Merging inheritance with different asset allocation

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bostondan
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Merging inheritance with different asset allocation

Post by bostondan » Thu Sep 21, 2017 11:58 am

We just completed the process of dividing the assets of my late mother between me and my sister. I am wondering about what strategy Bogleheads use for adjusting asset allocation in this situation where I will be merging a large amount of assets with a different AA. I will give general dollar amounts.

I am 32 years old. My wife is 30. Currently, using a three-fund portfolio, we have about $1.3 million invested with an AA of 75/25 (mix of taxable, Roth, 401k). It was previously 80/20, but became 75/25 with addition of some inherited taxable assets (already stepped-up basis, now with significant additional gains so can't be easily sold). I chose not to adjust it back to 80/20.

We now have about $2 million of inherited Roth IRA assets to integrate with our other assets. It is entirely invested in a Fidelity index target retirement date fund, with an approximate AA of 60/40.

We will need to start taking RMDs this year for the inherited IRA. It will be around 2%.

These are the options that I see:

- Immediately rebalance because there is no logical reason to not just have all my money at whatever AA I decided on previously. In this case, I would probably do 75/25, or maybe 70/30 since my need to take risk has probably declined a bit.
- Integrate the assets and leave the new AA at whatever it comes out to. Adjust slowly with RMDs, withdrawals, and new savings to get back to my desired AA (again, probably 75/25 or 7/30).
- Immediately rebalance to somewhere in the middle, then use method two to slowly get back to the desired AA.

The second option is essentially dollar cost averaging. I have never been a big fan of that, but I have also not previously had this amount of money to increase my anxiety level (I'm still not terribly anxious though, so am fine being told not to DCA). The third option is basically hedging, so I don't feel bad either way if the market goes up or down.

None of these AA are terribly different from each other, so it probably doesn't even make a huge difference in the long-term. Thoughts are appreciated. Thanks!
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aristotelian
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Re: Merging inheritance with different asset allocation

Post by aristotelian » Thu Sep 21, 2017 1:20 pm

The rational thing is #1 and just follow your IPS. The only question would be whether the inheritance changes your IPS. Allocation is about need, willingness, and ability to take risk. Does the inheritance change any of these factors?

On the one hand, the inheritance might increase your ability to take risk. If you were OK before with $300K in bonds, arguably you keep your $300k and put the new inheritance in 100% stock without changing your downside risk.

On the other hand, the inheritance reduces your need to take risk. If you were on track with $1.3M, another $2M means you have won the game. The only reason to keep your old allocation would be greed. You also may have less willingness to take risk for emotional reasons - perhaps you do not want to lose money that came from a loved one, or you think preserving their allocation would be a way of honoring their memory.

I would be inclined to reduce my risk exposure due to having won the game. My IPS says that greed is not an acceptable reason for taking risk.

Basically, I am saying you should treat it all as a whole portfolio, but it is perfectly legitimate to take stock and ask how this major windfall changes your plan.

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Re: Merging inheritance with different asset allocation

Post by jebmke » Thu Sep 21, 2017 1:29 pm

If you haven't already done so I would first try to make an objective assessment of where you want your allocation to be going forward. If necessary, park the money in short term assets long enough to do that. Then move it to the desired allocation (I have been through this twice and we moved the amounts all at once). If you add to equity in taxable just be prepared to do tax loss harvesting if the market drops but don't look back with regret. You can't change history.
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NotWhoYouThink
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Re: Merging inheritance with different asset allocation

Post by NotWhoYouThink » Thu Sep 21, 2017 1:31 pm

Just a reminder to keep an eye on the location of assets that are likely to generate taxable dividends. So if you have any bonds in your after-tax accounts, you might want to rebalance that account to equities. You may have already done that.
I'd put it in a spreadsheet, plan the target allocation in each account, and make one big move.

