What asset classes to put in a Roth?

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Re: What asset classes to put in a Roth?

Postby Doc » Sat Mar 23, 2013 10:50 am

The last several posts have all addressed the effect of lowering the withdrawal tax rate by one means or another. If these tax rate reduction schemes are applicable to you then the higher return assets should go into the ROTH provided there is no cost penalty involved. Even on the chance that the tax rate is lower you might as well put the high return assets in the ROTH.

Many of these scenarios involve inheritance issues which seems to me to be an estate issue not an investment issue. The marginal tax rate issue is unlikely by itself to be significant. Bracket changes are typically on the order of 3% and 3% of the your annualized return is well within the noise level. Changing your marginal rate by more than one bracket is not a high probability event unless you have a really huge traditional tax advantaged account.

A lot more can be saved by putting short duration bonds in taxable and intermediate bonds in tax advantaged with a corresponding shift in an equity position rather than all your FI in a TBM fund in tax advantaged.
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Re: What asset classes to put in a Roth?

Postby 2beachcombers » Sat Mar 23, 2013 4:24 pm

Doc wrote:The last several posts have all addressed the effect of lowering the withdrawal tax rate by one means or another. If these tax rate reduction schemes are applicable to you then the higher return assets should go into the ROTH provided there is no cost penalty involved. Even on the chance that the tax rate is lower you might as well put the high return assets in the ROTH.

Many of these scenarios involve inheritance issues which seems to me to be an estate issue not an investment issue. The marginal tax rate issue is unlikely by itself to be significant. Bracket changes are typically on the order of 3% and 3% of the your annualized return is well within the noise level. Changing your marginal rate by more than one bracket is not a high probability event unless you have a really huge traditional tax advantaged account.

A lot more can be saved by putting short duration bonds in taxable and intermediate bonds in tax advantaged with a corresponding shift in an equity position rather than all your FI in a TBM fund in tax advantaged.


Doc, pls explain the cost penalty above.

I do not need the RMD. Pensions and SS at 70 meet my expenses.

My case was at least 3%, and an additional savings of 5%(on a fraction of the RMD) as the IRA would have grown to 2M$. I also expect myself and then spouse to bank that saving for 20-40 more years. The no Roth case would have started at a 50K$ additional RMD bump growing to 90 K bump over 15 yrs. If I lived longer than that, the problem increases. 50k X 28% yields an additional 14K in taxes/yr.

After the conversions.--My spreadsheet also shows spouse can maintain the 15% tax rate(with a small amount of Roth help) after I am gone. If she does not need the LTC, IRAs to kids or charity.

Even if the savings was small. I still like the conversion move for LTC insurance and other little life emergencies, and spouse has be talking about a PHD. :shock:

The biggest part, by far, in my Estate Planning has been financial long term planning. Do not understand why you want to separate the two?

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Re: What asset classes to put in a Roth?

Postby Doc » Sat Mar 23, 2013 5:48 pm

2beachcombers wrote:
Doc wrote:The last several posts have all addressed the effect of lowering the withdrawal tax rate by one means or another. If these tax rate reduction schemes are applicable to you then the higher return assets should go into the ROTH provided there is no cost penalty involved. Even on the chance that the tax rate is lower you might as well put the high return assets in the ROTH.

Many of these scenarios involve inheritance issues which seems to me to be an estate issue not an investment issue. The marginal tax rate issue is unlikely by itself to be significant. Bracket changes are typically on the order of 3% and 3% of the your annualized return is well within the noise level. Changing your marginal rate by more than one bracket is not a high probability event unless you have a really huge traditional tax advantaged account.

A lot more can be saved by putting short duration bonds in taxable and intermediate bonds in tax advantaged with a corresponding shift in an equity position rather than all your FI in a TBM fund in tax advantaged.


Doc, pls explain the cost penalty above.

I do not need the RMD. Pensions and SS at 70 meet my expenses.

