Tax Efficient Fund Placement Question

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BSA44
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Joined: Wed Jul 31, 2013 6:43 pm

Tax Efficient Fund Placement Question

Post by BSA44 »

I read the great Wiki on tax efficient fund placement (http://www.bogleheads.org/wiki/Principl ... _Placement), but I have some follow-up questions to it.

The Wiki suggested first (Step 2) placing tax inefficient funds in a tax advantaged account (401k & Roth IRA). Then (Step 4), it was suggested that high growth funds should be placed in a Roth IRA. I have similarly read elsewhere that if you are investing for the long term (I am 25) it makes sense to put the high growth funds in the Roth IRA, so that you can maximize the amount in your Roth account. I imagine there is some trade-off level where if the tax difference between your most tax efficient and tax inefficient funds are minimal, it probably makes more sense to put your high growth funds (even though they may be more tax efficient) into the Roth IRA, so that they have more room to grow. I am not clear on how to determine that.

I am currently maxing out my 401k, Roth IRA, and have a bunch left over in a taxable brokerage account (I am lucky due to a recent windfall). My overall asset allocation is 90% Stocks (66% US, 33% International) and 10% bonds (66% US, 33% International) of the four ETFs below. Given that it will be about 40 years until I retire, which funds should I first allocate to my Roth IRA and 401k? Should I put the US bond fund in both first to minimize my taxes, or put my US stock fund in so that the tax advantaged accounts can grow more quickly? Note: My Roth IRA and 401k are both relatively new and my taxable account balance is high enough that my Roth IRA and 401k together only make up about 10% of my portfolio (i.e., I could almost fill them both entirely with just bond funds and still not deviate from my desired asset allocation).

VEU VANGUARD FTSE ALL WORLD EX US ETF
BND VANGUARD TOTAL BOND MARKET ETF
BNDX VANGUARD TOTAL INTL BOND INDEX ETF
VTI VANGUARD TOTAL STOCK MARKET ETF

I would be glad to clarify if you have any questions. Thank you for your help.
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Taylor Larimore
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Re: Tax Efficient Fund Placement Question

Post by Taylor Larimore »

Andrew:

Welcome to the Bogleheads Forum!

Your biggest decision, by far, is to put only tax-efficient funds into your taxable account.

The secondary decision which is much less important, is which tax-advantaged account will hold your remaining funds? There is no easy answer, in part, because we don't know our future income or changing tax-law. Also, it probably won't make much difference about fund placement between tax-advantaged accounts.

Your two taxable bond funds should go into your tax-advantaged accounts. Your 10% bond allocation will almost exactly fill both of them. If you need more bonds than the capacity of your IRA and 401K, use a tax-exempt bond fund in your taxable account.

Best wishes.
Taylor
"Simplicity is the master key to financial success." -- Jack Bogle
JJP
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Re: Tax Efficient Fund Placement Question

Post by JJP »

Is it true that Vanguard will not let you place ETFs in IRAs and you must go for the mutual fund replacement?
Topic Author
BSA44
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Re: Tax Efficient Fund Placement Question

Post by BSA44 »

JJP wrote:Is it true that Vanguard will not let you place ETFs in IRAs and you must go for the mutual fund replacement?
I have ETFs in my Roth IRA currently. Vanguard won't let me place ETFs in my 403b/401k, so I would have to use the mutual fund replacement.
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grabiner
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Re: Tax Efficient Fund Placement Question

Post by grabiner »

Welcome to the forum!
Andrew0504 wrote:The Wiki suggested first (Step 2) placing tax inefficient funds in a tax advantaged account (401k & Roth IRA). Then (Step 4), it was suggested that high growth funds should be placed in a Roth IRA.
The reason that the steps are in this order is that putting the right funds in tax-advantaged accounts is more important. The decision of what to place in the 401(k) and what to place in the Roth makes much less of a difference, and if you have different options in the 401(k) and Roth, that would be a more important consideration. (For example, if your 401(k) has better stock funds than bond funds, it's better to hold the stock funds in the 401(k).)
My overall asset allocation is 90% Stocks (66% US, 33% International) and 10% bonds (66% US, 33% International) of the four ETFs below. Given that it will be about 40 years until I retire, which funds should I first allocate to my Roth IRA and 401k? Should I put the US bond fund in both first to minimize my taxes, or put my US stock fund in so that the tax advantaged accounts can grow more quickly? Note: My Roth IRA and 401k are both relatively new and my taxable account balance is high enough that my Roth IRA and 401k together only make up about 10% of my portfolio (i.e., I could almost fill them both entirely with just bond funds and still not deviate from my desired asset allocation).

VEU VANGUARD FTSE ALL WORLD EX US ETF
BND VANGUARD TOTAL BOND MARKET ETF
BNDX VANGUARD TOTAL INTL BOND INDEX ETF
VTI VANGUARD TOTAL STOCK MARKET ETF
I would put the bond funds in the Roth IRA and 401(k) if the options are available.

You might also want to use VXUS (Total International) rather than VEU; VXUS includes small-caps, so it is the international equivalent to VTI.

If your Roth IRA and 401(k) get larger than your bond allocation, it is usually slightly better to put US stocks rather than foreign stocks in tax-deferred, because of the foreign tax credit.

Conversely, if your bond allocation is larger than your Roth IRA and 401(k), you probably want to hold municipal bonds for the taxable bond allocation; Intermediate-Term Tax-Exempt is the closest equivalent to your taxable funds. (Vanguard does not yet have a muni ETF, and the non-Vanguard muni ETFs are more expensive than Vanguard's funds.)
Wiki David Grabiner
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ruralavalon
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Re: Tax Efficient Fund Placement Question

Post by ruralavalon »

JJP wrote:Is it true that Vanguard will not let you place ETFs in IRAs and you must go for the mutual fund replacement?
No. You can hold ETFs in a Vanguard IRA.

You will need to ask for a brokerage feature to be added to your IRA, but they will do that.
"Everything should be as simple as it is, but not simpler." - Albert Einstein | Wiki article link: Bogleheads® investment philosophy
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