Increasing Bond Allocation in Taxable Accounts?

[sirion]

Hi, I'm new here. Been lurking for a few days, but I have a question.

A little background: I'm 35, married, one kid, our incomes combined are $94,000. Taxable savings are approx. $750,000 and tax-deferred savings are approx $250,000. Current allocation is 97% stock, 2% bonds, 1% cash. In addition, there's about $90,000 in a 529 for my daughter which is in a lifecycle fund for her college entrance date. I plan to retire at 55-60, depending on how much of a drag work is and whether the whole health insurance mess is figured out by then. Neither of us has a pension.

I am thinking I need to move a little more into bonds to add some diversification and stability to my accounts. The Vanguard Financial Planner I spoke with is suggesting I move some of my taxable money into bonds, but I'm unsure. I just can't see paying the Cap Gains taxes at this point. I'm considering moving my Traditional IRA (about $150,000) into bonds, but I'm also thinking I should convert my Traditional IRA (all tax-free contributions) to a Roth IRA for all the benefits that it confers. The planner said that you should never put bonds in a Roth because...? I'm not sure of the reason actually.

Is it a better idea just to put any additional savings into bonds to increase my asseet allocation? We save about $20,000/year, sometimes more if my parents are able to gift us money, which they've been doing for several years.

Any thoughts?

 

[teejayevans]

When possible, because dividends and capital gains get preferred tax treatment, they should be in your taxable account along with muni-bonds, then REITS and bonds that have income that's tax at normal rates should be in your non-taxable account.
TJ

 

[harley]

I don't see a problem with bonds in a Roth, because then the proceeds won't be taxed at all. So to me either the Roth or a traditional IRA is the best place for them. But I wouldn't sell any after tax investments to increase my bond allocation. You're still in the early accumulation phase, so I would recommend just using future savings to increase your bond allocation.

 

[DblDoc]

Hi, I'm new here. Been lurking for a few days, but I have a question.

A little background: I'm 35, married, one kid, our incomes combined are $94,000. Taxable savings are approx. $750,000 and tax-deferred savings are approx $250,000. Current allocation is 97% stock, 2% bonds, 1% cash. In addition, there's about $90,000 in a 529 for my daughter which is in a lifecycle fund for her college entrance date. I plan to retire at 55-60, depending on how much of a drag work is and whether the whole health insurance mess is figured out by then. Neither of us has a pension.

I am thinking I need to move a little more into bonds to add some diversification and stability to my accounts. The Vanguard Financial Planner I spoke with is suggesting I move some of my taxable money into bonds, but I'm unsure. I just can't see paying the Cap Gains taxes at this point. I'm considering moving my Traditional IRA (about $150,000) into bonds, but I'm also thinking I should convert my Traditional IRA (all tax-free contributions) to a Roth IRA for all the benefits that it confers. The planner said that you should never put bonds in a Roth because...? I'm not sure of the reason actually.

Is it a better idea just to put any additional savings into bonds to increase my asseet allocation? We save about $20,000/year, sometimes more if my parents are able to gift us money, which they've been doing for several years.

Any thoughts?

A) I would definitely increase the bond allocation. You have much less need to take risk then most at your age with your plan for another 20-25 years of working and $1M already saved.

B) I agree with harley and would not sell taxable assets and incur capital gains taxes

C) I would not buy bonds in my taxable account - unless you decide you absolutely must have more bonds then you can fit in your tax deferred. As harley suggested just add new money to bonds in your tax deferred accounts every year

D) The reasoning some give for putting equities into a ROTH is that you "hope" it grows substantially and then you get to withdraw it tax free down the road.

You might want to post this over at Bogleheads as as well Bogleheads :: View Forum - Investing - Help with Personal Investments. There are some very astute posters that can help answer these types of questions.

Oh and welcome to the forum.

DD

 

[WM]

Welcome! I'll let others give the advice, since you're ahead of DH and I on the savings, but congrats on getting such a great start!

D) The reasoning some give for putting equities into a ROTH is that you "hope" it grows substantially and then you get to withdraw it tax free down the road.DD

This is interesting, I'd never heard about not putting bonds into a ROTH. So the idea is since it's (hopefully) such a good deal to let the account grow and not pay taxes on the other end, you should fill it with equities in order to get the most benefit? Huh.

