Three Fund Portfolio over IRA and Taxable Accounts

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Three Fund Portfolio over IRA and Taxable Accounts

Postby Don46 » Fri May 03, 2013 9:28 pm

I'm planning on retiring within the next two years and will want to consolidate several IRA accounts into one that today amounts to about 1.75 million. I will also consolidate taxable accounts into one that now stands at about 2 million. 3.75 million total.
My idea is to put the IRA all into a Total Bond Index fund.
Then allocate my taxable account into Bond, Stock, International Index funds according to my overall allocation model.
In the taxable account I would bring my overall bond investment up to, say 66% and allocate the remainder to stocks and international according to the overall model.

Does this make sense?
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Re: Three Fund Portfolio over IRA and Taxable Accounts

Postby grabiner » Fri May 03, 2013 9:49 pm

This is a good plan. Since you are withdrawing money from these accounts, you save in taxed by withdrawing from a taxable stock fund rather than a bond fund. Qualified dividends on the stock funds are taxed at a lower rate (0% if you are in the 15% tax bracket, 15% in a higher bracket), and if you need more money from your taxable account, you can sell stock and pay tax at the capital-gains rate on only a portion of your withdrawals.

If you are in a 25% tax bracket (which might happen if you also have a pension or large Social Security benefit), consider municipal bonds rather than Total Bond Index for the taxable bond investment.
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Bond fund calculator

Postby Taylor Larimore » Fri May 03, 2013 10:09 pm

Hi Don:

I agree with Grabiner.

You will find this tax-equivalent yield calculator helpful in determining whether to use Total Bond Market or a tax-exempt bond fund with similar (credit & maturity) for bonds in the taxable account.

http://screen.morningstar.com/BondCalc/ ... alent.html

Come back if you have any questions.

Best wishes.
Taylor
"Simplicity is the master key to financial success." -- Jack Bogle
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Re: Three Fund Portfolio over IRA and Taxable Accounts

Postby Don46 » Sat May 04, 2013 11:29 am

If I understand the Required Minimum Dispersal RMD rules, in four years when I am 70.5 years old I have to begin drawing 1/17th (17 years life expectancy at age 70) of my (traditional) IRA assets that year, which will be around $100k. We will have about $80k coming in from SS for my wife and I and from her pension. We are in SC and some of the SS income is untaxed, but I expect we will wind up in the 25% federal tax bracket. I see what they mean by "tax deferred" accounts now!
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Re: Three Fund Portfolio over IRA and Taxable Accounts

Postby CABob » Sat May 04, 2013 11:48 am

Don46 wrote:If I understand the Required Minimum Dispersal RMD rules, in four years when I am 70.5 years old I have to begin drawing 1/17th (17 years life expectancy at age 70) of my (traditional) IRA assets that year, which will be around $100k. We will have about $80k coming in from SS for my wife and I and from her pension. We are in SC and some of the SS income is untaxed, but I expect we will wind up in the 25% federal tax bracket. I see what they mean by "tax deferred" accounts now!

You might want to check that life expectancy and withdrawal amount. The amount sounds high.
You should also be thinking about a withdrawal plan as far as what accounts to draw from and when. If your RMD amount is more than expenses you would then be adding to taxable accounts. Or being very generous to charities, family, etc.
Bob | An investment in knowledge pays the best interest. -- Benjamin Franklin
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Re: Three Fund Portfolio over IRA and Taxable Accounts

Postby Don46 » Sat May 04, 2013 4:57 pm

CABob wrote:You might want to check that life expectancy and withdrawal amount. The amount sounds high.
You should also be thinking about a withdrawal plan as far as what accounts to draw from and when. If your RMD amount is more than expenses you would then be adding to taxable accounts. Or being very generous to charities, family, etc.


