What Not To Hold In Tax Free/Deferred Fund?

[yakers]

My primary saving account is a 401k type tax deferred (Fed TSP) and I have chosen a target retirement type fund within it. I also have a small Roth fund in VG Asset Allocation (VAAPX). My wife's IRA is in the Wellesley fund. Then I have a few stocks in a trading account. I understand that there are some funds that should be in tax free/deferred accounts like bonds and REITs.
What types of assets should NOT be held in tax free/deferred accounts even when there is 'space' to make contributions? I assume that would be muni funds & ibonds. But what about very efficient funds like an S&P500 index. That is one of the most common choices in the TSP account. Is it a disadvantage to hold a S&P500 index fund in such an account?
I am no longer in the accumulation phase but do not expect to start withdrawals until next year.
I would post this over at the VG Bogelhead site but the responding wave can be hard to decipher.

 

[lucija]

A tax deferred/tax free account is not a place for tax managed funds (including tax exempt funds) or products which are tax deferred by definition (I-bonds, deferred annuities). Other than that, everything else is OK to hold in a tax deferred/tax free account.

You may have heard that it's better to hold index fund (such as index 500) in taxable and place something else in tax deferred/tax free account. This is true, but only if you do not have enough "space" within a tax deferred/tax free account for all your investments. Some also think, you are better off holding stock in taxable (assuming you are buy & hold investor), since you can limit you taxes to cap gains only.

If you are no longer accumulating and do not hold any bonds/REITs/small cap in taxable, I would not worry about content of your tax deferred/tax free account.

 

[FinanceDude]

A tax deferred/tax free account is not a place for tax managed funds (including tax exempt funds) or products which are tax deferred by definition (I-bonds, deferred annuities). Other than that, everything else is OK to hold in a tax deferred/tax free account.

Is that a general statement for everyone, or just in this case?

Some also think, you are better off holding stock in taxable (assuming you are buy & hold investor), since you can limit you taxes to cap gains only.

Also, you can take LOSSES, as invariably you will make mistakes........

 

[lucija]

FD - Good point about losses in taxable!

Is that a general statement for everyone, or just in this case?

I think it's a fairly general statement, but (as always) there are cases when alternatives should be considered. It seems that OP has a few stocks in taxable and index funds in the TSP account and I see no reason to change that... I do not see a reason for tax managed funds or deferred products in 401k/IRA. Come to think of it, I don't think you can even buy I-bonds in IRAs.

Could you help me understand better the exceptions when it would be better to have index 500 in taxable rather than in IRA? I guess, it would be useful to have everything in taxable, if you have tax efficient portfolio and want your heirs to take advantage of the stepped-up basis. Also, large IRAs may cause large (unexpected) RMDs. They also would be not the desired account type if you expect income tax to double in the future.

 

[Ronnieboy]

In this months issue of Money magazine, there is a section (after 'the only 7 funds you will need' article) that basically says you should have tax generating funds (bonds) in 401(k), IRA, etc. to avoid paying taxes. S&P 500 type funds that should be in your taxable b/c the monies thrown off by them are usually taxed at 15% capital gains. Or so that is the rough gist of it, please confirm or correct.

 

[LOL!]

... S&P 500 type funds that should be in your taxable b/c the monies thrown off by them are usually taxed at 15% capital gains. Or so that is the rough gist of it, please confirm or correct.

Not correct. If you change the word "should" to "may", then correct.

If you have room in tax-advantaged accounts for all your investments, then put all your investments there. If you have enough money leftover, so that you can invest in addition to the maximum contributions allowed for your tax-advantaged acounts, then choose tax-efficient investments for those taxable accounts.

 

[Spanky]

But what about very efficient funds like an S&P500 index. That is one of the most common choices in the TSP account. Is it a disadvantage to hold a S&P500 index fund in such an account?

There is no disadvantage to have tax efficient funds in a tax deferred account. The first thing to do is to identify an asset allocation. Then, place the least tax-efficient funds or investments into tax-deferred accounts and most tax-efficient funds into regular accounts.

 

[yakers]

If you have room in tax-advantaged accounts for all your investments, then put all your investments there. If you have enough money leftover, so that you can invest in addition to the maximum contributions allowed for your tax-advantaged acounts, then choose tax-efficient investments for those taxable accounts.

