Is not utilizing taxable space for long-term investing wise?

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ronin
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Is not utilizing taxable space for long-term investing wise?

Post by ronin » Sat Apr 11, 2015 11:28 pm

My wife and I are in are early 40s and have been diligently saving (high six figure portfolio) for retirement using a mix of traditional 401ks and Roth IRAs, but nothing specifically for this goal in taxable accounts. Separately, we do have a comfortable e-fund in a taxable savings account.

We've been so focused on using the 401k and Roth IRA, never giving much thought to using taxable space for efficient funds (total stock index, international, etc.). Is this approach flawed in terms of better tax planning efforts given those 401k withdrawals will be taxed at ordinary rates despite much of the underlying source of the withdrawals would have come from qualified dividends and LT cap gains, which receive preferred tax treatment? Should I open a taxable Vanguard account and start investing in stock index funds there instead? Maybe this is a question of comparing the deferral of higher rates versus the potential of paying lower rates sooner?

We'll be starting up 529s soon for our new family, so there will be yet another non-taxable-space location, but I gather that makes sense for college savings.

I welcome and perspective and/or a referral to another thread if this has been recently explored.

Thanks!

mhalley
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Re: Is not utilizing taxable space for long-term investing w

Post by mhalley » Sat Apr 11, 2015 11:47 pm

I think diversification is wise in all things, so that when you retire, you have the ability to draw on taxable, tax-deferred and tax free accounts to help with keeping your taxes low. Would I not max out my 401k in order to save money in taxable? Probably not. UNLESS I was planning on retiring before 59 1/2, but there are ways to withdraw from retirement plans prior to that, so maybe not even then. Also, don't forget the "stealth" tax savings of an hsa account if you have access to one.
Mike

DSInvestor
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Re: Is not utilizing taxable space for long-term investing w

Post by DSInvestor » Sun Apr 12, 2015 12:21 am

taxable investing for retirement is great once you have maxed out all tax advantaged contribution space. I believe 401k and IRA assets are not considered for college financial aid but 529 and taxable are considered. Make sure you max out 401k and IRA before contributing to 529.

MathWizard
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Re: Is not utilizing taxable space for long-term investing w

Post by MathWizard » Sun Apr 12, 2015 4:50 am

Yes,it is wise.

Certainly ROTH space is wise, because it is almost like taxable, without the taxes in earnings,because you can pull out the contributions at any time without penalty.

Roth 401Ks are almost like regular Roths, but I believe there is a 5 year rule and each
plan may have different restrictions if the 401k has a Roth option.

You certainly should have some, maybe the bulk of your retirement assets in pre-tax.
I was concerned about being able to get at that money before 59 1/2 without penalty if needed,
but the hardship and 72t options really negates that problem.

So I really see no need for taxable beyond a liquid EF, unless you can max out tax-advantaged.

One thing you need to do though, is to value the tax-deferred in your mind as less than full
value when comparing to ROTH or taxable accounts.
You'll want to account for
  • the cost of taxes when you pull the money out,
    the effect of RMDs on your tax bracket
    the effect of pulling from tax-deferred on your SS income.
The last two can be alleviated by Roth conversions between when you retire and when you start
SS (presumably at 70)

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ogd
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Re: Is not utilizing taxable space for long-term investing w

Post by ogd » Sun Apr 12, 2015 12:00 pm

ronin wrote: Is this approach flawed in terms of better tax planning efforts given those 401k withdrawals will be taxed at ordinary rates despite much of the underlying source of the withdrawals would have come from qualified dividends and LT cap gains, which receive preferred tax treatment? Should I open a taxable Vanguard account and start investing in stock index funds there instead? Maybe this is a question of comparing the deferral of higher rates versus the potential of paying lower rates sooner?
I think you forgot to account for the tax deduction you get when contributing.

Say you're in a 25% tax bracket now. For every $100 you save in taxable, you could have put $133 in a tax-advantaged account instead. Regardless of the intervening growth, this extra 33% (or 25% of the pretax amount) is enough to pay 25% ordinary income rates when withdrawing. Any additional taxes you pay in taxable (like dividend and capital gains) only worsen the deal from this point of equivalence.

