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letsgobobby
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Ketawa
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Re: If you tax adjust, how has it changed your life?

Post by Ketawa »

I started tax adjusting in 2012, I think. All of my fixed income is in the G Fund, and my TSP account is 74% Traditional/26% Roth. My stock/bond split is 80/20, but it is 77/23 pre-tax. A huge difference, I know! The gap will grow as my Traditional accounts start to outstrip Roth accounts; right now I am 37% Traditional and 63% Roth.

The other main change in my life is that I now get involved in long debates about optimal asset location. Red flags are raised in my mind whenever I read "the highest returning asset should go in a Roth".

Is the net effect positive or negative? The jury is still out.
Beantown85
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Re: If you tax adjust, how has it changed your life?

Post by Beantown85 »

I once knew a guy who tax adjusted. Knew.
Tanelorn
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Re: If you tax adjust, how has it changed your life?

Post by Tanelorn »

I definitely think about the fact that gains in a Traditional IRA are only 75% (or whatever) mine, and adjust my risk accordingly. I don't adjust taxable accounts vs Roth, but I don't have a lot of long term embedded gains either. That's a harder situation to think about treating properly, since it involves guessing how long you'll hold the appreciated position (as well as all the other tax-related guesses).
nonplussed
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Re: If you tax adjust, how has it changed your life?

Post by nonplussed »

I tax adjust assuming a future tax rate of 25% (state + fed). This causes the positions in my traditional IRA to be 7.4% larger than they would be without tax-adjusting. For example, because my REIT is going in my traditional IRA, I buy more of it. If it were going in my Roth, I'd buy less.

We can't know future tax rates, but I suppose 25% will be closer to the mark than the 0% being used by those who don't tax adjust.
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dbr
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Re: If you tax adjust, how has it changed your life?

Post by dbr »

I don't tax adjust because I can't figure out how doing so would have any effect on anything I do.

I wonder if there is a rationale we could apply that would tell us if we should care. First of all we will not allow the argument that the difference is too small to matter. While I think that is usually the case, it actually avoids rather than answer the question.

Now there is a paper by Reichenstein that devises a certain utility function. Using that he shows that one would care to tax adjust though the magnitude is arguable. I struggle to find how his utility function applies to anything actionable to me. I am not sure I really understand it. Others can see if there is an answer there.

Consider a simpler case of a nominal 50/50 allocation with bonds in tax deferred and stocks in taxable. Assume tax numbers that reduce the bond allocation more than the stock allocation, perhaps to 40/45 (47/53). Remember we will not argue that the difference is not worth worrying about. So now the investor has 15% less money and the asset allocation has shifted a little. A first question is why is the focus not on the having less money rather than on the risk of the allocation. To answer that we have to see what else has changed. One change is that the expenses to be supported are now changed. We can remove the tax cost from holding investments from our expenses. So I don't know how that should affect us, but one thing for sure is that the problem is not finished if we don't consider tax adjusting our cash flow and our withdrawal plan along with tax adjusting our assets. Note that without tax adjusting anything I can formulate an income plan where the needed income simply includes expected taxes as an expense.
learning_head
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Re: If you tax adjust, how has it changed your life?

Post by learning_head »

Imagine there were no tax differences but instead your Roth IRA balances were presented to you is US dollars, your taxable accounts in Australian dollars and your Traditional IRA / 401(k) in Canadian dollars, would you feel comfortable just adding these "dollars" up or setting AA based on such summations? Or would you first want to translate them to single currency?

It could very well be the case that differences between these currencies are not large enough to matter to you or that you would account for these differences as part of "expenses" of conversion later... That's perfectly fine as well.
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Kevin M
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Re: If you tax adjust, how has it changed your life?

Post by Kevin M »

Maybe one day I'll try to do the calculation and see how much difference it makes. The tIRA accounts should be pretty easy. I have a relatively small amount in Roth, so it won't impact things much anyway. For taxable, I'll have to first net my capital loss carryovers and unrealized gains, then figure out what share belongs to the federal and state governments.

Right now I can't even say what percentage is in taxable and what is in tax-advantaged, but I could figure that out. OK, I'll do a rough calculation ...

Without adjusting taxable, it looks like tax-adjusting the tIRA, assuming 30% tax (Fed + state), bumps me from 30/70 stock/fixed to 35/65. Tax adjusting taxable will knock that back down some; maybe I'll work on that later.

But I also have a rental property that I don't include in my financial portfolio when I state my AA, and including that as a risky asset bumps my AA to about 43/57 (risky/safe). Including my house as a risky asset would bump it up some more (EDIT: quite a bit more than including the rental).

I don't think I'll make any AA changes based on this. I already knew it would look riskier after tax adjusting. Including real estate has an even greater impact. Do folks think including their real estate in their portfolios is as important as tax adjusting?

Kevin
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arthurdawg
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Re: If you tax adjust, how has it changed your life?

Post by arthurdawg »

I do not tax adjust... but then I also don't keep my asset allocation that rigorously defined. I invest new funds to reach a 70:30 stock/bond split (about 10% of the "stocks" are REIT) and then slice and dice the stock portfolio 2-2.5:1 for both TSM:SCV and FTSE Big:FTSE Small... I don't really get too concerned if I'm off a fair amount as long as money is going in and I am generally moving back towards my planned allocation.
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letsgobobby
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Re: If you tax adjust, how has it changed your life?

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grabiner
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Re: If you tax adjust, how has it changed your life?

Post by grabiner »

I hold almost all of my REITs in my Roth IRA. My target allocation is 10%, and since I tax-adjust and the Roth IRA is a relatively small part of my portfolio, I have only 8% of the dollar value of my portfolio in REITs.