I was looking at the IRS 2012 publication 590 http://www.irs.gov/pub/irs-pdf/p590.pdf
I must have been looking at the wrong table. The IRS gives me almost 27 years more to live after I hit 70.5!
Hmmmm, I'm not sure I want to live that long, but never mind.
So I withdraw 1/27 or about 3.7 percent of my IRA, which will be not far from $65k.
That will keep my tax bill down some.
It all seems immensely more complicated than it ought to be, but I'm finding my way forward.
Thanks
Don
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Re: Three Fund Portfolio over IRA and Taxable Accounts

Postby grabiner » Sat May 04, 2013 8:56 pm

Don46 wrote:
CABob wrote:You might want to check that life expectancy and withdrawal amount. The amount sounds high.
You should also be thinking about a withdrawal plan as far as what accounts to draw from and when. If your RMD amount is more than expenses you would then be adding to taxable accounts. Or being very generous to charities, family, etc.


I was looking at the IRS 2012 publication 590 http://www.irs.gov/pub/irs-pdf/p590.pdf
I must have been looking at the wrong table. The IRS gives me almost 27 years more to live after I hit 70.5!
Hmmmm, I'm not sure I want to live that long, but never mind.
So I withdraw 1/27 or about 3.7 percent of my IRA, which will be not far from $65k.


Withdrawing $65K from your IRA will make a full 85% of your Social Security taxable, even if you are married, so you will be in the 25% tax bracket, and munis will make sense for your taxable bonds then.

In fact, munis make sense if your total taxable income is in the 25% bracket, even if your ordinary income is in the 15% bracket and only qualified dividends and capital gains push your total income over. The reason is that your marginal tax rate is actually 30% in this situation; every additional $1 of income is taxed at 15%, but it also pushes $1 of qualified dividends from the 0% to the 15% tax rate (from the 15% to the 25% tax bracket).

For similar reasons, you may want to use your large taxable account to convert some of your Traditional IRA to a Roth, but you should only do this up to the top of the 15% total taxable income bracket; it isn't worth paying 30% tax now to avoid paying 25% tax later. You might even buy munis in the 15% tax bracket, and take advantage of the additional tax-free income to do a larger IRA conversion up to the top of the 15% bracket; you would then be holding munis instead of bonds taxed at a marginal rate of 30%.
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Re: Three Fund Portfolio over IRA and Taxable Accounts

Postby bsteiner » Sat May 04, 2013 10:41 pm

grabiner wrote:... you may want to use your large taxable account to convert some of your Traditional IRA to a Roth, but you should only do this up to the top of the 15% total taxable income bracket; it isn't worth paying 30% tax now to avoid paying 25% tax later.


There are other benefits to the Roth conversion. One principal benefit is that, assuming you have other money with which to pay the tax on the conversion, you're effectively shifting more assets into a tax-free environment. The other is that there are no required distributions from a Roth after age 70 1/2. Therefore, the Roth conversion generally makes sense to the extent you can convert at a tax rate less than, equal to, or even somewhat higher (but not too much higher) than the tax rate that would otherwise apply to the distributions.

It may be worth creating a spreadsheet to analyze whether it's worth converting at 30% if the distributions would otherwise be taxable at 25%. To do so, you would have to make some reasonable assumptions at to the rate of return in the IRA, and the after-tax rate of return in the taxable account.
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Re: Three Fund Portfolio over IRA and Taxable Accounts

Postby Don46 » Sun May 05, 2013 12:16 pm

grabiner wrote:Withdrawing $65K from your IRA will make a full 85% of your Social Security taxable, even if you are married, so you will be in the 25% tax bracket, and munis will make sense for your taxable bonds then.

In fact, munis make sense if your total taxable income is in the 25% bracket, even if your ordinary income is in the 15% bracket and only qualified dividends and capital gains push your total income over. The reason is that your marginal tax rate is actually 30% in this situation; every additional $1 of income is taxed at 15%, but it also pushes $1 of qualified dividends from the 0% to the 15% tax rate (from the 15% to the 25% tax bracket).

For similar reasons, you may want to use your large taxable account to convert some of your Traditional IRA to a Roth, but you should only do this up to the top of the 15% total taxable income bracket; it isn't worth paying 30% tax now to avoid paying 25% tax later. You might even buy munis in the 15% tax bracket, and take advantage of the additional tax-free income to do a larger IRA conversion up to the top of the 15% bracket; you would then be holding munis instead of bonds taxed at a marginal rate of 30%.