The only reasons to invest in taxable is 1) if this is money you know you need sooner or 2) if you expect the tax bracket in retirement to be considerably higher than the current tax bracket, which is not the case for most people; even then you'd look into Roth first before taxable. Take note that in retirement you withdraw a good chunk of the money in the lower tax brackets before you reach the marginal bracket, whereas tax-deferred saving is always from the marginal bracket.

patja
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Re: Is not utilizing taxable space for long-term investing w

Post by patja » Sun Apr 12, 2015 12:12 pm

Since you say you are planning to start 529's I would offer a word of caution re: building up a taxable portfolio. College financial aid calculations will count your taxable portfolio against you in their calculations of your ability to contribute to college costs, but they ignore non-taxable retirement savings assets.

staythecourse
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Re: Is not utilizing taxable space for long-term investing w

Post by staythecourse » Sun Apr 12, 2015 12:42 pm

There are too many variables to predict for the future (future ordinary rates, future LTCG rates, dividend tax rates, RMD changes, step up basis law not changing, etc...) to even try to predict what WOULD have been the ideal. Unfortunately, investing like life is done going forward and NOT in the rear view mirror.

I think it is still advisable in order:
1. Eliminate any high yield debt
2. Contribute to get employer match in 401k
3. Contribute to deductible IRA or Roth IRA
4. Finish to max out 401k
5. 529 if going to have kids who go to college
6. Taxable investing

Of course, if HSA is done that should be probably number 3 and everything bumped down.

Now what I would say is there is a cult like mentality or more FEAR of folks on this board of taxable investing to the point they do not make wise investing decisions. I have seen WAY too often on this site folks who don't need the money for 20 years put it in savings bonds (I or EE bonds) instead of just starting a taxable account just because they let the tax tail wag the dog. If one does not need the money for 20 years why would ANYONE put money into a low returning asset class like I or EE bonds? If it was part of their asset allocation that is different, but doesn't seem to be based on many of the posts I have seen.

I have said for a long time it should be EVERBODY'S goal to get to the point they are investing in taxable just because that means the have already checked off 1-5 on the above list which shows excellent saving/ year.

Good luck.
"The stock market [fluctuation], therefore, is noise. A giant distraction from the business of investing.” | -Jack Bogle

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celia
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Re: Is not utilizing taxable space for long-term investing w

Post by celia » Sun Apr 12, 2015 12:44 pm

patja wrote:Since you say you are planning to start 529's I would offer a word of caution re: building up a taxable portfolio. College financial aid calculations will count your taxable portfolio against you in their calculations of your ability to contribute to college costs, but they ignore non-taxable retirement savings assets.
They also ignore the value of your house. So if you plan to remodel or pay down the mortgage, that would be good to do if you will be filing for financial aid.

Since you start applying for financial aid in the spring of the high school senior year, the tax year that is considered runs from the middle of the junior year to the middle of the senior year. So if you plan to shift your assets, you need to do it before then.
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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CABob
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Re: Is not utilizing taxable space for long-term investing w

Post by CABob » Sun Apr 12, 2015 1:02 pm

My guess is that most taxable investment accounts are opened because and after all available tax advantaged accounts have been utilized. I think this is a good thing since I don't recall anyone who reached retirement and were sorry that they had saved/invested so much. The other thing that occurs to me is that when in the withdrawal stage it is desirable to have tax deferred, tax free, and taxable accounts available.
Bob

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Re: Is not utilizing taxable space for long-term investing w

Post by KlangFool » Sun Apr 12, 2015 1:15 pm

TS,

1) Would you be old enough aka around 59 1/2 when your kids go to college?? If yes, does 529 still makes sense?? Or, just use money from your 401K and / or Roth IRA.

2) What if you are forced into early retirement before 59 1/2? Is Roth IRA enough or you need money in Taxable A/C too??

3) I consider threat of long term unemployment and under-employment before 59 1/2 as real and realistic. College education funding has a much lower priority than my family's financial survival. Hence, I do not fund 529. I fund my taxable A/C instead.

KlangFool

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Artsdoctor
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Re: Is not utilizing taxable space for long-term investing w

Post by Artsdoctor » Sun Apr 12, 2015 1:53 pm

If you have no investments in a taxable account, you lose the ability to donate appreciated shares in the future, you lose the ability to tax-loss harvest, and you lose tax diversification in retirement.

It is usually most beneficial to contribute the maximum amount each year to a tax-advantaged account, although even that can be potentially problematic if your 401k has tremendously high fees (funds with high ERs, high administrative costs, etc.); consequently, make sure you understand how much you're "paying" for those 401k's.

ronin
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Re: Is not utilizing taxable space for long-term investing w

Post by ronin » Sun Apr 12, 2015 10:40 pm

Thanks to everyone for their thoughtful responses to this post!

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