MESSY portfolio! How to reallocate?

[Ancal]

Hi! We are a couple who moved to the USA from Australia, along with our now three-year-old kid, just over a year ago. I had a tiny amount of money in retirement accounts from early days in low-paying jobs in the States, but we started basically from scratch when we moved. I was excited by Vanguard funds and started slicing and dicing into all kinds of weird funds. I've consolidated a lot since then, but my portfolio is still too complex. And small.

Our situation is below:

Emergency funds: 6 months + planned large expenses (car, down payment for a mortgage)
Debt: none
Tax filing status: Married filing jointly
Tax rate: 28% federal, 9.3% state
State of residence: California
Age: 35 (him), 38 (her)
Desired asset allocation: 75% stocks, 20% bonds, 5% "play money"
Desired international allocation: 40% of stocks
Total portfolio size: just over $100k

Current retirement assets

Taxable
20% Vanguard 500 Index Admiral (VFIAX) 0.05%
17% Vanguard Total Bond Market Admiral (VBTLX) 0.10%
8% Vanguard Emerging Markets Index Admiral (VEMAX) 0.20%
5% various stocks in a Sharebuilder account
2% various stocks in a Vanguard Brokerage Services account
7% in Lending Club (consumer debt)

His 401k
12% Great West Retirement 2045 (MXPLX) (1.12%)
no company match

His Roth IRA at Vanguard
8% Vanguard Small-Cap Index Admiral (VSMAX) (0.10%)

His Rollover tIRA at Vanguard
12% Vanguard 500 Index Admiral (VFIAX) (0.05%)

Her 403b
7% CREF Stock Fund (no symbol) (0.49%)
2% CREF Bond Market account (no symbol) (0.45%)
(employer match of up to 5%)

Contributions

New annual contributions

$17500 his 401k, no employer match
$5700 her 403b + $3800 employer match
$12000 taxable

Questions

1. What's the best way to simplify my portfolio so it better reflects a three-fund portfolio (total domestic, total international, total bond) without incurring large tax liabilities?

2. Should I move all my bonds into a retirement account since bonds aren't a tax-friendly investment? If so, how?

3. Right now, I'm putting no money into any sort of IRA because our income level is too high for a Roth IRA and for the same reason there's no tax deduction for putting anything into a traditional IRA. But is there any advantage into putting money into a traditional IRA that I'm missing?

4. Will we be eating cat food when we retire?

Any advice appreciated!

[zucckerbugger]

I'm no expert. Consider backdoor Roth Ira as an option. Others will explain and elaborate I'm sure.
Good luck.

[stlutz]

2. Should I move all my bonds into a retirement account since bonds aren't a tax-friendly investment? If so, how?

3. Right now, I'm putting no money into any sort of IRA because our income level is too high for a Roth IRA and for the same reason there's no tax deduction for putting anything into a traditional IRA. But is there any advantage into putting money into a traditional IRA that I'm missing?

4. Will we be eating cat food when we retire?

#2) I'd consider using Vanguard's CA muni fund. Given that you are in a high-tax state, the double tax-exemption really pays off.

3) You can do a "backdoor Roth" (google the term to read more and see the wiki http://www.bogleheads.org/wiki/Backdoor_Roth_IRA). Note that because you have a rollover TIRA, this is a little more complicated if you don't also convert that to a Roth.

4) Looks like you're saving a ton of money, so you're more likely to be fine than 95% of the rest of the population.

Lastly, an unsolicited suggestion--consider more bonds--like in the 25-40% range.

[zucckerbugger]

Here is a page on backdoor ROTH IRA. Read about the pro rata rule.

http://www.forbes.com/sites/ashleaebeli ... d-version/

"The barrier to the backdoor Roth—in many folks’ minds—is the pro rata rule. The rule says that you have to aggregate all your IRAs to determine how much income tax you owe when you convert. If you have no other IRAs and you open a $5,000 nondeductible IRA and then convert it, you only owe tax on the earnings, if any. By contrast, if you have a $95,000 traditional IRA (pre-tax contributions), and you convert a $5,000 nondeductible contribution to a new IRA, the conversion would be 95% taxable.

So how do you remove the pretax IRA from the equation? Transfer it to a 401(k). Many employer plans allow “roll-ins” of IRA money to 401(k)s. How does this work? Only pre-tax dollars can be transferred to a 401(k), explains Barry Picker, a CPA and IRA expert in Brooklyn, N.Y. Once you move the pre-tax dollars (and earnings) into a 401(k), that leaves an IRA with no taxable income. “Convert it to a Roth; pay no tax,” Picker says."

-http://www.forbes.com/sites/ashleaebeling/2012/01/23/the-backdoor-roth-ira-advanced-version/

I did not have to worry about the pro rata rule so hopefully somebody else on here will tell you if this is accurate.

Good Luck

[archbish99]

1. What's the best way to simplify my portfolio so it better reflects a three-fund portfolio (total domestic, total international, total bond) without incurring large tax liabilities?

2. Should I move all my bonds into a retirement account since bonds aren't a tax-friendly investment? If so, how?

You'll probably want to consolidate the ShareBuilder and Lending Club money (as notes wind down, unless you can sell them at a good price) to Vanguard to reduce your number of accounts, except for the 5% "play money" you're allowing yourself.

