Given low rates, more tax efficient to tax shelter stocks?

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badbear
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Given low rates, more tax efficient to tax shelter stocks?

Post by badbear »

This morning I saw this blog post in my feed, from our own tfb:
http://thefinancebuff.com/tax-efficienc ... olute.html

The gist of the article is that given the current interest rate environment, it may actually be more tax efficient to put your stock funds in your tax-deferred accounts. Once interest rates finally rise, bond funds will have a capital loss and the switch back to bonds in tax-deferred would be painless. What are your thoughts on this strategy?

Cheers!
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Re: Given low rates, more tax efficient to tax shelter stock

Post by dickenjb »

Interesting read. I suppose if one were to do this, it might make more sense to buy VWITX in taxable yielding 1.67% (before tax and after tax) than VBTLX yielding 1.69 before tax (and less AT).
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Doc
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Re: Given low rates, more tax efficient to tax shelter stock

Post by Doc »

badbear wrote:This morning I saw this blog post in my feed, from our own tfb:
http://thefinancebuff.com/tax-efficienc ... olute.html

The gist of the article is that given the current interest rate environment, it may actually be more tax efficient to put your stock funds in your tax-deferred accounts. Once interest rates finally rise, bond funds will have a capital loss and the switch back to bonds in tax-deferred would be painless. What are your thoughts on this strategy?

Cheers!
Yep. Been saying it for a long time but it's "heresy" so no one cares. :happy

The problem is that if you are sitting on a lot of appreciated stock in your taxable account it may be hard to get yourself out of the hole but at least you could stop digging.
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Re: Given low rates, more tax efficient to tax shelter stock

Post by Sidney »

Our equity will go to others when we are gone (or we will give it away while in the departure lounge) so I don't see a change making sense for me personally. Appreciated stock makes good tax deductions to offset tax on RMDs from IRAs.
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Re: Given low rates, more tax efficient to tax shelter stock

Post by Easy Rhino »

That's interesting. The trickiest part to me would be that the assumption that stocks are going to return 7%.

also, does it take into account the compounding feature? stocks are going to have relatively modest dividend distributions during their life, which would further their tax efficiency if held for the long term. There's also the wildcard of tax rates being lower in retirement than during employment (not due to tax changes, but due to having a 0% bracket to take distrbutions from)
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interplanetjanet
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Re: Given low rates, more tax efficient to tax shelter stock

Post by interplanetjanet »

Doc wrote:Yep. Been saying it for a long time but it's "heresy" so no one cares. :happy

The problem is that if you are sitting on a lot of appreciated stock in your taxable account it may be hard to get yourself out of the hole but at least you could stop digging.
I take this approach as well, using mostly munis in taxable. After doing the math I had come to the same conclusion.

-janet
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Re: Given low rates, more tax efficient to tax shelter stock

Post by interplanetjanet »

Easy Rhino wrote:That's interesting. The trickiest part to me would be that the assumption that stocks are going to return 7%.
Well, at least that's 7% nominal, not real - if inflation runs around 2-3%, that's 4-5% real growth which doesn't seem out of line.
also, does it take into account the compounding feature? stocks are going to have relatively modest dividend distributions during their life, which would further their tax efficiency if held for the long term.
Not sure what you mean here.
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Re: Given low rates, more tax efficient to tax shelter stock

Post by Doc »

interplanetjanet wrote:
Easy Rhino wrote:That's interesting. The trickiest part to me would be that the assumption that stocks are going to return 7%.
Well, at least that's 7% nominal, not real - if inflation runs around 2-3%, that's 4-5% real growth which doesn't seem out of line.
also, does it take into account the compounding feature? stocks are going to have relatively modest dividend distributions during their life, which would further their tax efficiency if held for the long term.
Not sure what you mean here.
I assume that TFB's 7% is the same compound rate of return including both price and dividends that we are all use to seeing in growth charts. Whether the dividend rate is 1 or 2 or 3% of the 7% makes very little difference given the fact that we are not even very sure of the 7% in the first place.
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Re: Given low rates, more tax efficient to tax shelter stock

Post by tfb »

badbear wrote:This morning I saw this blog post in my feed, from our own tfb:
http://thefinancebuff.com/tax-efficienc ... olute.html
Thank you for bringing it for discussion here. I appreciate the feedback.
dickenjb wrote:Interesting read. I suppose if one were to do this, it might make more sense to buy VWITX in taxable yielding 1.67% (before tax and after tax) than VBTLX yielding 1.69 before tax (and less AT).
Yes, once you show taxable bonds are more tax efficient than stocks, tax exempt bonds are even more so. There are many opportunities to earn more than taxable bonds. Buying tax exempt bonds is one. Buying I Bonds is another. I'm documenting these one at a time. I already have four or five lined up.
Doc wrote:Yep. Been saying it for a long time but it's "heresy" so no one cares.