The rest of my Roth IRA, and my HSA, are in value stocks (Vanguard's Value and Small-Cap Value Indexes, and Guggenheim S&P 600 Pure Value in the HSA) This doesn't actually affect my asset allocation because I am slightly underweighted in value even with these adjustments. I can't fix this because I don't have a value fund in my employer plan and won't hold one in my taxable account; I am not far enough off that I am willing to pay the tax cost for holding a value fund in taxable.
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letsgobobby
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Re: If you tax adjust, how has it changed your life?

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celia
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Re: If you tax adjust, how has it changed your life?

Post by celia »

I don't tax adjust because when I wihdraw (convert) money that is in a traditional IRA, I pay the taxes using money from current year income (whatever the currency is that year). :P

The dollar amount of the taxes is more important depending on what other financial needs I have each year and that controls how much I convert. So I guess you could say my life changes even though I don't tax adjust.
Ketawa wrote:Red flags are raised in my mind whenever I read "the highest returning asset should go in a Roth".
Ketawa, Do you mean the highest returns already earned or the likely future highest returns? Some people say it doesn't matter which funds you convert first since the percentages/tax rates will even out in the long run. But I look at the dollar amount the taxes will cost me. I started converting from the funds that had the highest future expected return, again, because I am looking at the taxes as a dollar amount. If I can afford to convert $x of Fund A or $x of Fund B (both with the same value on day of conversion), then I might as well choose the fund with the expected future highest growth. Past earnings in the traditional IRA are irrelevant since the whole withdrawal is taxed as ordinary income.
A dollar in Roth is worth more than a dollar in a taxable account. A dollar in taxable is worth more than a dollar in a tax-deferred account.
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Ketawa
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Re: If you tax adjust, how has it changed your life?

Post by Ketawa »

celia wrote:Ketawa, Do you mean the highest returns already earned or the likely future highest returns? Some people say it doesn't matter which funds you convert first since the percentages/tax rates will even out in the long run. But I look at the dollar amount the taxes will cost me. I started converting from the funds that had the highest future expected return, again, because I am looking at the taxes as a dollar amount. If I can afford to convert $x of Fund A or $x of Fund B (both with the same value on day of conversion), then I might as well choose the fund with the expected future highest growth. Past earnings in the traditional IRA are irrelevant since the whole withdrawal is taxed as ordinary income.
I mean highest expected (future) returns. The common misconception is that by putting the asset with the highest expected return in a Roth, you get to keep more of the gains. This is just a riskier portfolio since I don't own 100% of a Traditional account, but I do own 100% of a Roth account. An alternative is that I could hold a higher pre-tax allocation to the risky asset if it was in a Traditional account and my after-tax risk would be the same. More discussion in the threads linked from the OP and the wiki entry on Tax-adjusted asset allocation.
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Re: If you tax adjust, how has it changed your life?

Post by grabiner »

letsgobobby wrote:David, it sounds like you're saying the impact of tax adjusting has been extremely small, not enough to make any meaningful difference?
It's a 20% reduction in the dollar amount of any asset class I hold in my Roth IRA, compared to what I would hold with equal weights. At the moment, that affects only REITs, as 10% tax-adjusted versus 8% unadjusted, because I am underweighted in value funds even after adjustment. It had a similar effect on international small-cap when I held International Explorer in my Roth IRA. If I held bonds in my Roth IRA, it would be a more significant adjustment. (Instead, the adjustment is in the other direction and much smaller; I hold bonds in my employer plan, and since my employer plans and taxable account combined are much larger than my Roth IRA, the tax adjustment on the bond fund is closer to the average adjustment on the whole portfolio.)
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market timer
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Re: If you tax adjust, how has it changed your life?

Post by market timer »

Before deciding whether to contribute to a 401K, IRA, or Roth; whether to pay a tax (and up to what bracket) to convert an IRA to a Roth; whether to take out a 401K loan; whether to pay down student loans or invest in a retirement account; and so on, I asked myself what $1 in each of these accounts was worth to me. After making a ballpark estimate, and updating this estimate based on how my career trajectory has panned out, I've valued the accounts accordingly. Tax-adjusted asset allocation is a consequence of this weighting, but it is not the primary reason for the weighting. I sometimes employ strategies across accounts where this weighting matters, e.g., buying EE bonds in my taxable account and hedging the interest rate risk in my retirement account.

As it turns out, since I retired in my 30s, I now view my traditional IRA/401K the same as my Roth. I expect to convert from my IRA to my Roth without paying any taxes. My initial estimate was to discount the 401K by about 15%.
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grabiner
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Re: If you tax adjust, how has it changed your life?

Post by grabiner »

market timer wrote:Before deciding whether to contribute to a 401K, IRA, or Roth; whether to pay a tax (and up to what bracket) to convert an IRA to a Roth; whether to take out a 401K loan; whether to pay down student loans or invest in a retirement account; and so on, I asked myself what $1 in each of these accounts was worth to me.
And that is actually a good way of looking at tax adjustment. When I rolled over an old employer plan to an IRA, I had to make the decision whether to convert to a Roth. This decision was based on the tax-adjusted value; was it better for me to have $40,000 in a traditional IRA and $13,500 in a taxable account, or $40,000 in a Roth IRA and the $13,500 used to pay taxes? (7.95% state, 28% federal but with the state tax deducted, for an overall rate of 33.7%) This wasn't specifically an asset allocation decision, but the tax adjustment is the reason that I was willing to let my net worth decline by $13,400; the tax-adjusted net worth went up slightly, assuming that I will retire in Maryland in a 25% tax bracket.
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