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Winding Down with AA Confusion
Old 01-10-2019, 04:00 AM   #1
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Winding Down with AA Confusion

Hey all, as always your assistance is very much appreciated. I'll try not to be too long-winded. (try, mind you)

We're getting close. Both turning 55 later this year and should be done at the end of 2021 at 57. No kids.

We each have a 401K and a diversified after-tax portfolio at Fidelity. The latter will fund the "gap" and maybe even a bit further. We also have an Ally account with 3 years of expenses for emergencies/recession that I am not counting into the mix.

Overall for the three accounts our AA is about 63/37. I know I'm thinking we should be getting it closer to 55/45 being three years out. My issue is the after-tax account is 78/15/7, (the 7 in cash just waiting to re-allocate).

But I know that because of the time horizon when this money is needed is only three years put, that money should be more conservative than the 401K money. Maybe even 50/50. But it had always been more aggressive because the conventional wisdom was not to have tax inefficient investments in an after tax account such as income producing bonds.

Is my thinking all wrong? If it is correct, should I bite the tax bullet until we retire and dump a lot more into a diversified bonds prtfolio? Munis?

After 35 years of thinking almost always about equities, I am woefully under-schooled in fixed income investments.

Thanks for your collective wisdom.
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Old 01-10-2019, 05:38 AM   #2
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My situation at your age was pretty close. The last year pre-RE I stopped funding the investment accounts to build some spending money for the early years that was non equity. Take a look at bridging the time until you can tap the 401K/IRA's without penalty. Also, look at taxable vs muni bond rates. The munis may not be the best after tax return.
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Old 01-10-2019, 06:22 AM   #3
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Have an overall AA you are comfortable with.

Manage your investments for tax efficiency, as it seems you have been.

If you have to sell stocks at a low in your taxable account, you can always trade an equivalent amount of non-equities in your 401K/IRA for stocks. Just beware of wash rules if you are selling at a loss, and don't buy the same stock or similar fund. Wash rules are especially bad in this case because you've lost the tax loss forever.
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Old 01-10-2019, 07:54 AM   #4
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If you have to sell stocks at a low in your taxable account, you can always trade an equivalent amount of non-equities in your 401K/IRA for stocks.
^^^^ This is the answer to the OP's original question.

OP - if you're keeping 3 years of expenses in a safe place, I think you can continue to keep your taxable account mostly/all equities.

If this doesn't make sense, let us know.
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Old 01-10-2019, 08:01 AM   #5
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I handled it a different way. We keep our joint taxable 100% in equity index funds to keep taxable distributions as low as possible. In our individual 401Ks we are more conservative with the total portfolio coming out at 60/40. All of our bonds are in the 401Ks so their distributions are not affecting our taxes. We keep about 6 months of expenses in a MM fund at our bank where our checking account is and where all of our bills are paid.

Withdrawals all come from selling equities in the taxable joint account. If needed (during a serious downturn or to otherwise maintain the proper AA) when we sell equities in taxable we simultaneously exchange bond funds for equities in the 401Ks to stay even or balance the AA.

As we approach RMD territory we will need to change things up. The RMDs will exceed our expenses so we will be pulling more than we need and investing the excess into the joint taxable account which will remain 100% equities.

Edit: I see a couple of others pointed our the same concept while I was typing.
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Old 01-10-2019, 11:13 PM   #6
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relatively new to the forum. please...AA
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Old 01-10-2019, 11:34 PM   #7
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relatively new to the forum. please...AA
Asset Allocation.

OP - I think it would depend on how long the "gap" is that you're wanting to cover. If you roll the 401(k) to an IRA, you can start penalty-free distributions at age 59.5. Since you're 57, that means the gap could be just 2.5 years. In that scenario, I would spend the 3 years in the Ally account and maintain your overall AA by buying/selling in your tax-deferred account as others have already noted. I wouldn't mess with the taxable account and incur unnecessary taxes, unless you find a point where the market is relatively high - then you could just sell stocks to fund living expenses.