The problem is that if you are sitting on a lot of appreciated stock in your taxable account it may be hard to get yourself out of the hole but at least you could stop digging.
I also said it here before. I figure "heresy" needs repeating a few more times before it gets accepted. Stop digging is exactly what I suggested.

Yes the 7% used in the article is nominal, including both dividends and price appreciation.
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Don Christy
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Re: Given low rates, more tax efficient to tax shelter stock

Post by Don Christy »

I'm trying to assess whether this approach makes sense for me and have started a thread in the "Help with Personal Investment Forum."

Anyone interested in exploring a specific example or providing guidance on framing the analysis, please visit this thread:
http://www.bogleheads.org/forum/viewtop ... 1&t=104265

thanks!
Don
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badbear
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Re: Given low rates, more tax efficient to tax shelter stock

Post by badbear »

Having thought about this a bit, it occurs to me that one of the major costs of holding your stocks in taxable counts is the capital gains cost of rebalancing once your stocks have grown significantly. This could perhaps be offset by rebalancing with new contributions, and to some extent by tax loss harvesting, but it would likely be significant no matter what in a bull market if your holdings are a lot bigger than your annual contributions.

I did some calculations on this. At 2012 tax rates, people in the 15% tax bracket or less can rebalance annually for free. In every higher tax bracket, costs of rebalancing from stocks in your taxable account could easily swamp the tax cost for bond dividends in that same bracket. In every higher tax bracket capital gains tax from rebalancing would be the dominant cost.

So it seems like it would make sense to hold stocks in your tax sheltered accounts and doing your rebalancing from them into bonds when the stocks have done well. At the same time you probably want to have enough bonds in a tax shelter that you could rebalance during a recession. You could do this by exchanging from munis to stocks in your taxable account, I guess, but then you are somewhat less tax efficient than you want to be if rates are still low. I feel like there will be a lot of peculiarities to how people will want to do this depending on the relative size of the taxable and tax-advantaged accounts and their desired AA. It might be as simple as assuming a more aggressive AA in your tax-advantaged accounts and a more conservative one in your taxable accounts, such that it averages out to your desired AA. This would give you the most flexibility in doing your rebalancing.

As long as you can rebalance in tax-advantaged, when rates are low it may just become less important whether you have bonds in taxable or tax-advantaged. Another thing to consider is how much more risk are you taking on by holding munis rather than say, Total Bond Market? My inclination is that I want to hold both.
Last edited by badbear on Mon Oct 15, 2012 11:32 pm, edited 1 time in total.
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Taylor Larimore
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Switching from traditional stock bond locations ?

Post by Taylor Larimore »

Bogleheads:

Traditional fund location calls for "taxable bonds in tax-advantaged accounts and tax-efficient stock index funds in taxable accounts." Below are three studies (and one article) that support this advice:

Optimal Asset Location and Allocation with Taxable and Tax-Deferred Investing

Tax-Efficient Saving and Investing by William Reichenstein

Asset Location for Taxable Investors by Vanguard Investment Counseling & Research

What Goes Where? The Art of Asset Location

In my opinion, Bogleheads should be slow to switch from the traditional recommendations of "taxable bonds in tax-advantaged accounts and tax-efficient stock index funds in taxable accounts." Here's why:

* Selling profitable stocks in a taxable account will trigger capital gains.
* Selling bonds in tax-deferred accounts will trigger income tax on withdrawals and possible penalties.
* When bond yields rise, it will be costly again to switch back to the traditional recommendations.

Best wishes.
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baw703916
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Re: Given low rates, more tax efficient to tax shelter stock

Post by baw703916 »

Why is this discussion focused on taxable bonds in taxable accounts, as opposed to tax-exempt bonds?

TE bonds pretty much have to provide a better after-tax return in taxable accounts, at least for investors in the highest tax bracket. If they didn't nobody would have any reason to buy them.

