Asset location question

[SecondCor521]

Asset location question:

Suppose the following simplified / abstracted / numbers adjusted scenario:

An investor has $1M and wants to be 75% VTSAX / 25% VBTLX, so $750K / $250K. Set aside any critiques of their investment style, risk preference, asset allocation, and fund choices please.

They have a traditional IRA, a Roth IRA, and a taxable account. They're around 25% federal marginal tax rate (between base and IRMAA).

They have $300K in taxable and $500K in their Roth IRA, all in VTSAX. They have $200K in their traditional IRA and it is all VBTLX.

In which account should they move $50K from VTSAX to VBTLX to get to their target AA - Roth or taxable?

I think Roth is the better answer, because VBTLX has a higher current yield (4.x% vs 1.y%) and you'd prefer to have the 1.y% in the taxable. But am willing to listen to, and hopefully learn from, arguments for taxable.

 

[tulak]

I’d want more info, such as, what is the cost basis on VTSAX in the taxable account and more importantly, are there going to be yearly rebalancing/withdrawals?

In general, I prefer to keep equities in a Roth, but for rebalancing purposes, a Roth would be easier.

Since overall it’s a small amount relative to equities (90/10 in the Roth), I’d probably go with the Roth to keep it simple.

I could point out some other considerations: tax efficiency of VBTLX vs VTSAX in a taxable account, the potential growth of VTSAX in the Roth when compared to VBTLX. But I suspect that you’ve already thought of those.

If you never plan to rebalance or sell, then I would model the growth of VTSAX vs VBTLX in a Roth. I suspect in that case, it might be better to have VBTLX in taxable, regardless of its yield.

 

[mrfeh]

Asset location question:

Suppose the following simplified / abstracted / numbers adjusted scenario:

An investor has $1M and wants to be 75% VTSAX / 25% VBTLX, so $750K / $250K. Set aside any critiques of their investment style, risk preference, asset allocation, and fund choices please.

They have a traditional IRA, a Roth IRA, and a taxable account. They're around 25% federal marginal tax rate (between base and IRMAA).

They have $300K in taxable and $500K in their Roth IRA, all in VTSAX. They have $200K in their traditional IRA and it is all VBTLX.

In which account should they move $50K from VTSAX to VBTLX to get to their target AA - Roth or taxable?

I think Roth is the better answer, because VBTLX has a higher current yield (4.x% vs 1.y%) and you'd prefer to have the 1.y% in the taxable. But am willing to listen to, and hopefully learn from, arguments for taxable.

My first thought is put the fixed income in taxable. Roth should be all equities if possible. That being said, I didn't do any calculations. The answer is probably specific to a particular situation.

Also, don't use current yields for determining the answer. Yields will change.

I imagine there are a bunch of similar questions over on bogleheads.

 

[Exchme]

In our situation, we are planning on putting bonds in Roth if they overfill tax deferred, I've never actually studied it because putting bonds in taxable means selling appreciated stocks and paying taxes on that. Those would be new lifetime taxes which would make it pretty unlikely to be a good idea.
Also, if those $ of bond dividends put us over a cliff like ACA and IRMAA, that would be a real nuisance.

In this example, perhaps that initial burden could be lessened with "soft rebalancing", if they are at a time of life that they are saving, then save bonds, if they are selling assets, then sell stocks.

The detailed answer probably depends lots of factors like age, current and future income, savings, spending, rates of return, amount of appreciation in taxable, whether they will ever need to sell in taxable, etc. It probably be can be studied in some of the higher fidelity retirement planning tools like Pralana.

 

[bonvoyage]

I rebalanced our portfolio about 3 years ago based on the principles outlined here: https://www.bogleheads.org/wiki/Tax-efficient_fund_placement

We don't have Roth accounts as yet.

Currently our asset allocation is:

	Stocks	Bonds	Cash or equivalent
Tax deferred	49%	51%	0
Taxable	81%	7%	12%

 

[Jerry1]

I used to agree with the premise that ROTH’s should be 100% equities but have come to think different of late. Let’s say you really need to withdraw some funds for an emergency, you don’t want to have to pay taxes and you don’t want to sell equities in a down market. Because of this, I put a small percentage of my ROTH in a money market fund. Therefore, I’d move the money in the ROTH.

