How to allocate taxable and non-taxable money?

[Olav23]

Hi, I'm trying to get a friend's investments in order, as he doesn't have the understanding (or lack thereof) of asset allocation.

He has money that is relatively sitting in cash and needs to invest it. He's just turned 30.

Taxable investment accounts: 150k
IRA from 401k Rollover 38k
Traditional IRA 7k

I know the basics, like what kind of allocation between asset classes, but what I am not sure of is what funds/ETFs should go where. I'd like to set him up in low cost index funds and ETFs.

He actually started on his own but I'm not sure if it was the right thing to do now. He put 50k from the TAXABLE account into a vanguard 2045 retirement DCA'd over a period of 7 months. Now, he just got word that he'll be paying taxes on like 800$ in dividends. Should he sell out now and re-allocate to more tax-managed funds instead of the all in 1 solution in the taxable account?


Since the breakdown is 45k tax-sheltered, 150k taxable do something along the lines of:

150+45=$195k, and allocation I want to achieve:

10% Bonds $19,500.00
5% Reits $9,750.00
10% LC $19,500.00
20% LCV $39,000.00
10% SC $19,500.00
10% SCV $19,500.00
25% Intl $48,750.00
5% Emerg $9,750.00
5% DJP $9,750.00
100% Total $195,000.00
[LCV = large cap value, SCV=small cap value, Emerg=Emerging Markets, DJP=DJP Commodity ETF]

So, of course the Bonds, Reits and DJP will prob go into the tax-sheltered and 6k of the SCV.

That totals: 19500+9750+9750+6000=45000 Tax-Sheltered total
Then the taxable allocate to: LC, LCV, SC, Intl, Emerg and the leftover $3750 to SCV.

Does this sound like a doable plan? Is this how you guys do the exercise of allocating across different tax situation accounts?

Do you guys think it makes tax-efficient sense to just pump it all into the target retirement 2045 in both taxable and tax-sheltered accounts and pay taxes on dividends yearly? He lives in NYC and has a very high tax bracket including state, city and federal...

Thanks for any help you can provide. I figure it'll be a good exercise to explain to others how it's done...

 

[ats5g]

You may want to look at Vanguard's 2006 Qualified dividend income estimates and 2005's figures.

You can see what TR 2045 has done tax wise. Not too bad, but I think living in NY, your friend would want to be as stingy with taxes as possible. Plus, the TR funds use fully taxable bonds, which he could hold in his tax deferred accounts. Also note that the TR funds will be constantly realizing capital gains [LT + ST] rebalancing and gradually switching from stocks to bonds.

Small cap, and small cap value index funds and ETF's are going to include a large slug of REITs, which don't qualify for the lower dividend treatment. Plus, he's already going to have REITs in tax deferred account. Might want to go with Vanguard Tax-Managed Small-Cap Fund or even BRSIX for tax managed small cap.

Depending on how much small/value tilt he wants, for the taxable account you could suggest going with some combo of:

Total Stock Market Index Fund/ETF
Tax Managed Int'l fund/ EAFE ETF
EM index fund/ETF
Tax Managed Small Cap / BRSIX

- Alec

 

[LOL!]

Taxes on $800 in dividends? I think it's nye impossible not to have some dividends/distributions in a taxable account if you want to make money. I wouldn't be sweating only $800. I wouldn't even sweat 2% to 3% of my assets as dividends, but it should be pretty easy to allocate things to IRAs and 401(k)s to average even less than 2% of total assets in taxable dividends.

 

[lswswein]

Just a small note the TR2045 has dividends but 75% of them are Qualified dividends for 2005
https://flagship.vanguard.com/VGApp/hnw/planningeducation/taxcenter/PEdQDIfinalContent.jsp

I don't see the 2006 numbers yet, so the tax rate is not as bad.

-h

 

[Olav23]

Thank you everyone for the help. I was also thinking, since he is fairly happy with the Target Retirement, it looks like it holds:

Vanguard Total Stock Market Index Fund 71.9%
Vanguard European Stock Index Fund 10.5%
Vanguard Total Bond Market Index Fund 9.9%
Vanguard Pacific Stock Index Fund 5.0%
Vanguard Emerging Markets Stock Index Fund 2.7%

He could easily just dump the Targ Retirement, and just split it apart and buy:
Taxable:
Total Stock
European Stock
Pacific Stock

Tax-Deferred:
Emerging
Total Bond

Does this make sense? Would you switch some funds to other accounts instead?

Are there any resources you use (I like morningstar's after tax return page) for judging what is good in a tax-sheltered acct vs taxable? More of a database for things like qualified dividends instead of having to look at each fund separately?

Thanks again, all your help is invaluable to a lot of us...

 

[lswswein]

This is a handy list from a poster named Laura at diehards.org

4-Step Rule for Tax Efficient Fund Placement:

1. Put your most tax-inefficient funds in 401ks, 403bs, Traditional IRAs and similar retirement accounts. When full..
2. Put your next most tax-inefficient funds in your Roth(s). When your Roth(s) are full-
3. Put what's left into your taxable account.
4. Try to use only tax-efficient funds in taxable accounts.

Here is a list of securities in approximate order of their tax-efficiency. (Least tax efficient at the top.):
Hi-Yield Bonds
Taxable Bonds
TIPS
REIT Stocks
Stock trading accounts
Small-Value stocks
Small-Cap stocks
Large Value stocks
International stocks
Large Growth Stocks
Most stock index funds
Tax-Managed Funds
EE and I-Bonds
Tax-Exempt Bonds

 

[lswswein]

Hi OLav
Morningstar does have tax analysis data, though it might be a Quarter or so late.

http://quicktake.morningstar.com/FundNet/Tax.aspx?Country=USA&Symbol=VTSMX&fdtab=tax

Its one of the tabs on the left when you look at the snapshot. Also remember and be careful about how much your freind wants to rebalance etc. Target Retirments are great for set it and forget.

-h