Consider the following allocations (admiral shares, fund info as of 10/15/12):

Portfolio 1
TSM in taxable (2.04% SEC yield, 100% QDI)
TBM in tax-advantaged (1.69% SEC yield, 5.0 years duration)

Portfolio 2
Intermediate Term TE (VWIUX) in taxable (1.67% SEC yield, 4.9 years average duration)
TSM in tax-advantaged

Portfolio 1 has 30 bp of tax cost on the equities (assuming 15% QDI rate), and 2 bp higher yield on the bond portion. So I maintain that Portfolio 2 comes out ahead.
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Re: Given low rates, more tax efficient to tax shelter stock

Post by tfb »

Taylor Larimore wrote:* Selling profitable stocks in a taxable account will trigger capital gains.
* Selling bonds in tax-deferred accounts will trigger income tax on withdrawals and possible penalties.
I'm not suggesting either. Only buy bonds with new cash added to the taxable account. No triggering capital gains. No withdrawals from tax deferred accounts.
Taylor Larimore wrote:* When bond yields rise, it will be costly again to switch back to the traditional recommendations.
Not costly at all because you get a natural tax loss harvest.
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Re: Given low rates, more tax efficient to tax shelter stock

Post by tfb »

baw703916 wrote:Why is this discussion focused on taxable bonds in taxable accounts, as opposed to tax-exempt bonds?
Because after we show B > A, it would be easier to show C > B > A.
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Re: Switching from traditional stock bond locations ?

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Taylor Larimore wrote:Bogleheads:

Traditional fund location calls for "taxable bonds in tax-advantaged accounts and tax-efficient stock index funds in taxable accounts." Below are three studies (and one article) that support this advice:

Optimal Asset Location and Allocation with Taxable and Tax-Deferred Investing

Tax-Efficient Saving and Investing by William Reichenstein

Asset Location for Taxable Investors by Vanguard Investment Counseling & Research

What Goes Where? The Art of Asset Location
I should note all these studies were done when interest rates were much higher. The traditional strategy was correct when interest rates were higher. When the assumptions in the studies change, the conclusion will also change.
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Re: Switching from traditional stock bond locations ?

Post by baw703916 »

tfb wrote:
Taylor Larimore wrote:Bogleheads:

Traditional fund location calls for "taxable bonds in tax-advantaged accounts and tax-efficient stock index funds in taxable accounts." Below are three studies (and one article) that support this advice:

Optimal Asset Location and Allocation with Taxable and Tax-Deferred Investing

Tax-Efficient Saving and Investing by William Reichenstein

Asset Location for Taxable Investors by Vanguard Investment Counseling & Research

What Goes Where? The Art of Asset Location
I should note all these studies were done when interest rates were much higher. The traditional strategy was correct when interest rates were higher. When the assumptions in the studies change, the conclusion will also change.
I agree. To be able to conclude anything, a study must make some assumptions. Nothing wrong with that, but when analyzing the conclusions, it's important to ask whether the assumptions are accurate in the present moment. With respect to tax-exempt bonds, the first paper concludes that they are sub-optimal compared to taxable bonds in a tax-advantaged account--but makes the assumption that tax-exempt bonds always pay 20% lower interest rates than equivalent taxable bonds. That has been true historically, but isn't now.

And of course, revisions in the tax code could change things.
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Re: Given low rates, more tax efficient to tax shelter stock

Post by White Coat Investor »

Interesting topic. Irrelevant to me, but interesting none the less. I'm always surprised to learn just how many people have a taxable account. I have a hard time maxing out tax protected options, and I know I have a higher income than the vast majority of Americans. Even if all you had was a 401K, a couple of Roth IRAs, and a 529 or two, how many people really make enough to max those out and still have a significant taxable account? I had one for a while, but when more tax-protected accounts became available to me I gradually converted the money from taxable to tax protected.
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Re: Given low rates, more tax efficient to tax shelter stock

Post by xram »

If circumstances are able to change such that the correct strategy might change as well,...why not split the difference between the two viewpoints and have both taxable and tax-advantaged filled with your AA? In other words, have 60% stocks/40%bonds in taxable and 60% stocks/40% bonds in tax-advantaged as well? Just a simple thought...I am no expert on this subject. Thanks. -xram
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Re: Given low rates, more tax efficient to tax shelter stock

Post by Wagnerjb »

EmergDoc wrote: Even if all you had was a 401K, a couple of Roth IRAs, and a 529 or two, how many people really make enough to max those out and still have a significant taxable account?
If you inherit money, it goes into a taxable account...so you don't necessarily need a high income. In addition, I suspect older investors have larger taxable accounts if they started investing before the 401k and IRA were created (not totally positive of the facts, but I don't think these have been around for more than maybe 30-40 years).