 

[LOL!]

Uh-oh, I like bonds in Roth IRA if your other tax-deferred is already filled up with bonds.

I'm not sure I would convert a traditional IRA to a Roth IRA unless I was in a very low tax-bracket like 0%. When you retire early at age 55 without a pension and are living off of your taxable investments, then it is very likely that you will be in a ridiculously low tax bracket close to 0%. That's the time to do the conversion. Not now.

Also a Roth may be great for risky equities since they will probably gain and you won't owe taxes, but the converse is also true: if your equities drop in value, you won't be able to deduct the losses on your taxes. Since a Roth has a limited amount that you can contribute each year, you can't just make up for big losses in your Roth by adding lots more contributions. So I think you need to compromise: try not to lose money in your Roth, but by doing so you can't take big risks to make the big money either.

 

[harley]

Uh-oh, I like bonds in Roth IRA if your other tax-deferred is already filled up with bonds.

I'm not sure I would convert a traditional IRA to a Roth IRA unless I was in a very low tax-bracket like 0%. When you retire early at age 55 without a pension and are living off of your taxable investments, then it is very likely that you will be in a ridiculously low tax bracket close to 0%. That's the time to do the conversion. Not now.

Also a Roth may be great for risky equities since they will probably gain and you won't owe taxes, but the converse is also true: if your equities drop in value, you won't be able to deduct the losses on your taxes. Since a Roth has a limited amount that you can contribute each year, you can't just make up for big losses in your Roth by adding lots more contributions. So I think you need to compromise: try not to lose money in your Roth, but by doing so you can't take big risks to make the big money either.

I don't disagree with this post, but have a couple of comments. First, the OP said he(she?) is only 35 and has $1M put away already. I wouldn't bet on being in that ridiculously low tax bracket in 20 years.

I agree I wouldn't convert the traditional IRA to a Roth while in a high tax bracket. What I would do is try to start a Roth, and quit (or decrease) contributing to the pre-tax account. If your company offers a Roth 401(k), that would be a great option. If not, put money into a taxable IRA and then convert that to a Roth. You'll only have to pay taxes on any gains, probably minimal if you do it every year or so. But in a situation where you are likely to be a high dollar retiree, a Roth is an incredible way to pass wealth on to descendants. Read some of the Ed Slott books for additional information. And be aware that whatever you do now, they're (you know who "they" are ) liable to change the rules on you before your time is up. So keep paying atention, and adapt as best you can.

 

[jdw_fire]

If not, put money into a taxable IRA and then convert that to a Roth.

be aware that you cant just convert the already taxed part of the TIRA to a roth, what ever you convert will be partially already taxed (if you have any such money in your TIRA) and partially not already taxed.

 

[kyounge1956]

(snip) This is interesting, I'd never heard about not putting bonds into a ROTH. So the idea is since it's (hopefully) such a good deal to let the account grow and not pay taxes on the other end, you should fill it with equities in order to get the most benefit? Huh.

I've heard "no bonds in a Roth" too, but either never received or didn't understand the explanation.

 

[ziggy29]

I've heard "no bonds in a Roth" too, but either never received or didn't understand the explanation.

I think the reason is this, and it assumes you have both Roth and traditional tax-deferred retirement accounts:

Because what you put into a Roth is NEVER taxed, all else being equal, that's the pot you want to target for "maximum growth."

If you had $100,000 in a Roth and $100,000 in a traditional IRA and you wanted a 70/30 allocation, if you put 70/30 in both of these, in 30 years you might have $500,000 in each. That's $500,000 in a TIRA which is eventually taxable.

Now let's say instead that you put 100% stocks in a Roth and 40/60 in the traditional IRA (the same 70/30 AA overall). Now maybe you have $700,000 in the Roth and $300,000 in the traditional IRA after 30 years -- meaning you only have $300K taxable instead of $500K. You have a total of $1M either way before withdrawing -- but less is due in taxes this way.

So if you have a sufficient value in both a Roth and a traditional IRA/401K and you have decades to let it ride, you probably are better off concentrating the risk (and higher long-term return) in the Roth where it will (under current law) NEVER be taxed.