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Kevin M
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Re: Merging inheritance with different asset allocation

Post by Kevin M » Thu Sep 21, 2017 1:47 pm

bostondan wrote:
Thu Sep 21, 2017 11:58 am
- Immediately rebalance because there is no logical reason to not just have all my money at whatever AA I decided on previously. In this case, I would probably do 75/25, or maybe 70/30 since my need to take risk has probably declined a bit.
The first and second sentences here are in conflict (assuming that the AA you decided on previously was not including the inheritance), and the second sentence makes more sense. However, I'd say that your need to take risk has declined significantly, not just a bit.

As I understand it, your portfolio went from $1.3M to $3.3M, so that's a huge increase that gets you much closer to whatever goal you had for $1.3M at 80/20. You should be able to achieve the same goal with a much less risky AA.

Of course your ability to take risk also has increased. I believe the Larry Swedroe guidance is that the lower of your ability, willingness and need to take risk should dominate your decision, which would argue to adjust your allocation to stocks down significantly. In my case, I use willingness to take risk as the deciding factor--it sounds like you have high willingness to take risk, but you may not really know until you see the stock portion of your portfolio decline by 40-50% (I assume you didn't have enough invested in 2008/2009 to really feel the pain).

Another factor to consider is whether or not this changes when you might want to retire, since that also affects your ability and need to take risk.

Kevin
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letsgobobby
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Re: Merging inheritance with different asset allocation

Post by letsgobobby » Thu Sep 21, 2017 1:50 pm

bostondan wrote:
Thu Sep 21, 2017 11:58 am
We just completed the process of dividing the assets of my late mother between me and my sister. I am wondering about what strategy Bogleheads use for adjusting asset allocation in this situation where I will be merging a large amount of assets with a different AA. I will give general dollar amounts.

I am 32 years old. My wife is 30. Currently, using a three-fund portfolio, we have about $1.3 million invested with an AA of 75/25 (mix of taxable, Roth, 401k). It was previously 80/20, but became 75/25 with addition of some inherited taxable assets (already stepped-up basis, now with significant additional gains so can't be easily sold). I chose not to adjust it back to 80/20.

We now have about $2 million of inherited Roth IRA assets to integrate with our other assets. It is entirely invested in a Fidelity index target retirement date fund, with an approximate AA of 60/40.

We will need to start taking RMDs this year for the inherited IRA. It will be around 2%.

These are the options that I see:

- Immediately rebalance because there is no logical reason to not just have all my money at whatever AA I decided on previously. In this case, I would probably do 75/25, or maybe 70/30 since my need to take risk has probably declined a bit.
- Integrate the assets and leave the new AA at whatever it comes out to. Adjust slowly with RMDs, withdrawals, and new savings to get back to my desired AA (again, probably 75/25 or 7/30).
- Immediately rebalance to somewhere in the middle, then use method two to slowly get back to the desired AA.

The second option is essentially dollar cost averaging. I have never been a big fan of that, but I have also not previously had this amount of money to increase my anxiety level (I'm still not terribly anxious though, so am fine being told not to DCA). The third option is basically hedging, so I don't feel bad either way if the market goes up or down.

None of these AA are terribly different from each other, so it probably doesn't even make a huge difference in the long-term. Thoughts are appreciated. Thanks!
similar situation here. i opted for dollar cost averaging but that's in part because my IPS requires that when PE10 is so elevated. some inherited assets in our case are also part of a generation skipping trust with the implication being I must invest for my children's benefit first, not mine. my AA is 60/40. inherited assets total 40/60 now and will be 80/20 over several years.

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Re: Merging inheritance with different asset allocation

Post by livesoft » Thu Sep 21, 2017 1:51 pm

I cannot tell what is going on here. It seems there are enough tax-advantaged assets that can be used to get the overall portfolio Asset Allocation inline with your desires without any capital gains or tax consequences, so that the taxable assets can be dealt with in a rationale tax-efficient manor. So I'd do an initial adjustment right away and then deal with the taxable in a number of ways including a Donor-Advised Fund over the long-term.
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letsgobobby
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Re: Merging inheritance with different asset allocation

Post by letsgobobby » Thu Sep 21, 2017 1:56 pm

also adding that it would be common to keep inherited assets separate from marital assets.

