Tax Efficiency Bucket Question (Bonds in Tax Advantaged or Taxable Account)

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jimmy2017
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Tax Efficiency Bucket Question (Bonds in Tax Advantaged or Taxable Account)

Post by jimmy2017 » Wed Oct 04, 2017 5:10 pm

Hi All,
I know everyone says to "Put your bonds in tax advantaged accounts since it's more efficient. Put stocks in taxable." I understand why that makes sense from a pure TAX point-of-view (eg you get taxed on bond dividends every year in taxable but not tax advantaged account), but I don't understand why that makes sense from a PRACTICAL (or lifestyle) point-of-view. A few thoughts:
-For tax advantaged accounts, I'm not taking money out until retirement, so I think I should go 100% stocks (vtsax) since I have 30 years
-A taxable account is the money I'm going to take out before retirement (buying a car, house, vacations, etc). As such, I need access to money in my taxable account before retirement, thus I do not want that money to be volatile since I may be taking it out in 2 to 5 to 10 years. As such, it makes the most sense to have bonds (VBTLX) in my taxable accounts since they are less volatile, provide better returns than a savings account, and I can take them out anytime for these purchases.
-Why would I put bonds in my tax advantaged retirement accounts that I cannot access until I'm 59.5? Most of my reason for bonds is having safer short-to-medium-term returns on funds I'll access before retirement.

[Note: Above I'm considering most tax advantaged accounts to be retirement accounts like 401K or IRA, thus not being able to take this money out before retirement. I realize some tax advantaged accounts you can get money out before retirement (eg roth iras), but I don't think I want to be withdrawing money out of my roth IRA before retirement & losing out on free growth over the decades...thus, I don't think I would place my bonds there either.]

As such: I hold mostly bonds in my taxable account and 100% stocks in my tax advantaged retirement accounts. I realize it's not the most tax efficient, but it makes sense to have safer assets in my taxable account for early withdrawals and riskier/higher yield assets in my retirement accounts for after 59.5.

I would love to hear your thoughts on above since I want to be more tax efficient, but I'm just not seeing the practical application of it.
Thanks!

ThriftyPhD
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Re: Tax Efficiency Bucket Question (Bonds in Tax Advantaged or Taxable Account)

Post by ThriftyPhD » Wed Oct 04, 2017 5:17 pm

If you treat all of your accounts as one portfolio, you can spend stocks in taxable and rebalance in tax advantaged to maintain your asset allocation.

A simple example. You have a 401k with $100k, and a taxable account with $100k. You want a 50:50 stock:bond balance.

Code: Select all

$100k stocks in taxable. 
$100k bonds in 401k. 
Now you need to take out $20k for $REASONS. Sell $20k of stocks in taxable.

Code: Select all

$80k stocks taxable.
$100k bonds 401k.
Now, rebalance by selling bonds in 401k to buy stocks.

Code: Select all

$80k stocks taxable.
$90k bonds, $10k stocks 401k.
Or, if you want to have only 'sold' bonds, then transfer $20k stocks to bonds, but this will change your AA

Code: Select all

$80k stocks taxable.
$80k bonds, $20k stocks 401k.
So you essentially have pulled the money out of your bond portion, even though the only thing you sold in taxable was stocks.

That said, this only works if your accounts are big enough. If you have $50k in taxable and will need $50k in 2 years, better to keep in something with a much more stable value.

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neurosphere
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Re: Tax Efficiency Bucket Question (Bonds in Tax Advantaged or Taxable Account)

Post by neurosphere » Wed Oct 04, 2017 5:24 pm

jimmy2017 wrote:
Wed Oct 04, 2017 5:10 pm
-A taxable account is the money I'm going to take out before retirement (buying a car, house, vacations, etc). As such, I need access to money in my taxable account before retirement,
No a taxable account is NOT for money you are going to take out before retirement. Or it could be. Or it's a mix.

When one suggests bonds in retirement accounts, the assumption is that one is talking about an overall portfolio which is designed to be FOR RETIREMENT. That is, long term investing. If you need money next year for a car, and the year after for a home down payment, then these funds are not for retirement, and thus are for something else. In which case, things like shorter term bonds or CDs or a host of other such investments are fine. They HAVE To be in taxable accounts, to avoid tax/penalties when the money is needed.

Assume for a moment you only retirement space was an annual IRA contribution. No way to retire on $5500/year savings. So your retirement savings would be forced to be mostly in taxable accounts. And thus your claim that taxable accounts represent money which will be taken out "before retirement" is not correct.
-- Real name: Sotirios Keros. If you have to ask "Is a Target Retirement fund right for me?", the answer is yes.

mega317
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Re: Tax Efficiency Bucket Question (Bonds in Tax Advantaged or Taxable Account)

Post by mega317 » Wed Oct 04, 2017 5:47 pm

The example from ThriftyPhD is a good one. The other factor to add is that your taxable account needs to be large enough to do this. If it's all stock then it could drop significantly at any time. If that happens will there be enough left to buy what you want? If the answer is no you could delay the purchase, or else you need some more stable assets in taxable accounts.

My own taxable money is allocated such that if stocks dropped by half, I would have enough left for some upcoming expenses and my "emergency fund". At present that's about 60% stock, 40% municipal bond funds.

livesoft
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Re: Tax Efficiency Bucket Question (Bonds in Tax Advantaged or Taxable Account)

Post by livesoft » Wed Oct 04, 2017 6:02 pm

One will have more tax-loss harvesting opportunities with volatile tax-efficient equity funds in taxable than they would with bonds in taxable. It turns out it is very good to lose money from time to time -- especially when you can make other taxpayers pay for your losses. This is just another way that the wealthy get wealthier.
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abuss368
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Re: Tax Efficiency Bucket Question (Bonds in Tax Advantaged or Taxable Account)

Post by abuss368 » Wed Oct 04, 2017 8:58 pm

Hi Jimmy2017 -

There is nothing incorrect or wrong with having an allocation to bonds in a taxable account. Depending on your tax bracket or investment preference, you can select Total Bond Index or Intermediate Term Tax Exempt.

Much more importance is placed on living below your means, saving, investing, keeping investment cost low, don't time the market or try to pick the best investment, and select a reasonable asset allocation based on your timeframe, goals, and tolerance for risk.

We are dancing on the head of a needle!
John C. Bogle: "You simply do not need to put your money into 8 different mutual funds!" | | Disclosure: Three Fund Portfolio + U.S. & International REITs

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