Best wishes.
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Re: Given low rates, more tax efficient to tax shelter stock

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EmergDoc wrote:Interesting topic. Irrelevant to me, but interesting none the less. I'm always surprised to learn just how many people have a taxable account. I have a hard time maxing out tax protected options, and I know I have a higher income than the vast majority of Americans. Even if all you had was a 401K, a couple of Roth IRAs, and a 529 or two, how many people really make enough to max those out and still have a significant taxable account? I had one for a while, but when more tax-protected accounts became available to me I gradually converted the money from taxable to tax protected.
In my case the issue is employee stock options. When you exercise them, it is ordinary income and what is left over is in a taxable account. Also a Non Qualified deferred income account which paid out after I retired. And a Non Qualified pension which I took as a lump sum since it was not guaranteed by PBGC. Up until recently I had very little in taxable, now I have a great deal in taxable.
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Re: Given low rates, more tax efficient to tax shelter stock

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This topic interests me greatly. I put together a spreadsheet with what I thought were reasonable assumptions:

Stock TR: 4.00%, 7%, 10%
Muni yld: 1.65%
TSM yield: 2.04%
LTCG rate: 15.00%
QD rate: 15.00%
Ord Inc: 25.00%
TBM yield: 1.69%

Put $100K in taxable and $100K in a Roth (so as not to have a tax adjusted AA scenario). 20 year planning horizon.

Under all assumptions for total return on stocks, munis in taxable gave more final wealth:

Code: Select all

Stock TR        Munis in Tax      Stocks in Tax

4%                  $351                      $330

7%                   $519                      $465

10%                  $805                      $696
Even assuming that at the end of the 20 years, one dies and enjoyed the step up of basis, the munis in taxable left more final wealth. Additionally it left more of the total in a Roth for your heirs vs taxable. ("Stretch" possible).
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Re: Given low rates, more tax efficient to tax shelter stock

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badbear wrote:Having thought about this a bit, it occurs to me that one of the major costs of holding your stocks in taxable counts is the capital gains cost of rebalancing once your stocks have grown significantly.
Probably not a major cost. Say you need to sell 5% of your portfolio every year with a 50% LTCG or 2.5% LTCG. At a 15% tax rate that is 37.5 bps. But this is not an additional cost since you wold have to pay that tax eventually anyway. The real cost is only the interest on that 37 bps which at 10% interest (say what!) is only 4 bps per year.
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Re: Given low rates, more tax efficient to tax shelter stock

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Doc wrote:
badbear wrote:Having thought about this a bit, it occurs to me that one of the major costs of holding your stocks in taxable counts is the capital gains cost of rebalancing once your stocks have grown significantly.
Probably not a major cost. Say you need to sell 5% of your portfolio every year with a 50% LTCG or 2.5% LTCG. At a 15% tax rate that is 37.5 bps. But this is not an additional cost since you wold have to pay that tax eventually anyway. The real cost is only the interest on that 37 bps which at 10% interest (say what!) is only 4 bps per year.
If you will spend it all down then yes, you will pay it eventually. But if the basis steps up when you croak you never pay it at all. :) This is reason enough for me to save a lot and try to rebalance elsewhere.
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Re: Given low rates, more tax efficient to tax shelter stock

Post by Doc »

badbear wrote:
Doc wrote:
badbear wrote:Having thought about this a bit, it occurs to me that one of the major costs of holding your stocks in taxable counts is the capital gains cost of rebalancing once your stocks have grown significantly.
Probably not a major cost. Say you need to sell 5% of your portfolio every year with a 50% LTCG or 2.5% LTCG. At a 15% tax rate that is 37.5 bps. But this is not an additional cost since you wold have to pay that tax eventually anyway. The real cost is only the interest on that 37 bps which at 10% interest (say what!) is only 4 bps per year.
If you will spend it all down then yes, you will pay it eventually. But if the basis steps up when you croak you never pay it at all. :) This is reason enough for me to save a lot and try to rebalance elsewhere.
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Unfortunately I am in the "spend all your money and die" category and can't take advantge of your idea.
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Re: Switching from traditional stock bond locations ?

