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What to do with taxable funds?
Old 05-02-2008, 03:01 PM   #1
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What to do with taxable funds?

As I indicated in my introductory thread on this forum, my wife and I plan to retire in 6 years when I turn 55. Our total 401K/IRA balance is sitting at $560K, and our house is estimated to be worth well over $900K more than the balance on the mortgage (high real estate cost of Cupertino, CA).

We have finally caught up with the cost of owning a home in our area and are now adding $30K per year into the 401Ks. The house, well, this is Cupertino. In the face of declining property values, most homes in our area are still rising.

I should start off by saying that I am an investment novice. I have probably learned more about investments in the past 3-4 weeks I have been lurking here than I have on my own. It never became an interest until I considered the idea of an early retirement.

Because of that, my wife and I have tried to save as much as possible. Given that, plus some money we inherited from my FIL last year, we have almost $1M in taxable accounts that really needs to be invested more properly than it currently is.

My biggest fear is something that we encountered on a small scale last year in closing out my FIL's estate. We ended up with some capital gains, dividends, and interest income we were not expecting. Given our income level (just into the AMT level) and the state taxes in California, we saw a lot of this "extra" money lost due to taxes.

My first thought was to look into the tax-exempt, AMT-free bond funds, but the payout on these are not that high. OTOH, given our high state taxes (9.3%), we would need to earn almost 7% taxable to match a 4% rate from a tax-exempt account.

I am open to any suggestions (and after a quick check of my thick skin, criticisms). I am not looking for exact financial advice, but mainly what my options are with the taxable funds.
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Old 05-02-2008, 03:08 PM   #2
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Statsman - It would help if you posted your asset allocation and the make up of your current portfolio. Without that, even though there are many different investment philosophies here, I don't think any of us can give you meaningfull advice.

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Old 05-02-2008, 03:21 PM   #3
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If you are in the upper tax brackets then I think that the following are good options for taxable accounts:

- Index funds for equities (they don't trade much and therefore don't generate a lot of capital gains)
- CA muni funds for bonds (tax free at both state and fed level)

Vanguard has good, low cost options for both. Fidelity and TRP are also good choices.

But first you need to decide if you want stocks, bonds or both in your after tax portfolio based on your overall asset allocation (including before tax accounts). You need to look at your portfolio as a whole and decide on the asset allocation based on your goals and risk tolerance before trying to optimize the after tax portfolio.

MB
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Old 05-02-2008, 04:10 PM   #4
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If you are in the upper tax brackets then I think that the following are good options for taxable accounts:

- Index funds for equities (they don't trade much and therefore don't generate a lot of capital gains)
- CA muni funds for bonds (tax free at both state and fed level)

Vanguard has good, low cost options for both. Fidelity and TRP are also good choices.
Thank you for the suggestion about the index funds for equities. I had considered the CA tax-exempt bond funds, but I wanted some investments in stocks to balance it out.

Quote:
Originally Posted by mb View Post
But first you need to decide if you want stocks, bonds or both in your after tax portfolio based on your overall asset allocation (including before tax accounts). You need to look at your portfolio as a whole and decide on the asset allocation based on your goals and risk tolerance before trying to optimize the after tax portfolio.
Thanks for the guidance. I've got some spreadsheet work to do this weekend.
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Old 05-02-2008, 05:25 PM   #5
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Statsman,

I'm in a similar situation:

- I live in the Santa Clara valley
- My combined fed and state incremental tax rate is at least 42%
- My after tax portfolio is similar in magnitude to my before tax portfolio

I try to keep things that are tax inefficient (e.g. taxable bonds, REITs, actively managed funds that trade a lot in tax deferred accounts such as 401ks and IRAs) and keep the after tax portfolio simple with a couple of index funds, a CA muni bond fund and a money market fund. I also do most of the buying and selling of individual stocks in a self managed IRA.

I think that this minimizes tax burden and also makes it a bit easier to prepare taxes.

MB
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Old 05-02-2008, 05:58 PM   #6
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statsman, I think the best forum for portfolio advice is the Vanguard Diehards forum: Bogleheads :: View Forum - Investing - Portfolio Help Check it out.

In a nutshell, figure out your desired asset allocation, then use tax-efficient index funds in your taxable accounts. There are really two to start with: Total Stock Market (tickers: VTSMX or VTI) and total international FTSE all-world ex-US (tickers: VWFIX or VEU). Use your 401(k) and Roth IRAs for tax inefficient investments like bonds, REITs, cash, commodities.

But check out the link above. For more on asset allocation, look at this tutorial: Asset allocation tutorial?
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Old 05-02-2008, 06:50 PM   #7
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Just a thought that someone around here advised me about recently that enabled me to fix my dividend/interest problem in case you have a similar misconception. I was keeping cash/cash like assets in taxable because I wanted a spending cushion (cash bucket) to use to pay off a mortgage and pay for a few years expenses if a downturn is in progress when DW stops working next year. I was thinking it needed to be in taxable for ready access and to avoid prematurely tapping IRA funds which would be 100% "income taxable." It hadn't dawned on me that I could keep the interest generating funds in the IRAs and still access them from taxable when needed.

I simply sold $xxxxxx.xx in equities in the IRAs and simultaneously bought the same amount of equivalent equity funds in my taxable account. No net impact on the bottom line or the asset allocation. If I need cash (e.g. to pay off the mortgage) I will reverse the process - buy equities in the IRA and sell the same amount in the taxable to generate needed cash. I will have capital gains in taxable but they won't be much (or if they are I won't be complaining).
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Old 05-02-2008, 08:08 PM   #8
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statsman,

This is not an answer to the question you asked, but let me throw it out anyway...

With somewhere around 2.5 million net worth, how about moving to a lower-cost area of the country, buying a house outright - say around $300,000 - and the 2.2 million generates an inflation-adjusted $88,000 per year at a 4% withdrawal rate?

Sound better than working six more years? (Honest question, everyone has their own answer. Just want you to be aware of other options.)
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Old 05-02-2008, 08:31 PM   #9
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This is not an answer to the question you asked, but let me throw it out anyway...

With somewhere around 2.5 million net worth, how about moving to a lower-cost area of the country, buying a house outright - say around $300,000 - and the 2.2 million generates an inflation-adjusted $88,000 per year at a 4% withdrawal rate?

Sound better than working six more years? (Honest question, everyone has their own answer. Just want you to be aware of other options.)
There are a few reasons why I will continue to work. I'm currently 49. If I retire now, my pension at 55 would be about $7.5K per year and I would not qualify for retiree medical. If I retire at 55 (or 53 before being laid off), the pension would be about $24-30K per year and I would qualify for retiree medical which pays about 60% of the monthly premiums. In addition, our daughter has three more years of high school plus college to get through. Lastly, my wife isn't ready to retire right now.
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Old 05-04-2008, 10:31 AM   #10
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Statsman,

My recommendation is to read a few good books on investments before making any decisions on your portfolio. You have to be well informed about the ramifications of any suggestion before making any decisions. The collective wisdom of this great forum can then help you fine-tune based on your unique situation and needs.

The Bogleheads forum has a great list of reading material at
Bogleheads :: View Forum - Reference Library

Personally, my favourites are The Four Pillars of Investing: Lessons for Building a Winning Portfolio by William Bernstein, and Live More, Work Less by Bob Clyatt.
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