My case was at least 3%, and an additional savings of 5%(on a fraction of the RMD) as the IRA would have grown to 2M$. I also expect myself and then spouse to bank that saving for 20-40 more years. The no Roth case would have started at a 50K$ additional RMD bump growing to 90 K bump over 15 yrs. If I lived longer than that, the problem increases. 50k X 28% yields an additional 14K in taxes/yr.

After the conversions.--My spreadsheet also shows spouse can maintain the 15% tax rate(with a small amount of Roth help) after I am gone. If she does not need the LTC, IRAs to kids or charity.

Even if the savings was small. I still like the conversion move for LTC insurance and other little life emergencies, and spouse has be talking about a PHD. :shock:

The biggest part, by far, in my Estate Planning has been financial long term planning. Do not understand why you want to separate the two?

jerry


Cost: Sometimes costs are higher in one type of account than another because of higher fees etc.

RMD's: I don't need them either but if don't take them the IRS penalizes me.

Amount of savings: An extra 3% in taxes means that your investment grows at 5.8% instead of 6%. but I don't know whether that should be 6%, or 8% or even 10%. The 3% in taxes on the growthis well within the range of our return estimates.

Estate planing involves distributing the after tax value of your net worth to your heirs when you die. Investing is maximizing your net worth before you die. My kids would be much better off if I left them $2m with a $1m tax bill then only $1m with a measly $200k tax bill. :happy
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Re: What asset classes to put in a Roth?

Postby 2beachcombers » Sun Mar 24, 2013 11:08 am

Doc, thanks for the cost answer. I have no cost issue as I can buy any fund in either taxable or deferred.

My plan is to leave to the kids tax free $$ and pay as little taxes as possible on the way.

The 3% may be a small issue but doesn't the additional taxes also need to be considered ? Am I missing something with the underlined below?? Looks like real $$ to me.

[b]My case was at least 3%, and an additional savings of 5%(on a fraction of the RMD) as the IRA would have grown to 2M$. I also expect myself and then spouse to bank that saving for 20-40 more years. The no Roth case would have started at a 50K$ additional RMD bump growing to 90 K bump over 15 yrs. If I lived longer than that, the problem increases. 50k X 28% yields an additional 14K in taxes/yr.[/b]
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Re: What asset classes to put in a Roth?

Postby Doc » Sun Mar 24, 2013 11:46 am

2beachcombers wrote: .
The 3% may be a small issue but doesn't the additional taxes also need to be considered ? Am I missing something with the underlined below?? Looks like real $$ to me.


1) The amount of tax is the wrong metric. The amount you have left after tax is all that matters. Paying more taxes and having more after tax is a good thing not a bad thing.

2) I do not understand your example. If you portfolio returns 8% before tax and your tax rate increases by 3% your return only drops by 8*.03=0.24%. But you don't know whether that return rate is going to be 8% or 9% or only 7% and you don't know if your tax bracket before the RMD is going to be 28% or only 25%. The .24% is meaningless given the other unknowns. A lot of people don't want to adjust retirement accounts because they can't accurately determine their future tax bracket. Your calculation depends not only on the bracket but where your are in that bracket. I don't know those things now and I am retired. In 2013 my marginal tax bracket can be anything form 10% to 27.75% depending on my choice to harvest capital gains or capital losses this year. If you can predict what these things are going to be 15 years in the future with any degree of certainly I would like to borrow your crystal ball.

If there is no penalty for putting high return assets in your ROTH go ahead. It is not likely to hurt from an investment viewpoint. I have little knowledge or interest in any estate issues.
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Re: What asset classes to put in a Roth?

Postby 2beachcombers » Sun Mar 24, 2013 12:21 pm

I have confidence in my crystal ball for future tax rates as I have the flexibility with manageable income sources , Roths, Dividends, capital loss carry overs, etc. I have been managing my income sources to plan for the past 13 yrs in retirement.
My primary assumptions are--- I doubt my tax rates will decrease in the future. Maximize after tax rtn to heirs and continuued long term compounding. Dispose of IRA thru LTC or other life issues, or charity.