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bostondan
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Re: Merging inheritance with different asset allocation

Post by bostondan » Thu Sep 21, 2017 7:47 pm

livesoft wrote:
Thu Sep 21, 2017 1:51 pm
I cannot tell what is going on here. It seems there are enough tax-advantaged assets that can be used to get the overall portfolio Asset Allocation inline with your desires without any capital gains or tax consequences, so that the taxable assets can be dealt with in a rationale tax-efficient manor. So I'd do an initial adjustment right away and then deal with the taxable in a number of ways including a Donor-Advised Fund over the long-term.
I think this is what I'm going to do. I'll probably move to a 70/30 or 75/25 AA, but use this method to deal with taxable assets over time.

Thanks to all for the thoughts.
“There may be times when we are powerless to prevent injustice, but there must never be a time when we fail to protest.” - Elie Wiesel

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Watty
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Re: Merging inheritance with different asset allocation

Post by Watty » Thu Sep 21, 2017 9:25 pm

If you have a mortgage then you might want to consider paying it off because while it is not exact in a lot of ways a mortgage is like a negative bond in your asset allocation.

A frequent recommendation is to look at all your portfolios combined and then get to your desired asset allocation by putting the investments in the most tax efficient account like in this wiki.

https://www.bogleheads.org/wiki/Tax-eff ... _placement

I think that you could be in a situation though which is an exception to this rule since the inherited IRA belongs to one of you and all the other accounts belong to both of you combined. No one plans on getting divorced but if that should happen then how the inherited IRA was invested could be important because if it was all in one asset class just by random chance it that asset class could be way up or down at the time of a divorce. This is not just to protect the owner of the inherited IRA but also the spouse too. The problem is that in a divorce the asset class that the inherited IRA is in could be way up and your other investments could be underperforming. Combined your portfolios could be doing OK overall but if the spouse only gets half of the underperforming assets that the non-inherited assets are in then that might not be fair to the spouse.

You might want to just put the entire inherited IRA into one of the lifestrategy funds or a target date fund.

https://investor.vanguard.com/mutual-fu ... #/?lang=en

You mentioned dollar cost averaging, since taxes are not an issue in the inherited account you could initially put all the money into a conservative life strategy fund and then gradually move it to a more aggressive life strategy fund. That might not be the mathematically optimal plan but if that lets you sleep well at night it could be a reasonable choice.

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Re: Merging inheritance with different asset allocation

Post by Nearly A Moose » Fri Sep 22, 2017 8:11 am

Sounds like you have a plan in mind now, but if it helps, what would your IPS (regardless of whether it's written or in your head) tell you to do x years from now when you would have "naturally" grown your portfolio to $3.3M?

I don't plan to significantly adjust mine too much more conservatively when I hit that point. (And I'm basically the same age as you.) I would just readjust the ira to match my desired allocation right away and be fine with it. And I'd be around 80/20 to 75/25. (I lean towards the ability to take risk, especially so young; let that money compoubd and we're talking inter generational wealth). But frankly it doesnt make that much difference whether youre at 80/20 or 70/30. Either will do fine, either will hurt in a market downturn, and either will recover if you hold and don't sell.

As others have mentioned, now might be a good opportunity to decide whether you want to deleverage (pay off mortgage), super-fund college savings, start a donor advised fund to flush out taxable gains, etc. No need to make a rash decision, but could be useful to think through.

Finally, my condolences for your loss.

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bostondan
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Re: Merging inheritance with different asset allocation

Post by bostondan » Sat Sep 23, 2017 9:27 am

Nearly A Moose wrote:
Fri Sep 22, 2017 8:11 am
Sounds like you have a plan in mind now, but if it helps, what would your IPS (regardless of whether it's written or in your head) tell you to do x years from now when you would have "naturally" grown your portfolio to $3.3M?
Good question. I think it would tell me to not change anything. I'll probably do 75/25 just because it sounds better to me. I know I haven't suffered a major market crash, but I feel pretty confident that I'll be fine.
Nearly A Moose wrote:
Fri Sep 22, 2017 8:11 am
As others have mentioned, now might be a good opportunity to decide whether you want to deleverage (pay off mortgage), super-fund college savings, start a donor advised fund to flush out taxable gains, etc. No need to make a rash decision, but could be useful to think through.
I don't currently have a mortgage. We are renting from the university associated with the hospital I work at as a physician because they basically provide subsidized housing for staff. It is a two-story brownstone in the middle of Boston that would probably sell for $3+ million, yet we're renting it for dirt cheap relatively speaking. At some point we'll probably buy something, but we're not in a rush because of our current living situation.

