Asset Allocation Help / Placement of Funds for Tax Purposes

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Topic Author
mkinvestor
Posts: 21
Joined: Mon Aug 11, 2014 10:58 am

Asset Allocation Help / Placement of Funds for Tax Purposes

Post by mkinvestor »

Hi,
We are planning to move all of our investments from an actively managed portfolio to a passive 3-fund strategy based on the Bogleheads philosophy. Our assets are currently held in a managed account at MorganStanley. We plan to open an account with Vanguard soon and move the funds over in order to begin this strategy. I’d like some help/validation with the asset allocation and plan, specifically in which accounts we should hold which funds for tax purposes.

We have calculated and are planning for the capital gains taxes that will be generated when we sell the managed funds in our taxable account in order to start this plan.

We are fairly aggressive investors and are accustomed to saving a lot and living well below our means. We plan to retire in approx. 15-20 years.

Here is where we currently stand:
Emergency funds: 3 months in checking account
Debt : $170k on house
Tax filing status : Married
Tax rate : 28% Federal and 4.25% State
State of Residence: MI
Age: 38
Spouse Age: 32
Desired Allocation : 80% Stocks (70% US, 30% Int’l), 20% US Bonds.

Retirement Assets (IRAs, Taxable Acct, and His 401k are in managed funds now – plan to move to all index funds, so I’m not listing our current positions):
His 401k: $462k (26,250 annual contrib incl employer match)
His Roth IRA: $112k (5,500 annual contrib)
Her 401k: $187k
Her Roth 401k: $23k (24,220 annual contrib incl employer match)
Her Roth IRA: $106k (5,500 annual contrib)
Taxable: $295k (31,000 annual contrib)

Main limiting factor is His 401k, which is the biggest chunk of money, but only offers 1 index fund on the S&P 500. Her 401k offers Vanguard Target Retirement Date funds plus a few other index fund options.

Here’s my plan so far:
His 401k: $462k in T. Rowe Price Equity Index 500 (PREIX)
His Roth IRA: $112k in Vanguard Total Bond Market Index (VBTLX)
Her 401k: $127k in Vanguard Target Retirement Fund 2045 (VTIVX), $60k in BlackRock MSCI ACWI Ex-US (BDOAX)
Her Roth 401k: $23k in Vanguard Target Retirement Fund 2045 (VTIVX)
Her Roth IRA: $106k in Vanguard Total Bond Market Index (VBTLX)
Taxable: $190k in Vanguard Total International Stock Index Fund (VTIAX), $105k in Vanguard Extended Market Index Fund (VEXAX)

Alternate Index Fund choices in her 401k (aside from the Target Retirement Dates funds) are:
NTGI Aggregate Bond Index NL
DFA Inflation-Protected Securities Portfolio
SSgA US Total Market Index

Any thoughts – good, bad, or otherwise on the allocation or placement of these funds for tax purposes?

Thanks!
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kenyan
Posts: 3015
Joined: Wed Jan 12, 2011 11:16 pm

Re: Asset Allocation Help / Placement of Funds for Tax Purpo

Post by kenyan »

Looks like a very sound plan. The Target Retirement funds make it a little more complicated, but since you're going with 3-fund, it shouldn't be that difficult to manage.

A couple of other options you could look at for more tax efficiency -

Series I savings bonds to replace some of your taxable investments (would count as bonds in your AA, naturally).
After-Tax contributions to either of your 401k plans, if available - the "Mega Backdoor Roth"

Also, you could look at 'tax-adjusting' your asset allocation, as you have large portions of pretax, Roth, and taxable. There is a page in the wiki on it. Generally, you weight everything by their post-tax values, so your Roth accounts are correspondingly more valuable by whatever factor you estimate (retirement tax rate). I tend to lean toward it being more work than it's worth, but you could look at it.
Retirement investing is a marathon.
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ruralavalon
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Joined: Sat Feb 02, 2008 9:29 am
Location: Illinois

Re: Asset Allocation Help / Placement of Funds for Tax Purpo

Post by ruralavalon »

His 401k: $462k (26,250 annual contrib incl employer match; 28% of annual contributions)
His Roth IRA: $112k (5,500 annual contrib; 06% of annual contributions)
Her 401k: $187k
Her Roth 401k: $23k (24,220 annual contrib incl employer match; 26% of annual contributions)
Her Roth IRA: $106k (5,500 annual contrib; 06% of annual contributions)
Taxable: $295k (31,000 annual contrib; 34% of annual contributions)

Desired Allocation 80% Stocks (70% US, 30% Int’l), 20% US Bonds; $1,185k total portfolio; $92k annual contributions.

I would move extended market out of taxable and replace with total market, for better tax efficiency. I would not use the TR funds, they just make it harder to keep track of your asset allocation and usually have expense ratios that are a bit higher. I would put as much of the bond allocation as possible in her traditional 401k, and because Roth withdrawals will be tax free use the Roths as much as possible for stock index funds with their higher expected returns.

. .. . .

Here’s an alternative plan, all percentages and dollar amounts are rounded off:

His 401k ($462k, 39% of portfolio, 28% of new ann. contrib.)
$462k (39%) in T. Rowe Price Equity Index 500 (PREIX)

His Roth IRA ($112k, 09% of portfolio, 06% of new ann. contrib.)
$50k (04%) in Vanguard Total Bond Market Index (VBTLX);
$50k (04%) in Vanguard Total International Stock Index Fund (VTIAX);
$12k (01%) in Vanguard Total Stock Index Fund (VTSAX)

Her 401k ($187k, 16% of portfolio)
$187k (16%) in NTGI Aggregate Bond Index NL, <= tracks Barclays US Capital Aggregate Bond Index, same as VBTLX

Her Roth 401k ($23k, 02% of portfolio, 26% of new ann. contrib.)
$23k (02%) in Vanguard Total International Stock Index Fund (VTIAX)

Her Roth IRA ($106k, 09% of portfolio, 06% of new ann. contrib)
$106k (09%) in Vanguard Extended Market Index Fund (VEXAX), <= 1:4 ratio with the S&P 500 in his 401k, to approximate total stock market

Taxable account ($295k, 25% of portfolio, 34% of new ann. contrib)
$177k (15%) in Vanguard Total International Stock Index Fund (VTIAX);
$118k (10%) in Vanguard Total Stock Index Fund (VTSAX)

. . . . .