As far as getting to a three-fund, we'll need two more pieces of information: the current capital gains in your taxable accounts per fund/stock, and the fund options in your 401k/403b. The ideal would be something like 30% Total International (preferably in taxable), 45% Total Stock (anywhere), and 20% Total Bond (preferably in tax-advantaged).

The reality will still be a little messy, for two reasons. First, if you have accumulated large capital gains, it may not be worth selling those in the taxable account. For example, if you have large gains on the S&P 500 fund, you might just get enough Extended Market in a different account to balance it (~80% S&P 500 + ~20% Extended Market makes Total Stock Market) rather than selling it. On the other hand, if you have losses, you can sell it for the tax benefit and buy Total Stock Market directly. Simpler.

Second, 401k and 403b plans will have more limited options, so you'll want to play to their strengths. Find the one or two best funds in them and allocate the rest of your accounts around those as far as possible. That's often an S&P 500 fund and a bond fund.

I'm also curious why you're not putting the maximum into the 403b plan when you've got the money (see taxable contribution) and you're in a high-tax state. It takes some truly awful fund choices to outweigh the tax benefit, and it looks like her plan has at least some decent choices.

3. Right now, I'm putting no money into any sort of IRA because our income level is too high for a Roth IRA and for the same reason there's no tax deduction for putting anything into a traditional IRA. But is there any advantage into putting money into a traditional IRA that I'm missing?

As others have noted, back-door Roth is your best bet. If your 401k options aren't bad, it might be worth moving the rollover TIRA into the 401k so you can take advantage of this option. Go ahead and make your 2012 contribution to a *separate* TIRA for each of you so you make it by the 2012 limit. Later, you can make your 2013 contributions and convert the lot.

[Ancal]

Thank you for all the incredibly helpful responses. I am much clearer about what I need to do now. I will probably not sell any of the taxable accounts (as I have gains in all of them), and instead try to "mimic" the total-market equivalents by reallocating. I will also try to up my bond percentage by investing in CA tax-exempt bonds.

I have three outstanding questions:

1. On the backdoor Roth, could I skip the complexity around "hiding" my tIRA by just opening a tIRA in my wife's name, making nondeductible contributions to that, then converting it to Roth? Is there a limit to how much money I could put in this?

2. Is there any advantage at all to contributing to a tIRA and keeping that money in the tIRA if contributions are not deductible?

3. I can buy and sell funds willy-nilly in the Roth IRA with no tax issues, right? (So if I want to reallocate funds to a three-fund portfolio in the Roth, there's nothing stopping me?)

Oh, and to answer the question about why my wife doesn't contribute the max to the 403b—bizarrely, her workplace only lets people allocate up to 7.5% of their income into the 403b. That sounds strange to me. Perhaps I should do some digging.

[archbish99]

Thank you for all the incredibly helpful responses. I am much clearer about what I need to do now. I will probably not sell any of the taxable accounts (as I have gains in all of them), and instead try to "mimic" the total-market equivalents by reallocating. I will also try to up my bond percentage by investing in CA tax-exempt bonds.

Double-check the actual cost basis on at least the bond fund, though. It's quite possible that the bulk of the "gain" in your head is actually the dividends you've already been taxed on, and the capital gain itself is small. I would stick with your current holdings if the actual unrealized gains are large, particularly if they're short-term, but if they're relatively small and long-term it's worth considering. In a high tax bracket, you may save money in the long run by taking the capital gain hit now vs. the ongoing tax on the distributions, though they're small in the current interest rate environment.

1. On the backdoor Roth, could I skip the complexity around "hiding" my tIRA by just opening a tIRA in my wife's name, making nondeductible contributions to that, then converting it to Roth? Is there a limit to how much money I could put in this?

For 2013, $5500/person. For 2012, $5000/person. You can definitely do it in your wife's name, but if you do one each you get twice the tax-advantaged space. Just depends how much that's worth to you (and how the 401k options are).

2. Is there any advantage at all to contributing to a tIRA and keeping that money in the tIRA if contributions are not deductible?

Debatable. Tax-deferral is a modestly good thing for bonds and a bad thing for stocks. Unless you're really stuck for tax-advantaged room (i.e. all tax-advantaged accounts are in bonds, you've bought the annual maximum in I-Bonds, and you still need more bonds), non-deductible contributions are generally worse than just a taxable account over the long run. You're not there yet.

3. I can buy and sell funds willy-nilly in the Roth IRA with no tax issues, right? (So if I want to reallocate funds to a three-fund portfolio in the Roth, there's nothing stopping me?)

Correct.

Oh, and to answer the question about why my wife doesn't contribute the max to the 403b—bizarrely, her workplace only lets people allocate up to 7.5% of their income into the 403b. That sounds strange to me. Perhaps I should do some digging.

Hm. Weird, but probably legitimate. Employers can impose their own maximums as well, but my current employer caps it at no more than 50% to Traditional and 50% to Roth, so it's pretty non-impactful. I'm sure there's someone part-time who wants to go 75% Traditional, but it's not a limit I'd ever dream of hitting.