Post by tfb »

baw703916 wrote:To be able to conclude anything, a study must make some assumptions. Nothing wrong with that, but when analyzing the conclusions, it's important to ask whether the assumptions are accurate in the present moment. With respect to tax-exempt bonds, the first paper concludes that they are sub-optimal compared to taxable bonds in a tax-advantaged account--but makes the assumption that tax-exempt bonds always pay 20% lower interest rates than equivalent taxable bonds. That has been true historically, but isn't now.
Even if we say tax exempt bonds having 100% of the yield of taxable bonds is anomaly and they will go back to 80%, we should note that when taxable bond yield was 6%, the 20% difference was 1.20%. Now the difference is only 0.34% in 'absolute' units under the assumption that tax-exempt bonds always pay 20% lower interest rates than equivalent taxable bonds. The 'absolute' number is the more important one.
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Re: Given low rates, more tax efficient to tax shelter stock

Post by Wagnerjb »

dickenjb wrote:Put $100K in taxable and $100K in a Roth (so as not to have a tax adjusted AA scenario). 20 year planning horizon.

Under all assumptions for total return on stocks, munis in taxable gave more final wealth:
You have answered one particular question - that is, "what if you only have a Roth and a Taxable account?" And the obvious answer - in a plain vanilla world - is to put the higher returning investment in Roth. That isn't a particularly hard question, although your answer ignores the tax benefits to sophisticated investors with stocks in taxable accounts. Examples of those benefits are tax loss harvesting, donating appreciated stocks to charity, bequeathing appreciated shares to heirs, gifting appreciated shares to children.

When you start to think about taxes a bit more, you get some odd answers to your situation. If you truly only have a taxable account and a Roth, you pay no income taxes. Then why would you invest in a Muni bond fund in your taxable account? (Yes, I know today the yields are very close, but even at the exact same yield Munis are riskier and less diversified). You should invest in a Regular bond fund in the taxable account in that particular situation.

What if you have an IRA/401K and a taxable account? The math tells you to put stocks in the taxable account; however some people disagree based on the apparent difference in AA. I have demonstrated (in other posts) that those people with less than $1MM in their IRA will experience a 0% tax rate on their RMD's and thus the AA issue is really not relevant for most people. So, for them the answer is stocks in taxable.

Best wishes.
Andy
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Re: Switching from traditional stock bond locations ?

Post by baw703916 »

tfb wrote:
Even if we say tax exempt bonds having 100% of the yield of taxable bonds is anomaly and they will go back to 80%, we should note that when taxable bond yield was 6%, the 20% difference was 1.20%. Now the difference is only 0.34% in 'absolute' units under the assumption that tax-exempt bonds always pay 20% lower interest rates than equivalent taxable bonds. The 'absolute' number is the more important one.
I think the Dammon et al. paper did their analysis assuming a taxable yield of 5% and a tax exempt yield of 4%. So yes, it was based on higher interest rates in general, as well as on higher differentials.
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Re: Given low rates, more tax efficient to tax shelter stock

Post by baw703916 »

Wagnerjb wrote: If you truly only have a taxable account and a Roth, you pay no income taxes.
Andy, I'm not sure I understand what you mean. I personally know of a counterexample (whose employer does not offer a 401(k), but who does pay income taxes, and has a Roth account as well as a taxable account, the latter due to an inheritance).
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Re: Given low rates, more tax efficient to tax shelter stock

Post by tfb »

Wagnerjb wrote:What if you have an IRA/401K and a taxable account? The math tells you to put stocks in the taxable account; however some people disagree based on the apparent difference in AA. I have demonstrated (in other posts) that those people with less than $1MM in their IRA will experience a 0% tax rate on their RMD's and thus the AA issue is really not relevant for most people. So, for them the answer is stocks in taxable.
If you have a tradition IRA/401k but you will pay 0% tax rate on withdrawal, you really have a super Roth. Not sure why the answer would change from the "obvious" case.
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Re: Given low rates, more tax efficient to tax shelter stock

Post by Wagnerjb »

baw703916 wrote:
Wagnerjb wrote: If you truly only have a taxable account and a Roth, you pay no income taxes.
Andy, I'm not sure I understand what you mean. I personally know of a counterexample (whose employer does not offer a 401(k), but who does pay income taxes, and has a Roth account as well as a taxable account, the latter due to an inheritance).
I should have been clearer - I was thinking about a retiree. I agree with you and TFB that a working individual would at least consider holding Muni bonds in his account if he chose to put fixed income in taxable.
Andy
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Re: Given low rates, more tax efficient to tax shelter stock

Post by baw703916 »

OK, now I understand what you meant. Thanks for clarifying.
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Re: Given low rates, more tax efficient to tax shelter stock

Post by baw703916 »

One wrinkle, though, is that there's no tax-exempt equivalent of TIPS. So buying the yearly allowance of I Bonds may be a good move.
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Re: Given low rates, more tax efficient to tax shelter stock

Post by grabiner »

I discussed a rule of thumb in this thread

If the yield of munis is less than the yield of stocks, then it may be better to hold munis in a taxable account and stocks in tax-deferred rather than corporate bonds in tax-deferred and stocks in taxable. (If the yield of munis then rises, you can switch to stocks in taxable and sell the munis for a capital loss.)