Super-funding college savings is an interesting idea. I'm currently saving for college, but not very aggressively.
Nearly A Moose wrote:
Fri Sep 22, 2017 8:11 am
Finally, my condolences for your loss.
Thank you. It is an odd situation to have lost both my parents prematurely. Luckily we have a one year old daughter who has been a blessing.
“There may be times when we are powerless to prevent injustice, but there must never be a time when we fail to protest.” - Elie Wiesel

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Re: Merging inheritance with different asset allocation

Post by Nearly A Moose » Sat Sep 23, 2017 3:11 pm

I haven't run the numbers because I don't have the money lying around to do it, but you're allowed to basically frontload your 529 contributions. Something like $70k at once (you then have to wait a period of I think 5 years, but please dont rely on my post for the details). The upshot is that the money begins accumulating with tax-free gains immediately. So you effectively could fund college today and be done with it. And it gives you another tax-preferred pile of money that can grow. And if it outgrows the educational costs, you can just reassign it to a new eligible beneficiary (you, another kid, grandkid, niece). So it's a useful estate planning piece in that regard.
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Re: Merging inheritance with different asset allocation

Post by Nearly A Moose » Sat Sep 23, 2017 3:13 pm

Also, if you think you might buy a home in like 5 years or something, you might think about setting aside a downpayment fund in a somewhat conservative investment so you're not forced to sell low or something. But at 75/25, youd have $750k in bonds anyway, so presumably you could just raid that if the market is down whenever you buy. But nice find - would love a subsidized brownstone!
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Re: Merging inheritance with different asset allocation

Post by letsgobobby » Sat Sep 23, 2017 6:23 pm

Nearly A Moose wrote:
Sat Sep 23, 2017 3:11 pm
I haven't run the numbers because I don't have the money lying around to do it, but you're allowed to basically frontload your 529 contributions. Something like $70k at once (you then have to wait a period of I think 5 years, but please dont rely on my post for the details). The upshot is that the money begins accumulating with tax-free gains immediately. So you effectively could fund college today and be done with it. And it gives you another tax-preferred pile of money that can grow. And if it outgrows the educational costs, you can just reassign it to a new eligible beneficiary (you, another kid, grandkid, niece). So it's a useful estate planning piece in that regard.
Since he is married, he and his wife can contribute $140k to each child without gift tax consequences. That would probably be enough to 'fully fund' college in many cases, assuming reasonable returns going forward. But since that is less than the current 4 year cost of attendance at many private universities, he would need returns to be higher than cost inflation for that to happen.

Also, the cash is currently in a Roth IRA. Taking out more than the RMDs isn't generally recommended unless the money is needed for spending, since there would be a loss of tax-free status and potentially some loss of liability protections. However, if he were to deposit withdrawals into a 529, he'd maintain some tax-free status and some liability protection. The only downside there would be comingling inherited with marital assets. He might mitigate that by having himself be the owner of the 529s and not having his wife's name on the account. In the event of divorce, there would be a clear path from inherited asset to individual 529. This might offer some protection. But note that I am not a lawyer, and this probably depends quite a bit on state law (community property vs common law state, for example).

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Re: Merging inheritance with different asset allocation

Post by celia » Sat Sep 23, 2017 6:50 pm

bostondan wrote:
Thu Sep 21, 2017 11:58 am
Currently, using a three-fund portfolio, we have about $1.3 million invested with an AA of 75/25 (mix of taxable, Roth, 401k). It was previously 80/20, but became 75/25 with addition of some inherited taxable assets (already stepped-up basis, now with significant additional gains so can't be easily sold). I chose not to adjust it back to 80/20.

