Tax deferred Mutual fund account

[geeman]

I have a T Rowe Price Retirement 2045 account.  I was told that this fund makes more sense as a tax deferred account (I have it as a taxable account) because as the fund changes from stocks to bonds, and I will be paying unnecessary income and capital-gain taxes every year on the increasing distributions.  Did I screw up by opening this account as a taxable account and if so how do I change this?

In addition to the Retirement 2045 account I also have Real Estate, New Asia, and Mid Cap Value in my taxable portfolio.

In my tax deferred accounts I have Vanguard S&P 500 (IRA) and Maxim S&P (401K).

Thanks

 

[wildcat]

Geeman -

You should have tax bill generating funds in a non-tax.  Keep plain vanilla blend (as growth and value tend to turn more often according to the fund's objective) index funds or tax managed funds in active.  Keeps the tax bill low and you happy.  Bonds are also recommended by many to be in non-tax.  Shouldn't be a big deal to switch funds in your accounts.

FYI if you are going to split value/growth as some of your current allocation suggests I would place the style funds in non-tax but it's up to you

 

[geeman]

So do you think I'll be paying a lot of taxes when the fund converts to more of a bond fund in 20/30 years?

 

[wildcat]

I haven't really looked at the target retirement funds but if it rebalances and sells it will generate tax bills. Bonds will also. I would rather be taxed on stock dividends. It may be wise to change it. Taxes eat returns and you will not be a happy camper at the end of each year.

 

[geeman]

What do you guys recommend I do? I don't want to actually get rid of the funds. What mutual funds are good for a non-tax deferred protfolio? I guess it's best to knock out these problems while I'm young

I have:

T Rowe Price (taxed):
I have Mid-Cap Value $1060 - invest $100 a month
New Asia $480 - invest $100 a month
Retirement 2040 $1000 - invest a month $200
Real Estate $1110 - invest $100 a month

Vanguard (Roth IRA):
Vanguard 500 Index Fund Investor Shares ($3260) - Invest $340 a month

401K - Maxim S&P ($0 - just opened account) - $90 a month

 

[wildcat]

ahhhh ummmm

Keep plain vanilla blend (as growth and value tend to turn more often according to the fund's objective) index funds or tax managed funds in active.

 

[geeman]

I don't get what you're saying.

 

[wildcat]

OK sorry. Plain vanilla is just an expression I use to describe boring blend index funds like the S&P 500. Less turnover than style tilted funds that have to trade to meet fund objectives. For example, your mid cap value will sell stocks if the stock is no longer a value. That will occur often which raises the turnover. Blend index funds just buy and hold which keeps turnover low and tax bills low.

 

[ats5g]

Geeman,

Here is a M* conversation that kind of deals with your question about what to hold where:

Here is a 4-step rule for 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
TIPS
Taxable bonds
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

And here is M*'s analysis of the tax efficiency of the TRP funds and VFINX. [the Retirement 2040 fund hasn't been around long enough for this yet].

TRMCX

PRASX

TRREX

VFINX

Anyway, I think it'd probably make more sense to hold VFINX [or better yet, Vanguard's Total Stock Market Index fund] in the taxable account, and the TRP funds in the Roth IRA. While two of the TRP funds are fairly tax efficient [PRASX much more so that TRMCX], they do have managers that may leave in the future and (1) may not stay as tax efficient (2) may get new managers that herendously underperform and you may want to sell but the pent up capital gains may hinder this. If you hold the TRP funds in the Roth IRA, you can change funds in the future with no tax consequences.

VFINX and VTSMX by their design [as well as the indexes they track] are going to be very tax efficient, plus since they're index funds, they by definition cannot underperform their asset class [see W. Sharpe's The Arithmetic of Active Management]. IMO in a taxable account, you want to hold those funds that you're going to hold for a looooooooooooooooooooooooong time.

- Alec

 

[geeman]

So move my ROTH IRA (S&P) to my T Rowe Price funds? Can a ROTH consist of more than one mutual fund?