However, the secondary conditions may be more important. If your 401(k) has better stock options than bond options (or vice versa), that should determine what you hold in the 401(k). In particular, if you have the TSP G fund, or have a good stable-value fund (TIAA-CREF, for example), you may want all your bonds in the 401(k). If you are likely to leave a lot of your taxable account to your heirs or donate it to charity, then stocks have an advantage in taxable because you will never pay the capital-gains tax.
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Re: Given low rates, more tax efficient to tax shelter stock

Post by BornInCA »

For Young Saver's Only:
I don't like to let the tax tail wag the dog. However, I think for most young people in a low to mid-tax bracket who want to save for retirement and other short term goals simultaneously, bonds in taxable accounts and stocks in retirement accounts make sense primarily because for young people, retirement is a long way away. Here's how it breaks down:

Goal #1: Retirement
Time Horizon: 30+ Years
Best asset class(es) for goal: Equities (stocks, REITs, all-caps, all-sytles)

Goal #2: Short term goals (e.g. Emergency fund)
Time Horizon: 5 years or less
Best asset class(es) for these goals: Cash, Short Term Bond Funds
Since it's a taxable account, I would use Short-Term Bond Index (for funds under $50k) or Short-Term Treasury (for funds $50k or above). I know about savings bonds as well. I think they (especially I-bonds) are good savings vehicles for young people as long as they can sacrifice liquidity for exactly one year.

Thus, thefinancebuff article confirms an idea I've had in my mind for awhile: If CDs, money markets, and bonds pay such super low rates of interest, who cares about taxes? Exception to that is if a young person is in the top two highest federal income tax brackets. Maybe short-term municipal bond funds would be more suitable for these lucky few.

Also living in a state with high state income tax also strengthens the case for short-term government bond funds in taxable accounts.
SteveKL
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Re: Given low rates, more tax efficient to tax shelter stock

Post by SteveKL »

EmergDoc wrote:Even if all you had was a 401K, a couple of Roth IRAs, and a 529 or two, how many people really make enough to max those out and still have a significant taxable account?
In my experience, people with 401(k)s and similar employer-sponsored retirement plans with high contribution limits have little understanding or sympathy for folks who, by choice or circumstance, do not enjoy that benefit. Similarly, people who work for employers who give them (yes, give, as in tax-free) health insurance are generally of the "Let them eat cake" mentality when it comes to folks without, or those for whom health insurance is a dominant line-item in their monthly budget. And 529s? What about those of us who are child-free by choice? Roth? Over the limit.

Call me the poster child for taxable investing.
gwrvmd
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Re: Given low rates, more tax efficient to tax shelter stock

Post by gwrvmd »

Call me the Poster Child for Tax Deferred Investing. I agree with EmergDoc. I have always put the maximum stock possible in tax deferred( IRA, 403b, 401K, Keogh). I am a long term buy and hold investor who is still compounding the tax deferred income and capital gains from 1985 and every year since. My rough calculation is that my tax defered accounts are now worth somewhere about
4 - 5 times what I put in them probably about one third of which is compounded tax I haven't paid. When the RMD I have to take out each year is only about 3.8- 4.5% of tax deferred assets,I am very happy. I am compounding the governments money for many years and only paying 15 - 20% on it when I take it out......Gordon.
Disciple of John Neff
grok87
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Re: Given low rates, more tax efficient to tax shelter stock

Post by grok87 »

Lately I've been doing, for my bond allocation, a mix of long dated tips (30 year) in tax-advantaged accounts and cash/ibonds with taxable money. i think tips belong in tax-advantaged because the main reason to buy them is protection against high inflation scenarios and in those scenarios the tax drag will be enormous if you hold in taxable.
cheers,
RIP Mr. Bogle.
SteveKL
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Re: Given low rates, more tax efficient to tax shelter stock