We now have about $2 million of inherited Roth IRA assets to integrate with our other assets. It is entirely invested in a Fidelity index target retirement date fund, with an approximate AA of 60/40.
I don't know what you mean by "integrate" the Inherited Roth assets with your own assets. You can't combine it with your own Roth. I hope you don't pull more than your RMD out of the inherited Roth each year, since that tax-free growth is a terrific opportunity that you have inherited. And there is no RMD requirement from the Roth in the year of death. Only an Inherited traditional IRA will have an RMD requirement in year of death if she was over 70.5 and had not taken her own RMD yet. So just think of it as a Roth in a separate account. There is no tax consequence for exchanging all of it for anything you like and in any AA.

Be sure all your new accounts have up-to-date beneficiaries.

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Re: Merging inheritance with different asset allocation

Post by Nearly A Moose » Sat Sep 23, 2017 7:35 pm

letsgobobby wrote:
Sat Sep 23, 2017 6:23 pm
Nearly A Moose wrote:
Sat Sep 23, 2017 3:11 pm
I haven't run the numbers because I don't have the money lying around to do it, but you're allowed to basically frontload your 529 contributions. Something like $70k at once (you then have to wait a period of I think 5 years, but please dont rely on my post for the details). The upshot is that the money begins accumulating with tax-free gains immediately. So you effectively could fund college today and be done with it. And it gives you another tax-preferred pile of money that can grow. And if it outgrows the educational costs, you can just reassign it to a new eligible beneficiary (you, another kid, grandkid, niece). So it's a useful estate planning piece in that regard.
Since he is married, he and his wife can contribute $140k to each child without gift tax consequences. That would probably be enough to 'fully fund' college in many cases, assuming reasonable returns going forward. But since that is less than the current 4 year cost of attendance at many private universities, he would need returns to be higher than cost inflation for that to happen.

Also, the cash is currently in a Roth IRA. Taking out more than the RMDs isn't generally recommended unless the money is needed for spending, since there would be a loss of tax-free status and potentially some loss of liability protections. However, if he were to deposit withdrawals into a 529, he'd maintain some tax-free status and some liability protection. The only downside there would be comingling inherited with marital assets. He might mitigate that by having himself be the owner of the 529s and not having his wife's name on the account. In the event of divorce, there would be a clear path from inherited asset to individual 529. This might offer some protection. But note that I am not a lawyer, and this probably depends quite a bit on state law (community property vs common law state, for example).
Good point about being married. I was assuming OP has enough in his taxable account earmarked for long term savings that he could pull from that without issue. Obviously not a one size fits all approach, and certainly not one to rush into.
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Re: Merging inheritance with different asset allocation

Post by bostondan » Sat Sep 23, 2017 9:19 pm

letsgobobby wrote:
Sat Sep 23, 2017 6:23 pm
Also, the cash is currently in a Roth IRA. Taking out more than the RMDs isn't generally recommended unless the money is needed for spending, since there would be a loss of tax-free status and potentially some loss of liability protections. However, if he were to deposit withdrawals into a 529, he'd maintain some tax-free status and some liability protection. The only downside there would be comingling inherited with marital assets. He might mitigate that by having himself be the owner of the 529s and not having his wife's name on the account. In the event of divorce, there would be a clear path from inherited asset to individual 529. This might offer some protection. But note that I am not a lawyer, and this probably depends quite a bit on state law (community property vs common law state, for example).
I do not plan to take out more than the RMDs. I will more likely use personal income and non-inherited assets to fill the college funds in a tax-efficient manner. The first RMD is required this year.

I'm not terribly worried about the marital aspect of all these things. Most of this money is held within a trust for which I am the beneficiary and one of the trustees. My wife is the other trustee, but I am allowed to replace her. Her parents similarly will be providing her inheritance in trust, hopefully not for a very long time though.
“There may be times when we are powerless to prevent injustice, but there must never be a time when we fail to protest.” - Elie Wiesel

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