I think that is what I was getting at. I was wondering if tax deferred accounts might turn out to be suboptimal investments. The bulk of my savings are tax deferred. All of my pension income and all tax deferred withdrawals will be taxable so I will probably be in the same tax bracket in retirement as when I worked. I was just pondering if I would have been better off putting more into taxable (but tax efficient) stocks/funds than putting it all into tax deferred. Of course it felt really good to be avoiding taxes all that time I was working.

 

[statsman]

I was just pondering if I would have been better off putting more into taxable (but tax efficient) stocks/funds than putting it all into tax deferred. Of course it felt really good to be avoiding taxes all that time I was working.

I have been wondering the opposite. My wife and I currently have much more in our taxable accounts than in our tax deferred accounts. Part of the taxable account overkill was the obsession to save enough money to pay off the house (California real estate costs in the Bay Area) and cover our salaries in case of layoffs (which my wife experienced 5 years ago). Part of it was the sale of a second home. Another part of it was some inheritance money.

I like that I can shift our tax deferred investments around without the need for the massive bookkeeping it would have required. It is trying to decide which "tax efficent" funds to invest in that keeps us from moving our money out of our very conservative MM/savings acounts.

 

[LOL!]

I think that is what I was getting at. I was wondering if tax deferred accounts might turn out to be suboptimal investments. The bulk of my savings are tax deferred. All of my pension income and all tax deferred withdrawals will be taxable so I will probably be in the same tax bracket in retirement as when I worked.

The underlined statement (my underlining) does not follow from the previous statement. Just because something is taxable does not mean you will be in the same tax bracket. Your withdrawals in retirement will depend on your expenses which in turn will depend on the amounts you have saved up and invested.

Some expenses you will not have to pay when you stop earning money:
(1) Social security taxes
(2) Medicare taxes
(3) 401(k) savings
(4) IRA investments
(5) etc.

You should run some scenarios in TurboTax to see what your taxes might be like when you stop working and start withdrawing from your retirement assets. Don't guess.

 

[FinanceDude]

I think it's a fairly general statement, but (as always) there are cases when alternatives should be considered. It seems that OP has a few stocks in taxable and index funds in the TSP account and I see no reason to change that... I do not see a reason for tax managed funds or deferred products in 401k/IRA. Come to think of it, I don't think you can even buy I-bonds in IRAs.

What about performance or asset allocation issues?

Could you help me understand better the exceptions when it would be better to have index 500 in taxable rather than in IRA? I guess, it would be useful to have everything in taxable, if you have tax efficient portfolio and want your heirs to take advantage of the stepped-up basis. Also, large IRAs may cause large (unexpected) RMDs. They also would be not the desired account type if you expect income tax to double in the future.

Some on here have the majority of assets in taxable. Obviously, due to step-up rules and the like, a taxable account can be better than a tax-deferred. Funding Roth IRAS if applicable and converting to Roths if it is advantageous are other things you can do.

One should look at the long-term history of their mutual fund holdings to see how FREQUENT short-term gains are paid. Unfortunately, there is a better than 50% chance the long-tem cap gain rate is going up.........

I have to go down the tax-efficient taxable account method myself. For a number of years, DW and I have been unable to fund Roths. However, the upcoming change where folks can convert regardless of annual income will be most helpful. My goal is to have tha largest Roth I can, hopefully a 100% conversion to Roth before I retire. I strongly believe Roths are going away, but they will be grandfathered in..........

 

[Gotadimple]

I strongly believe Roths are going away, but they will be grandfathered in..........

And that would be because??

The Federal government needs tax income now?
Business will revert to providing defined benefit plans to attract/retain employees? So employees won't have to save outside of their workplace?
The tax deferral rules for 401K's disappear at the same time Roth's do?

Inquiring minds, gotta know!

-- Rita

 

[FinanceDude]

And that would be because??

The Federal government needs tax income now?
Business will revert to providing defined benefit plans to attract/retain employees? So employees won't have to save outside of their workplace?
The tax deferral rules for 401K's disappear at the same time Roth's do?

Inquiring minds, gotta know!

-- Rita

When the Roth was intorduced in 1998, they govt allowed folks to convert their regular IRAs to Roths over a 4-year period. They thought that EVERYONE under the income caps would do so, and were counting on that extra revenue to fund govt spending. Trouble was, ONLY 25% actually converted........ Whoops!, now what do we do??

Call it a gut feeling, I can't prove that it will come to pass. But I trust Congress about as far as I can keep them in eyesight..........