My plan is to use the IRA for most of my bond investments. It would not make sense to use an IRA for tax exempt investments.
I can see I have a lot to learn about post retirement taxes and social security taxation in particular. Here is where I throw up my hands and ask for advice from my accountant.
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Re: Three Fund Portfolio over IRA and Taxable Accounts

Postby Calm Man » Sun May 05, 2013 1:38 pm

Don46 wrote:
CABob wrote:You might want to check that life expectancy and withdrawal amount. The amount sounds high.
You should also be thinking about a withdrawal plan as far as what accounts to draw from and when. If your RMD amount is more than expenses you would then be adding to taxable accounts. Or being very generous to charities, family, etc.


I was looking at the IRS 2012 publication 590 http://www.irs.gov/pub/irs-pdf/p590.pdf
I must have been looking at the wrong table. The IRS gives me almost 27 years more to live after I hit 70.5!
Hmmmm, I'm not sure I want to live that long, but never mind.
So I withdraw 1/27 or about 3.7 percent of my IRA, which will be not far from $65k.
That will keep my tax bill down some.
It all seems immensely more complicated than it ought to be, but I'm finding my way forward.
Thanks
Don


Don, the 1/27 of the first year becomes a smaller fraction every year although I am personally hoping my life expectancy in terms of future years will always stay the same. So if the portfolio grows, you will see larger and larger RMDs as the years go by. I notice that with my parents RMDs; they are in the 80s.
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Re: Three Fund Portfolio over IRA and Taxable Accounts

Postby Don46 » Sun May 05, 2013 3:38 pm

Calm Man wrote:Don, the 1/27 of the first year becomes a smaller fraction every year although I am personally hoping my life expectancy in terms of future years will always stay the same. So if the portfolio grows, you will see larger and larger RMDs as the years go by. I notice that with my parents RMDs; they are in the 80s.


How do people keep track of all this as they age, I wonder?
Jack Bogle brings us the majesty of simplicity in investing for retirement but where is the simplicity in the rest of all this?!
Thanks for the warning Calm Man
--Don
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Re: Bond fund calculator

Postby CashIsKing » Wed May 15, 2013 12:10 pm

Taylor Larimore wrote:Hi Don:

I agree with Grabiner.

You will find this tax-equivalent yield calculator helpful in determining whether to use Total Bond Market or a tax-exempt bond fund with similar (credit & maturity) for bonds in the taxable account.

http://screen.morningstar.com/BondCalc/ ... alent.html

Come back if you have any questions.

Best wishes.
Taylor


I used the bond calculator, and found to my naive surprise, that even without considering the tax consequences, Vanguard Intermediate-Term Tax-Exempt Fund Admiral Shares (VWIUX) currently has higher returns & yield than Vanguard Total Bond (BND.) I guess I always assumed tax-free would have lower nominal returns than taxable, given similar credit & maturity characteristics. I currently have a 50/50 allocation between stocks & bonds. I cannot put anymore into my tax-advantaged plans. I have about $150000.00 in taxable bond funds (That's another story, but I need to consolidate a few bond funds into one.) That leads me to my first question: Given the bond calc. results, I'm considering moving all my taxable bond money into VWIUX. I just want to make sure I'm not mixing my oranges with tangerines. I see differences in the specific fund characteristics, BUT their fund-style boxes are the same. Is that adequate "proof" that they are similar enough? My second question sounds goofy even to me: If the answer to the above question happens to be "yes," then why wouldn't one move their tax deferred money into VWIUX? If the nominal yield is higher than, say, BND, and has better trailing returns, then why not? It's very counter-intuitive, and I know the knowledge people here will have answers. My more important, practical question is the first one; the second question is more for my financial edification. I have lots more questions, but I'll try to spread them out and ask them in the appropriate forums.
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Re: Three Fund Portfolio over IRA and Taxable Accounts

Postby tomd37 » Wed May 15, 2013 1:01 pm

Don,

If I interpret Table III of IRS Publication 590 correctly, and assuming you meet the qualifications at the top of that table, your RMD withdrawal rates for various ages would be approximately

Age 70 3.65%
Age 75 4.37%
Age 80 5.35%
Age 85 6.76%
Age 90 8.77%
Age 95 11.63%

Withdrawal factors are divided into the previous year's IRA balance and your age is based on your age at the end of the given withdrawal year.
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