Having said that, if the bulk of your tax-deferred retirement portfolio is of the Roth type (and almost none of the traditional IRA/401K) it's a moot point and there's nothing wrong with bonds in there.

 

[sirion]

Thank you all for your insights. I am already maxing out my Roth IRA contributions (for both me and my husband--I'm a "she") plus I contribute 12% of my income to my 401(k). Husband does not have a retirement plan at work for the first time starting this year, so we are still deciding what to do for him. I really think the best thing (and you guys seem to agree) is to start putting more of my contributions into bonds. I think I'm going to put my 401(k) into some bond fund to help us out. The other option is to put my Trad IRA into bonds--there's $150k in that account.

As for converting the Trad IRA to a Roth, I appreciate the insight. It's just so hard to know what the tax brackets are going to do. Part of me just wants to lock in the 25% while I still have access to it. I have no guarantees that my bracket will go down in retirement because I expect to be generating at least $100k/year in taxable income. Also, since I expect we'll have more than we need (we really don't deny ourselves anything--we just aren't spenders), I love the idea of passing the Roth to my daughter when I'm gone. I don't relish the idea of taking the RMD's if I don't need them.

I'm going to take another look at this Vanguard plan and maybe check out the Bogleheads forum.

 

[LOL!]

May I ask how you expect to generate $100K in income during retirement? There may be a way to tax-shelter that as well.

 

[charlie]

I don't believe anybody has mentioned using a muni bond fund
in your taxable account yet. That seems like an option to me for
sheltering some investment income. Have you looked carefully at
your equities in your taxable account to see if you could offset
capital gains by matching losses and gains?

I agree with the others that you should use your IRA and Roth for
income producing investments to the extent possible. Decide on the
AA goal you want/need in the long run and start working toward that.
I gather from your numbers that will probably eventually need to buy
munis in your taxable. If you do, use a bond fund ..... don't buy
individual securities on the secondary market (you can get beaten up
big time).

Remember, you don't have to get this done overnight. Make haste
slowly.

Cheers,

charlie

 

[kyounge1956]

I think the reason is this, and it assumes you have both Roth and traditional tax-deferred retirement accounts:

Because what you put into a Roth is NEVER taxed, all else being equal, that's the pot you want to target for "maximum growth."

If you had $100,000 in a Roth and $100,000 in a traditional IRA and you wanted a 70/30 allocation, if you put 70/30 in both of these, in 30 years you might have $500,000 in each. That's $500,000 in a TIRA which is eventually taxable.

Now let's say instead that you put 100% stocks in a Roth and 40/60 in the traditional IRA (the same 70/30 AA overall). Now maybe you have $700,000 in the Roth and $300,000 in the traditional IRA after 30 years -- meaning you only have $300K taxable instead of $500K. You have a total of $1M either way before withdrawing -- but less is due in taxes this way.

So if you have a sufficient value in both a Roth and a traditional IRA/401K and you have decades to let it ride, you probably are better off concentrating the risk (and higher long-term return) in the Roth where it will (under current law) NEVER be taxed.

Having said that, if the bulk of your tax-deferred retirement portfolio is of the Roth type (and almost none of the traditional IRA/401K) it's a moot point and there's nothing wrong with bonds in there.

Isn't comparing money in a Roth to the same amount of money in a tax-deferred account mixing apples and oranges? Because it isn't really accurate to say that money in a Roth is never taxed—it's taxed before you put it in.

Suppose I have $2000—I can either put it all in a tax deferred account, or pay the tax and put what's left into a Roth. What to do, what to do?? I can't decide, so I put $1000 in tax-deferred and the after tax amount—let's call it $750—in the Roth, each in a 70/30 allocation. If, as in your example, the account multiplies itself by five in 30 years, there will be $5000 in tax-deferred and only $3750 in the Roth—but I haven't paid the taxes yet on the former. If I'm still in the 25% tax bracket, the tax-deferred account after tax is worth 75% of $5000, which is $3750, the same amount I have tax free in the Roth. The total spendable amount from both accounts is $7500. Now suppose I had put the whole Roth in stocks. That is $750, so to retain the overall 70/30 AA, the tax-deferred account will contain $475 worth of stocks, and $(1000-475)=$525 worth of bonds. Using the same ratios you used, after 30 years, the Roth multiplies itself by seven, so it has $5250 in it. The tax-deferred account triples, so it now has $3000. After tax, that's $2250, and added to the $5250 in the Roth, the spendable total is again $7500. With these particular parameters, keeping the bonds in the tax-deferred account made no difference to the final outcome, but I don't know if that would be true of all the possibilities across the board. (I doubt it.)