As mentioned by Kenyan, you can use some of the ongoing annual "taxable" contributions ($20k/yr; 22% of annual contributions) to buy I-bonds (and help free-up the Roth space for use by stock index funds with their higher expected returns). Please see: wiki article, "I savings bonds". "Interest from I Bonds accumulates tax-deferred for up to 30 years. (I Bonds do not distribute interest like CDs and other bonds do.) "
"Everything should be as simple as it is, but not simpler." - Albert Einstein | Wiki article link: Bogleheads® investment philosophy
Topic Author
mkinvestor
Posts: 21
Joined: Mon Aug 11, 2014 10:58 am

Re: Asset Allocation Help / Placement of Funds for Tax Purpo

Post by mkinvestor »

Wow, this is great advice. Thank you so much! There may not be a simple answer to this, but I'll ask anyway: For long term investing in a taxable account, how does the real return of I-bonds compare with a Total Bond Market Index like VBTLX?
dickenjb
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Joined: Tue Jan 05, 2010 12:11 pm
Location: Philadelphia PA

Re: Asset Allocation Help / Placement of Funds for Tax Purpo

Post by dickenjb »

mkinvestor wrote:Wow, this is great advice. Thank you so much! There may not be a simple answer to this, but I'll ask anyway: For long term investing in a taxable account, how does the real return of I-bonds compare with a Total Bond Market Index like VBTLX?
Some say similar. Others say because I bonds offer less risk as they are inflation hedged, they should offer slightly lower returns. Actually they say this about TIPS, not I bonds but the two are similar. I bonds aren't sold at auction like TIPS so maybe what applies to TIPS doesn't apply.
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kenyan
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Joined: Wed Jan 12, 2011 11:16 pm

Re: Asset Allocation Help / Placement of Funds for Tax Purpo

Post by kenyan »

mkinvestor wrote:Wow, this is great advice. Thank you so much! There may not be a simple answer to this, but I'll ask anyway: For long term investing in a taxable account, how does the real return of I-bonds compare with a Total Bond Market Index like VBTLX?
As noted, I bonds are not marketable securities, so it's perfectly rational for them to offer superior risk/return combinations to what you can purchase in the market (TIPS, nominal bonds, etc). I bonds cannot lose value, even temporarily, unlike other types of bonds. You have to pay a small penalty if you redeem them between 1-5 years, but after that, they ofter real (pre-tax) return with no downside risk.

I bonds purchased early last decade continue to earn fabulous returns with no risk (fixed rate 3+ percent, on top of the inflation component). Today, you'll earn 0.1% plus the inflation component. Doesn't sound great, but you have to go out to a 9-year TIPS before you earn a yield that 'high,' and suffer the tax consequences as well. Vanguard's TIPS fund Admiral Shares, VAIPX, has a duration of 7.9 years (longer than intermediate bond funds like Total Bond Market), and a real yield of -0.20%, so the market expectation for I bonds at +0.10% real is to outperform most bond funds prior to taking tax advantage into account.
Retirement investing is a marathon.
Topic Author
mkinvestor
Posts: 21
Joined: Mon Aug 11, 2014 10:58 am

Re: Asset Allocation Help / Placement of Funds for Tax Purpo

Post by mkinvestor »

Thanks for all your help everyone. I think I might go with a combo of an intermediate-term tax-exempt bond fund in my taxable account as well as possibly adding some I-bonds in order to free up the investing space in His Roth IRA for equities.
Topic Author
mkinvestor
Posts: 21
Joined: Mon Aug 11, 2014 10:58 am

Re: Asset Allocation Help / Placement of Funds for Tax Purpo

Post by mkinvestor »

I revised this a bit based on some additional advice/research on tax-exempt bond funds in taxable accounts and would like to submit for thoughts one more time before we implement this plan:

His 401k ($462k, 39% of portfolio, 28% of new ann. contrib.)
$462k (39%) in T. Rowe Price Equity Index 500 (PREIX)

His Roth IRA ($112k, 9% of portfolio, 6% of new ann. contrib.)
$112k (9%) in Vanguard Total International Stock Index Fund (VTIAX);

Her 401k ($187k, 16% of portfolio)
$187k (16%) in NTGI Aggregate Bond Index NL

Her Roth 401k ($23k, 2% of portfolio, 26% of new ann. contrib.)
$23k (2%) in Vanguard Total International Stock Index Fund (VTIAX)

Her Roth IRA ($106k, 9% of portfolio, 06% of new ann. contrib)
$106k (9%) in Vanguard Extended Market Index Fund (VEXAX), <= 1:4 ratio with the S&P 500 in his 401k, to approximate total stock market

Taxable account ($295k, 25% of portfolio, 34% of new ann. contrib)
$155k (13%) in Vanguard Total International Stock Index Fund (VTIAX);
$90k (8%) in Vanguard Total Stock Index Fund (VTSAX)
$50k (4%) in Vanguard Intermediate-Term Tax-Exempt Fund (VWIUX)

How does that look? Any tweaks or recommendations?

Thanks!
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