Bonds in Taxable Account or tIRA - Spreadsheet Answer

[Animorph]

While placing bonds and other income producing investments in a traditional IRA makes sense to avoid the tax drag, it always bugged me that it also resulted in the low growth (presumably) investment going into the tIRA.

So, considering everything, where is the best place for bonds? What I found was that of course the tIRA was better for both stocks and bonds (with equal in and out tax rates). However, the advantage was larger with stocks rather than bonds. So if you contribute $1000 for stocks in the tIRA and $1000 - $250 taxes for bonds in the taxable account your withdrawal amounts are higher than if you bought bonds in the tIRA and stocks in the taxable account. The withdrawals were about 8% higher with bonds in a taxable account and stocks in the tIRA. The result was fairly robust with a few different tax rates and investment gains. Bond yields had to approach stock total returns before they were better placed in the tIRA.

I made a spreadsheet, hopefully attached, that compared the income available if you have $1000/year available to save pre-tax, and saved it as stocks or bonds in a taxable account or stocks or bonds in a tIRA. I assume 30 years of saving, and then 30 years of withdrawals, with the withdrawals sized to zero out the portfolio in the last year.

I used a fixed stock growth rate of 6% plus a 1% yield. I used a fixed bond yield of 3% with 0% principal growth. No inflation, so it's all real rates. I taxed the yields at a 15% rate in the taxable account. I taxed stock withdrawals at 10% from the taxable account, assuming 15% capital gains and noting roughly 1/3 tax basis at retirement to avoid tracking the stock basis. I taxed contributions to the taxable account at a 25% rate and withdrawals from the tIRA at 25%. The results were about the same using a 15% tax rate for both.

The spreadsheet uses iteration to find the withdrawal amount that gives a $0 final portfolio value for each of the four combinations of stock/bonds and taxable/tIRA.

You can plug in your own numbers or modify to your heart's content. This is just a quick and dirty start.

View attachment 18629

or

https://www.dropbox.com/s/tbvsnh2ccb0tih3/Taxable or tIRA.xls

(I can't get the regular attachment to download for me.)

 

[pb4uski]

Did you consider that stocks generate qualified dividends and LTCG in a taxable account are taxed at 0% or 15% depending on your tax bracket and bond interest in a taxable account is taxed at ordinary rates?

I think what you are seeing is the power of deferral of taxes.

I think a 2% dividend yield would be more realistic than 1%.

 

[Animorph]

Did you consider that stocks generate qualified dividends and LTCG in a taxable account are taxed at 0% or 15% depending on your tax bracket and bond interest in a taxable account is taxed at ordinary rates?

I think what you are seeing is the power of deferral of taxes.

I think a 2% dividend yield would be more realistic than 1%.

Easy enough to try that out. If I change to a 5% growth and 2% yield for stocks, placing the bonds in the taxable account gives 11.5% better retirement income. 4% growth and 3% yield makes it 15% better. More yield for stocks, leaving total growth the same, makes it look even better inside the tIRA where the increased yield is not taxed.

The big key is getting the most tax deferred growth. That's stocks unless you expect them to do worse than bonds.

I needed 0% growth and 5% to 6% yield for bonds to make it pay to put bonds in the tIRA. Certainly that could apply in the future, but not today.

 

[pb4uski]

So its seems to me that you have proved that if deferral of taxes is good then more deferral of taxes is better.

But.. I'm guessing that the advantage diminishes if you apply ordinary tax rates to bond income and preferential tax rates to equity income.

 

[Animorph]

So its seems to me that you have proved that if deferral of taxes is good then more deferral of taxes is better.

But.. I'm guessing that the advantage diminishes if you apply ordinary tax rates to bond income and preferential tax rates to equity income.

I did tax bond income at 15%. If I raise that to 25%, holding bonds in the taxable account results in a 6% retirement income benefit instead of the original 8% benefit. So that does move in the direction of favoring bonds in the tIRA, but not by a lot. If I use 0% tax on stock dividends as well, the benefit goes from 6% to 3%. Still favoring bonds in the taxable account, or really placing as much of your stocks as possible into the tIRA.

You really have to fool with the growth and yield assumptions pretty heavily before stocks in a taxable account looks better.