Post by SteveKL »

gwrvmd wrote:Call me the Poster Child for Tax Deferred Investing.
Gordon, that's nice "work" if you can get it. My point to the good doctor was that an investor who states they have all the room they need in tax-deferred space must have more room there than do I. Given the opportunity, I'd greatly prefer to put more in tax-deferred, but the playing field is distinctly non-level, based on which plan(s) are made available by one's employer.
YDNAL
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Re: Given low rates, more tax efficient to tax shelter stock

Post by YDNAL »

badbear wrote:This morning I saw this blog post in my feed, from our own tfb:
http://thefinancebuff.com/tax-efficienc ... olute.html

The gist of the article is that given the current interest rate environment, it may actually be more tax efficient to put your stock funds in your tax-deferred accounts. Once interest rates finally rise, bond funds will have a capital loss and the switch back to bonds in tax-deferred would be painless. What are your thoughts on this strategy?

Cheers!
A Taxable account is a quazi (or hybrid) tax-deferred account for accumulators - pay taxes on distributions and otherwise defer taxable gains. If you don't use and get passed-on, it gets stepped basis.
  • So, of course, when distributions from Fixed Income are less than distributions from Equity investments, it would make sense to reverse the order - I agree with tfb.
  • Otherwise, it doesn't make sense.
  • It certainly wouldn't make sense to sell Taxable investments and realize capital gains just to exchange these investments for Fixed Income.
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kingsnake
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Re: Given low rates, more tax efficient to tax shelter stock

Post by kingsnake »

seems to me it wouldn't be too difficult to have a decent amount of money in a taxable account even if you're lucky enough to have 401k offered.

$ 17,000 in 401 taken out pre tax
and $ 5,000 IRA after tax

So, if single and save more than 22K per year after expenses you could build up significan $ in a taxable account
xram
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Re: Given low rates, more tax efficient to tax shelter stock

Post by xram »

Let me ask a stupid question. If the taxation of qualified dividends goes up to 39.6% in 2013, it becomes a no-brainier to put stock funds in tax-favorable accounts (401k, Roths) and bond funds in taxable, is that correct? Especially if not selling anything for a gain?

http://www.bogleheads.org/wiki/Principl ... _Placement

Thanks
VTI, VBR, VTWV, SCHH, VXUS, VEA, VWO, VSS, FM, VNQI, VBTLX, VFITX, SCHP, VWITX, IBONDS, EEBONDS, EF(EverBank), UTAH-529
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badbear
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Re: Given low rates, more tax efficient to tax shelter stock

Post by badbear »

xram wrote:Let me ask a stupid question. If the taxation of qualified dividends goes up to 39.6% in 2013, it becomes a no-brainier to put stock funds in tax-favorable accounts (401k, Roths) and bond funds in taxable, is that correct? Especially if not selling anything for a gain?

http://www.bogleheads.org/wiki/Principl ... _Placement

Thanks
Yes, if you assume no or minimal capital gains or if you are investing new money. If you would have a significant capital gain it probably is not worth changing anything just for tax reasons since you do not know how long interest rates will stay this low. And of course you would want to hold tax-exempt bonds in taxable. :beer
xram
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Re: Given low rates, more tax efficient to tax shelter stock

Post by xram »

badbear wrote:
xram wrote:Let me ask a stupid question. If the taxation of qualified dividends goes up to 39.6% in 2013, it becomes a no-brainier to put stock funds in tax-favorable accounts (401k, Roths) and bond funds in taxable, is that correct? Especially if not selling anything for a gain?

http://www.bogleheads.org/wiki/Principl ... _Placement

Thanks
Yes, if you assume no or minimal capital gains or if you are investing new money. If you would have a significant capital gain it probably is not worth changing anything just for tax reasons since you do not know how long interest rates will stay this low. And of course you would want to hold tax-exempt bonds in taxable. :beer
thanks

1) I will have no capital gains, not selling anything.
2) I will be investing with new money.

Assuming that one is gonna made this change........

So one's entire bond portion of portfolio could only include ?
.....tax exempt muni fund?
......I bonds?

Coud not hold TBM in taxable?

Not worth it to sell the stock funds (TSM, TISM , VSS, VWO etc) from taxable ?
......or only sell the ones that haven't increased in value (nothing I own is older than 17 months Old, I just started investing last April or so)

Even if I fill up Roths aNd 401k with stock funds, I WILL run out of room for stock funds in those places. What stock funds are then OK to place in taxable?