If you're wanting to cover a longer "gap" for some reason (can't imagine how/why) then I'd probably suggest differently.
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Old 01-10-2019, 11:54 PM   #8
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well, duh! thanks.
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Old 01-11-2019, 06:18 AM   #9
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Old 01-11-2019, 09:59 AM   #10
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Originally Posted by mbnj77 View Post
... We also have an Ally account with 3 years of expenses for emergencies/recession that I am not counting into the mix. ...
Nothing wrong with that. It's called "mental accounting." (https://en.wikipedia.org/wiki/Mental_accounting) But its effect is that when you look at an AA without this account, you cannot use AA as a measurement of your portfolio risk. So, really, no one can answer your questions sensibly.

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Originally Posted by mbnj77 View Post
... 63/37... 55/45... 50/50. ...
If you go to https://www.portfoliovisualizer.com/ and play around I think you will find that there is a not a lot of long-term performance difference between these allocations. That might be a good time, too, to plug in your "true" AA and see how that looks.
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Old 01-11-2019, 10:37 AM   #11
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If you roll the 401(k) to an IRA, you can start penalty-free distributions at age 59.5.
If the 401(k) is from your current job, and you turn 55 this year, you can start penalty-free withdrawals the day you retire. The rule of 55 says you don't have to wait for 59 1/2. But only if you don't roll it into an IRA.
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Old 01-11-2019, 11:39 AM   #12
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If the 401(k) is from your current job, and you turn 55 this year, you can start penalty-free withdrawals the day you retire. The rule of 55 says you don't have to wait for 59 1/2. But only if you don't roll it into an IRA.
True, and maybe I should have mentioned that.

Note that if you follow the rule of 55, your 401(k) provider is *not* required to provide you withdrawal flexibility. They may limit you to once a year, or a lump sum withdrawal of the entire account, or place other restrictions on you. IOW, you may not be able to treat it like a checking account and withdraw whatever you want whenever you want. The standard advice is to check with your plan provider and/or read your plan documents to see what withdrawal options you have.
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Old 01-11-2019, 03:55 PM   #13
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Originally Posted by mbnj77 View Post
.... My issue is the after-tax account is 78/15/7, (the 7 in cash just waiting to re-allocate).

But I know that because of the time horizon when this money is needed is only three years put, that money should be more conservative than the 401K money. Maybe even 50/50. But it had always been more aggressive because the conventional wisdom was not to have tax inefficient investments in an after tax account such as income producing bonds.

Is my thinking all wrong?....
Sort of. Your thinking that after-tax money shoudl be invested for tax efficiency is spot on.
Your thinking that you need to have taxable account money be more conservative than tax-deferred money since you will be using it in the near term is wrong.

My favorite investment for my after-tax accounts is international equities. While a portion of the dividends are not qualified, the foreign tax credit usually exceeds the modest tax on the non-qualified dividends. Also, if you hold international equities in tax-deferred or tax-free accounts then the benefit is totally wasted. My second favorite investment is domestic equities, because most of the dividends are qualifed and taxed at either 0% or 15% for most taxpayers as are long-term capital gains.

As you use taxable funds you just sell stocks for the cash you need and then sell bonds and buy stocks to rebalance in your tax-deferred accounts... easy peasy.

However, if you have penalty free access to tax-deferred money you may want to use those to some extent at low tax rates between ER and when any pensions, SS or RMDs start to avoid the dreaded tax torpedo.
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Old 01-11-2019, 04:33 PM   #14
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Check out VTMFX (VG Tax Managed Balanced). Roughly 50/50 and managed to be tax efficient for after-tax accounts. Great management and great long-term performance record. 2.27% yield, but generates mostly Qualified Dividends in the taxable distributions.

Ditto VWITX - VG Intermediate Term Tax-Exempt. Federal tax free. 2.41% yield, free of fed taxes.
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