The other thing is that the stocks are more volatile than a mix of stocks and bonds, so maybe the Roth doesn't multiply by seven. Maybe it goes up ten or fifteen times instead of seven, but then again maybe it drops like a rock right before I planned to take it out. I have to go to w*rk now, and don't hav time to figure out what the impact of that would be, compared to keeping a blended AA in both accounts, but I suspect that the outcome of putting the higher-returning and hence riskier investment in the Roth is not always favorable. Maybe it is favorable more often than not?

 

[Rambler]

My situation is probably a little unique because I can't use a Roth, 401k or take the deferral on a T-IRA. So, I use Munis in my taxable to balance things out. I'm slightly bond heavy in my taxable right now, but targeting 60/40 or 55/45 long term.

If I were in a different situation though, I would pay close attention to LOL!'s strategy (I don't have time now but you could do a search on Bonds and income ore something like that, where he has gone into more detail).

BTW, congrats on your nice nestegg. Wish I would have been there at age 35...good job!

R

 

[sirion]

I
Remember, you don't have to get this done overnight. Make haste
slowly.

Thank you for this statement! I really needed to hear that. I haven't looked at my investments for years. I had my daughter about 4 years ago and literally ignored everything except my day-to-day cash flow until just about two weeks ago. I realize that I just can't "fix" years of neglect with a week of intense thought. I went back over my plan, together with some comments from here, think I have a strategy that I'm comfortable with. Basically, I put my existing (four-figure) 401(k) into a bond fund and plan to convert my entire Traditional IRA ($150,000) to a total bond market index fund. Those two actions will raise my asset allocation to 85 stock/15 bonds or thereabouts. I know I will sleep better once those changes are made.

Next, I will convert my husband's Traditional IRA to his Roth IRA in 2010 and pay the taxes on that with some of the cash that I have in a savings account (not my emergency fund). After that, I'll contine to invest into my 401(k) in only bonds until I get my allocation up to 80/20.

As to the question of generating income in retirement, I have no clue how to do that I guess I just thoght that the income would generate itself somehow. You all are correct that I may want to think about muni bonds as time goes on. I know my dad has muni bonds. Where does one go to learn how to position your investments as you retire?

 

[travelover]

........................... Where does one go to learn how to position your investments as you retire?

I'd start here.

Bogleheads Investing Advice and Info

Read this:

http://www.amazon.com/gp/product/B0..._m=ATVPDKIKX0DER&pf_rd_r=1JXV6ZJKZ5YMENZJ1C4X

Or read a couple of these books


Investment Books

 

[mathjak107]

since our bonds are basically a bucket 2 investment i cant see paying taxes to convert them to a roth at 57 only to start to be withdrawn in 8 years or so. plus the gains are so much smaller then equities ill just leave them in my tira and taxable account and let the roth be for the bigger gains longer term money

 

[charlie]

One of the best things about tax sheltered accounts is that you can change investments and AA as you approach retirement without causing "taxable events"

Your problem as you stated is a reluctance to incurr cap gains taxes on your $750k in your taxable .... all equity I assume.

Keep in mind that this year and next are the last chance for 15% cap gains tax rate. It might be a good idea to start converting that equity now by selling some of the stuff you don't like. Remember that your most recent investments problbly have the least amount of capital gains.

Visualize what you would like your combined portfolio to look like at retirement and start moving slowly but surely in that direction.


Cheers,

charlie

 

[teejayevans]

since our bonds are basically a bucket 2 investment i cant see paying taxes to convert them to a roth at 57 only to start to be withdrawn in 8 years or so. plus the gains are so much smaller then equities ill just leave them in my tira and taxable account and let the roth be for the bigger gains longer term money

Unless you can pay taxes now at a lower rate then when you are 65 and collecting SS.
TJ