Years ago, I ran multiple forcast of Roth, no Roth for my case and the after tax rtn was significantly better >15% for Roth case. The largest part of the differential was ever increasing annual tax on the RMDs.
And, agree--multiple assumptions, longevity, tax rate, tax changes, growth, etc will make a difference.

Thanks, time will tell. :sharebeer

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Re: What asset classes to put in a Roth?

Postby Doc » Sun Mar 24, 2013 1:04 pm

2beachcombers wrote:The largest part of the differential was ever increasing annual tax on the RMDs.


Well that is certainly the one. I am surprised at the size of the effect. Is the amount of your tIRA/401k a very large percentage of you total portfolio? Or perhaps the 15% is the difference in the future value of a small difference compounded over many years?
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Re: What asset classes to put in a Roth?

Postby 2beachcombers » Sun Mar 24, 2013 5:58 pm

Doc wrote:
2beachcombers wrote:The largest part of the differential was ever increasing annual tax on the RMDs.


Well that is certainly the one. I am surprised at the size of the effect. Is the amount of your tIRA/401k a very large percentage of you total portfolio? Or perhaps the 15% is the difference in the future value of a small difference compounded over many years?


Correct 25 yrs compounding. Also correct on Large IRA percent of portfolio.

Before Roth changes and the market changes over the past 13 yrs, the IRA would have been 70-80% of my total portfolio.
After selling a south Fla house and putting half the gains a taxable account, The IRA would have dropped to about 50%. of total portfolio.

After Roth conversion, gifting, 529s, when I start my RMDs in 3 yrs, the IRA will be around 15% total portfolio

Today the accounts are:
Taxable---------- 45%
Roth---------------30%
IRA---------------- 25%( 800K), will cash in 300k over next 4 yrs.before SS at 70 yrs

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Re: What asset classes to put in a Roth?

Postby Doc » Mon Mar 25, 2013 12:30 pm

2beachcombers wrote:
Doc wrote:
2beachcombers wrote:The largest part of the differential was ever increasing annual tax on the RMDs.


Well that is certainly the one. I am surprised at the size of the effect. Is the amount of your tIRA/401k a very large percentage of you total portfolio? Or perhaps the 15% is the difference in the future value of a small difference compounded over many years?


Correct 25 yrs compounding.


A major drawback in the future value calculations is that one's assumptions about future events gets magnified by the compounding. This makes the future assumptions get greater weight than current assumptions which are more certain. A way to minimize this effect is to use a given interest rate (hurdle rate) and calculate the net present value of the cash flow stream. Same equations just has NPV as the dependent variable and the discount rate (YTM) as the known variable. This method is common in evaluating industrial projects but I have not seen it used in finance.

Maybe there is a finance major out there that can comment.
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Re: What asset classes to put in a Roth?

Postby teacher » Mon Mar 25, 2013 5:47 pm

When we reconfigured our portfolio in late summer of '09, we put TIPS in our ROTHs and later rolled over the Vanguard Health Care Admiral Fund into my ROTH. We plan to roll over the Capital Opportunity Admiral Fund into DH's ROTH account this year. Those are the only two non-index funds we have in Vanguard. The thinking is the TIPS are more secure and the two managed equity funds have the potential to provide above average growth as they have in the past, so the two extremes somewhat balance each other in our most important accounts. Without the Cap Opportunity funds, about 23% of our portfolio is in ROTHs. Impending RMDs motivate us to roll over as much as we can before we reach 70 1/2. We are a little short on TIPS, so that may be the next rollover destination next year.
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Re: What asset classes to put in a Roth?

Postby 2beachcombers » Tue Mar 26, 2013 2:40 pm

Teacher---I count my SS as TIPS equivalent

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Re: What asset classes to put in a Roth?

Postby teacher » Tue Mar 26, 2013 3:13 pm

Cali teachers don't get SS. They get a pension with no COLA and fully taxable. The pension can slip down to 85% of spending value, then it is maintained at that level.
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