 

[charlottebandito]

The S&P 500 is pretty much a Large Cap Blend.  Not really diversified (IRA & 401K).  However, it looks like you're creating diversification for your taxable account, which is good except that several of them are reaping capital gains which means active trading within the fund.  These should be placed into your tax-deffered accounts:  REIT, Bonds, Gold, Precious Metals...etc. 

Have you considered ETFs?  They do not produce capital gains (equities only) but do divis.  That means only a (1) method tax hit.  Sharebuilder allows $4 monthly trades for ETFs or stocks so that may be a worthwhile option.  How about keeping S&P 500 and Retirement 2040 funds in your ROTH (20%/80%), SP 500, REIT, MCap Value & New Asia in 401k (if offered: REIT 10% or less), and begin an ETF portfolio for taxable account. 

You're pretty heavy on large blend (SP 500) and very light on small cap which has performed similar if not better than SP 500.  On ETFs, go the index route and maybe commodities such as Utilities, Energy, or even Health care for a small percentage.  MFs produce divis & capital gains, ETFs produces on divis if you stay away from REITs & bonds.  Stay with equities & commodities for ETFs.

 

[ats5g]

Hey charlottebandito,

Have you considered ETFs? They do not produce capital gains (equities only) but do divis. That means only a (1) method tax hit.

Not to nit pick to much , but ETF's certainly do distribute capital gains, albeit not that much. If you go to iShares Site and click on All Funds' Historical Distributions, you can see all the Ishares distributions broken down into LT & ST gains, Income, and return of capital. Or you can just look at each individual ETF's on its screen.

You can use M* to compare the tax analysis of various funds and ETF's.

Large Caps:

ETF's

IVV

IWV

IYY

VTI

Funds:

VFINX

VTSMX

Small Caps:

ETF's:

IJR

IWM

Funds:

BRSIX

VTMSX

It appears that the tax advantage of ETF's in large caps over say Vanguard's large cap index funds is nil and sometimes negative. If I was just starting out, and had a small amount of money like geeman, I think I'd favor the index funds over the ETF's.

There certainly are options for small caps besides ETF's for those who don't have enough to make the transaction costs of buying ETF's negligible. However, VTMSX does require $10,000 to start off with, so that's out the window for geeman. One can buy BRSIX directly from bridgeway as well.

I think small caps, value, and especially small cap value is where the ETF's will most likely be better utilized in taxable accounts.

Geeman,

Yes you can have multiple funds in a Roth IRA with one company [like TRP] or multiple companies. I'd try and hold any REITs and bond in your IRA.

- Alec

 

[ats5g]

Vanguard has some excellent info on ETF's on their advisor site:

Exchange-traded funds overview

- Alec

 

[geeman]

Thanks for all of the replies. I just don't want to retire in 30 years and have 3 mil for my nest egg and have to payout tons of it in taxes. Guess thats why I've got my Roth and 401K also

 

[justin]

Thanks for all of the replies. I just don't want to retire in 30 years and have 3 mil for my nest egg and have to payout tons of it in taxes. Guess thats why I've got my Roth and 401K also

In 30 years, your 401k withdrawals will all be taxed as ordinary income. Unless things change in the next 30 years.

 

[geeman]

Great, I guess IRA is going to be my only hope...?

 

[Nords]

Great, I guess IRA is going to be my only hope...?

Nothing wrong with paying taxes on $3M. And while a Roth looks like a great tax deal today, I'm sure it'll get messed with as much as deductible IRAs were gored by the last wave of tax reform.

Geeman, the time you spend posting these questions may be better served by reading Bernstein's "Four Pillars", "Investing for Dummies", "Mutual Funds for Dummies", or Ed Slott's IRA books. Bernstein's Four Pillars is a big help too.

And I'd recommend Vanguard's or Fidelity's index funds over ETFs any day for those who are still DCA'ing, especially when the fund companies are able to offer a similar index fund for a lower expense ratio.

 

[wildcat]

And I'd recommend Vanguard's or Fidelity's index funds over ETFs any day for those who are still DCA'ing, especially when the fund companies are able to offer a similar index fund for a lower expense ratio

Agree and still surprised so many people are reco'ing the heck out of em. Good to have available and good in some situations but not always the best option IMHO.