:beer
VTI, VBR, VTWV, SCHH, VXUS, VEA, VWO, VSS, FM, VNQI, VBTLX, VFITX, SCHP, VWITX, IBONDS, EEBONDS, EF(EverBank), UTAH-529
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tfb
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Re: Given low rates, more tax efficient to tax shelter stock

Post by tfb »

xram wrote:1) I will have no capital gains, not selling anything.
2) I will be investing with new money.

Assuming that one is gonna made this change........

So one's entire bond portion of portfolio could only include ?
.....tax exempt muni fund?
......I bonds?

Coud not hold TBM in taxable?
You can hold TBM if you want some more diversification. Also look at FDIC insured CDs.
xram wrote:Not worth it to sell the stock funds (TSM, TISM , VSS, VWO etc) from taxable ?
......or only sell the ones that haven't increased in value (nothing I own is older than 17 months Old, I just started investing last April or so)
You already said you will have no capital gains. So only sell the ones that haven't increased in value if necessary.
xram wrote:Even if I fill up Roths aNd 401k with stock funds, I WILL run out of room for stock funds in those places. What stock funds are then OK to place in taxable?
Of course.
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badbear
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Re: Given low rates, more tax efficient to tax shelter stock

Post by badbear »

xram wrote:Even if I fill up Roths aNd 401k with stock funds, I WILL run out of room for stock funds in those places. What stock funds are then OK to place in taxable?
If you don't have enough room in tax-advantaged accounts you would most likely want to hold total stock market index funds (domestic and/or international) in taxable. Specific sector bets like REITs, or active mutual funds, generally have higher tax costs and would be best held in tax-deferred.
mrspremise
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Re: Given low rates, more tax efficient to tax shelter stock

Post by mrspremise »

EmergDoc wrote:Interesting topic. Irrelevant to me, but interesting none the less. I'm always surprised to learn just how many people have a taxable account. I have a hard time maxing out tax protected options, and I know I have a higher income than the vast majority of Americans. Even if all you had was a 401K, a couple of Roth IRAs, and a 529 or two, how many people really make enough to max those out and still have a significant taxable account? I had one for a while, but when more tax-protected accounts became available to me I gradually converted the money from taxable to tax protected.
Both I and my hubby have reasonably high paying jobs (engineers with good performance records), came out of college with little enough loans to handle in the first years of working, live in a reasonably low cost of living area, and tend to be savers by nature. About 5 years after purchasing our first home and a car (with a home loan refinance with a low rate), what with raises and promotions but no major lifestyle changes, we suddenly found ourselves accumulating money at an unexpectedly high rate despite having a child (yes we opened a 529). I think the key is our wages grew faster than our needs, and absolutely low interest rates spurred us to think about what we were doing with the savings.
bikenfool
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Re: Given low rates, more tax efficient to tax shelter stock

Post by bikenfool »

I don't think this makes sense because you're losing out on the lower tax rate available for dividends and cap gains. In the short term it looks better because you're paying lower taxes on the bonds, but eventually you're going to take that money out of the 401k & pay full income tax rates earnings instead of the lower CG & dividends rate. What am I missing?
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interplanetjanet
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Re: Given low rates, more tax efficient to tax shelter stock

Post by interplanetjanet »

bradrh wrote:I don't think this makes sense because you're losing out on the lower tax rate available for dividends and cap gains. In the short term it looks better because you're paying lower taxes on the bonds, but eventually you're going to take that money out of the 401k & pay full income tax rates earnings instead of the lower CG & dividends rate. What am I missing?
It's that Traditional 401k/IRA accounts don't really "convert" capital gains into income tax - rather, they defer income tax and completely eliminate capital gains tax. The upfront tax deduction on Traditional contributions compensates for the tax at withdrawal; how much so depends on the difference between tax rates at contribution and withdrawal times.

It may be instructional to compare placement between a Roth account and taxable rather than between Traditional and taxable. This may make things a bit easier to see.
bikenfool
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Re: Given low rates, more tax efficient to tax shelter stock

Post by bikenfool »

interplanetjanet wrote: It may be instructional to compare placement between a Roth account and taxable rather than between Traditional and taxable. This may make things a bit easier to see.
That doesn't make it easier for me to see anyway. It always makes sense to put the highest return investment in Roth, but that can only be determined in hindsight. That expected high return investment could turn out to lose money. For the example in the article above the equities made more than the bonds, but it may not turn out that way.
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