big returns, but I'd argue that emergency money should be in places with very low risk.

I'd also look at using the money to replace the IRA withdrawals to reduce your tax bill
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Old 11-18-2012, 08:46 PM   #15
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Have you considered a municipal bond fund?
For someone who doesn't pay income taxes?
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Old 11-18-2012, 09:26 PM   #16
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For someone who doesn't pay income taxes?
Bruce
True, munis wouldn't help someone like that much, but the OP wrote "I expect that in 2013 we will be in the 25% tax bracket."
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Old 11-18-2012, 10:48 PM   #17
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Although if you want to keep this money around for emergency expenses I'd still argue that putting some in a saving account is a good idea and why not look at I-Bonds or putting some of it into a CD ladder. They won't give you big returns, but I'd argue that emergency money should be in places with very low risk.
We already do keep some emergency money in cash (well in the bank) - about $25k to $30k that isn't spoken for. This is in addition to that. And actually of the money that we are receiving only about 2/3 of it is going to Vanguard for investment. The other 1/3 (about $50k) is going to be partially used for some home improvements and the rest will be kept in the bank.

I'm actually thinking I didn't ask my question the right way so I'll try to reword it a little.

We have $100k that is in our taxable accounts that we want to invest at Vanguard. This $100k is not all of the money that we have in taxable accounts. We also have some money in the bank. This is part of it that we want to invest. We might at some point use some of it for big expenses that we don't want to withdraw from the IRA from (but then we might not). The point is that we have no present intention to do anything with it other than invest it for probably at least 2 years and maybe longer.

I don't want to change our 55/45 asset allocation. I'm happy with the funds we are in now. I am just uncertain as to which of them I should put this money in to limit taxes. Depending on the choice I will then move around stuff in the IRA.
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Old 11-18-2012, 11:22 PM   #18
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Check out Principles of Tax-Efficient Fund Placement - Bogleheads for a nice step-by-step guide on optimizing the tax efficiency of your portfolio.

Since you have substantial funds at Vanguard, you could go through their financial planning process highlighting your objective of tax efficiency and see what recommendations they have.

If you're just looking for a single, simple, tax efficient investment for that $100k, then take a look at the Vanguard Tax Managed Balanced Fund Admiral Shares.
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Old 11-19-2012, 06:30 AM   #19
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We already do keep some emergency money in cash (well in the bank) - about $25k to $30k that isn't spoken for. This is in addition to that. And actually of the money that we are receiving only about 2/3 of it is going to Vanguard for investment. The other 1/3 (about $50k) is going to be partially used for some home improvements and the rest will be kept in the bank.

I'm actually thinking I didn't ask my question the right way so I'll try to reword it a little.

We have $100k that is in our taxable accounts that we want to invest at Vanguard. This $100k is not all of the money that we have in taxable accounts. We also have some money in the bank. This is part of it that we want to invest. We might at some point use some of it for big expenses that we don't want to withdraw from the IRA from (but then we might not). The point is that we have no present intention to do anything with it other than invest it for probably at least 2 years and maybe longer.

I don't want to change our 55/45 asset allocation. I'm happy with the funds we are in now. I am just uncertain as to which of them I should put this money in to limit taxes. Depending on the choice I will then move around stuff in the IRA.
Then just transfer some of your retirement account index equity funds to an index bond fund and put the taxable money into index equity funds to keep your AA where you want it. Equity index funds are tax efficient.
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