 

[mrfeh]

I used to agree with the premise that ROTH’s should be 100% equities but have come to think different of late. Let’s say you really need to withdraw some funds for an emergency, you don’t want to have to pay taxes and you don’t want to sell equities in a down market. Because of this, I put a small percentage of my ROTH in a money market fund. Therefore, I’d move the money in the ROTH.

There are better options for an emergency fund than a Roth.

 

[Jerry1]

There are better options for an emergency fund than a Roth.

Mostly true, but most of my net worth is in my IRA so the options are limited.

 

[pb4uski]

Put the $50k of VBTLX in taxable, leaving the faster growth VTSAX in Roth

 

[Exchme]

It occurred to me that since I had never modeled this, I might be wrong. Pralana just added support for evaluating rebalancing costs in taxable, so I looked at it for our situation. Turns out it's very simple, you just change the order of priority of where to put stocks first.

For us, it turned out that spillover bonds were always better in Roth than in taxable. If there is an initial rebalance as in the case of the OP, then the difference between the cases got even larger.

As I said above, it is likely situational. [Edit: For instance, if we had to eventually deplete taxable, then we would have had to pay LTCGs on the extra stocks in taxable and that might switch the decision. But as of now, it doesn't look like that will happen, so the only difference between taxable and Roth for us is tax drag and minimizing tax drag means keeping bonds out of taxable.]

 

[VanWinkle]

I have the exact same situation with the same funds. I had a 50/50 allocation but have increased it to 60/40 due to gains in stocks. That
has required me to make the decision you are pondering. I put the bonds into my Roth instead of taxable to reduce the tax bomb of additional ordinary income in my taxable account and increased taxes on Social Security. I still wonder if the choice was the best, but I decided to live with it. Reducing Total Bond to 40% also helped.

 

[imjustawarrior]

My understanding is that generally it is better to put the extra bonds in Roth. This would be an easy spreadsheet exercise. When bonds were yielding nothing, taxable was better, but in general bonds are better in a tax advantaged account (pre-tax first, Roth next).

Side Note: If I want to maintain my 75/25 AA and reduce my IRA to the level I want, I will face this issue. I'm thinking of side stepping the issue and switch to 5-10 years of bonds in IRA and equities every where else. I'm still a decade away from having to make this decision.

 

[COcheesehead]

My Roth is 100% bond like CEFs. It’s averaged over 12% returns. Over 15% YTD. In my mind equities are already tax advantaged if used correctly so having them in a Roth doesn’t add as much value as something that throws off high income.

 

[Phroig]

I know you said to take the fund choices as given, but with a marginal rate of 25%, would you consider a muni fund in taxable? VWIUX currently yields almost 3.5%.

 

[Dalton]

Do they take any distributions/withdrawals from these accounts? If they put $50k in the brokerage acct, it will produce approx $2k in dividends and have to pay income tax on it, but if it happens that they are taking more than that out of their tIRA already (that's not required ala RMD), they could just spend the divs out of the brokerage (since they are paying taxes anyway) and reduce/offset their withdrawal from the tIRA by the same amount.

 

[SecondCor521]

Thanks all!

OK, answers to questions if it helps:

VTSAX basis is $150K (50%).

They rebalance regularly to the 75/25 ratio. What has happened is that the VTSAX has grown such that the traditional IRA can't hold the required 25% VBTLX, and they've elected VTSAX in taxable thus far to minimize tax drag.

They withdraw, but at such a low rate to where that can essentially be ignored. No plan to spend either Roth or taxable; they have RMDs from the traditional IRA (plus SS and a small pension) which more than fund their lifestyle - the excess currently gets reinvested in VTSAX in taxable each month.

They understand about VWIUX vs VBTLX in taxable (and actually own it where appropriate); let's ignore that for now. This is really about asset location, not specific bond investment.

 

[FlaGator]

My reflex is to do it in Roth because I don't like to idea of paying taxes *solely* to adjust allocations for a few points. I have sold and paid taxes when I needed $$ for expenses and, concurrently, consciously lowered the equities by 10-ish points.

I would look at 2 factors, primarily tax-based:
-cost basis of the shares to be sold in the taxable account for the reallocation
-need for, and impact of additional income in the taxable account