30 - Portfolio Strategy - Tax efficiency questions

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ltv
Posts: 3
Joined: Tue Nov 06, 2018 7:09 pm

30 - Portfolio Strategy - Tax efficiency questions

Post by ltv » Wed Nov 07, 2018 3:30 pm

Hi everyone! First I just want to say thanks to this incredible community. I have spent the last few weeks pouring through this forum, and I have to say this has to be one of the most helpful group of people anywhere on the internet.

My wife and I recently have had significant salary increases and I’m looking for some help to make sure we set up our portfolio properly.

Emergency fund: 50k (held in Ally savings)
Down Payment Savings: 100k (also currently held in Ally savings)
Debt: 680k mortgage - 3.75% fixed - 28 years left (currently house hacking - will be a full time rental in the future)
Tax Filing Status: MFJ
Tax Rate (using 2019 income): 37% Federal, 12.3% State
State of Residence: California
Age: 30
Desired Asset allocation: 80% stocks / 20% bonds
Desired International allocation: 30% of stocks


Current retirement assets

All accounts are Vanguard except her 401k
Taxable-170k - cash
His Rollover IRA-77.5k - vanguard target 2055 (VFFVX) (.15%) [this account will get rolled into his new 401k plan before EOY]
His 401k -0- at Vanguard - job starts next week
His Roth IRA-24k - vanguard target 2055 (VFFVX) (.15%)
His Traditional IRA-11k - vanguard target 2055 (VFFVX) (.15%) [this account will get rolled into his new 401k plan before EOY]
Her 401k at Fidelity
110k - Vanguard Target Retirement 2060 Trust I (.07%)
47k Vanguard Target Retirement 2055 Trust I (.07%)
Her Roth IRA-27k - at Vanguard - vanguard target 2055 (VFFVX) (.15%)

Expected 2019 Contributions
19k his pretax 401k +8.5k company match
19k her pretax 401k +6k company match
28.5k in his Aftertax contributions rolled over in-plan to Roth 401k (megaback door roth)
31k in hers Aftertax contributions rolled over in-plan to Roth 401k (megaback door roth)
6k his Roth IRA (back door)
6k her Roth IRA (back door)
200k-250k extra savings (most of this will likely go to a taxable retirement account though it’s still undecided what portion will go towards down payment savings or other potential investments)

Funds available in his 401(k)
I will have this info next week once I start. Plan is administered through Vanguard

Funds available in her 401(k)
DFA US LG CAP VAL (DFLVX) Stock Investments Large Cap 0.37%
FID CONTRAFUND K (FCNKX) Stock Investments Large Cap 0.65%
VANG INST INDEX PLUS (VIIIX) Stock Investments Large Cap 0.02%
VANG EXT MKT IDX INS (VIEIX) Stock Investments Mid-Cap 0.06%
JPM SM CAP GROWTH R6 (JGSMX) Stock Investments Small Cap 0.83%
VAN EM MKT ST IDX IS (VEMIX) Stock Investments International 0.11%
VANG INTL GROWTH ADM (VWILX) Stock Investments International 0.32%
VANG TOT INTL STK IS (VTSNX) Stock Investments International 0.09%
VAN REAL EST IDX IS (VGSNX) Stock Investments Specialty 0.1%
VANGUARD TARGET 2015 Blended Fund Investments* N/A 0.07%
VANGUARD TARGET 2020 Blended Fund Investments* N/A 0.07%
VANGUARD TARGET 2025 Blended Fund Investments* N/A 0.07%
VANGUARD TARGET 2030 Blended Fund Investments* N/A 0.07%
VANGUARD TARGET 2035 Blended Fund Investments* N/A 0.07%
VANGUARD TARGET 2040 Blended Fund Investments* N/A 0.07%
VANGUARD TARGET 2045 Blended Fund Investments* N/A 0.07%
VANGUARD TARGET 2050 Blended Fund Investments* N/A 0.07%
VANGUARD TARGET 2055 Blended Fund Investments* N/A 0.07%
VANGUARD TARGET 2060 Blended Fund Investments* N/A 0.07%
VANGUARD TARGET 2065 Blended Fund Investments* N/A 0.07%
VANGUARD TARGET RET Blended Fund Investments* N/A 0.07%
PIM TOTAL RT INST (PTTRX) Bond Investments Income 0.55%
VANG TOT BD MKT INST (VBTIX) Bond Investments Income 0.04%

Goals and Other Info:
  • Our main goal is to maximize the fortunate situation we are currently in so that we don’t have spend as much time and energy thinking about money in the future. Whether this materializes as early retirement or simply switching to less stressful jobs remains to be seen.
  • We have no issues with our tax bill and understand the wisdom of maximizing after tax returns NOT minimizing the tax bill. The goal is simply to optimize as much as possible with tax efficient asset allocation.
  • Expenses are pretty low but we plan to have kids in 2-4 years which will likely drive up expenses considerably. Between child care and moving to a less sketchy neighborhood our savings rate will definitely be decreasing in the future.
    We plan to purchase another house more suitable for a family around this time (3-5 years) and will be saving for this separately as down payments in our area are considerable.We will keep the existing house as a rental property as it will cash flow nicely
  • With all of the above in mind, I want to keep our portfolio strategy as simple as possible while maintaining the right asset allocation and some semblance of tax efficiency.
Questions:
  1. Where do our bonds go?
    I have spent an inordinate amount of time reading on this topic, but it seems our high tax brackets and significant future ROTH contributions will make the situation somewhat unique.
    My current thinking is to increase the bond allocation in our 401ks by switching to vanguard 2025 target funds, put only equities in the ROTH accounts, and then split the taxable account between total stock market funds and muni bonds to get the overall desired allocation. Thoughts on this?

  2. Timing of contributions
    1. Should the 150k cash sitting in the taxable account be invested all in one lump sum or should I try to do some dollar cost averaging over some short to medium term duration?
    2. Future 401k (both pre and after tax) contributions will be done monthly out of our paychecks, but contributions to our taxable account will be done in lump sums corresponding to bonuses and equity vesting. Does this affect the strategy at all? Is there any concern with buying into the market with lump sums of 30-40k a few times a year?
  3. Maintaining asset allocation as portfolio grows
    One of the things I am most leery of is setting up the portfolio in a way that makes it simple to maintain the right AA in future years. With the rapid increase of funds in the ROTH and taxable accounts I’m nervous that the wrong 401k fund choice will make re-balancing in the future difficult, especially when considering tax efficiency.

Sorry for the long post. I really appreciate any help and insight.

Cheers
Last edited by ltv on Wed Nov 07, 2018 7:26 pm, edited 1 time in total.

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Duckie
Posts: 6016
Joined: Thu Mar 08, 2007 2:55 pm

Re: 30 - Portfolio Strategy - Tax efficiency questions

Post by Duckie » Wed Nov 07, 2018 6:54 pm

ltv, welcome to the forum.
ltv wrote:Age: 30
Desired Asset allocation: 80% stocks / 20% bonds
Desired International allocation: 30% of stocks
This is reasonable. It breaks down to 56% US stocks, 24% international stocks, and 20% bonds.
Current retirement assets
All accounts are Vanguard except her 401k
Taxable-170k - cash
His Rollover IRA-77.5k - vanguard target 2055 (VFFVX) (.15%)
His 401k-0- at Vanguard - job starts next week
His Roth IRA-24k - vanguard target 2055 (VFFVX) (.15%)
His Traditional IRA-11k - vanguard target 2055 (VFFVX) (.15%)
Her 401k at Fidelity
110k - Vanguard Target Retirement 2060 Trust I (.07%)
47k Vanguard Target Retirement 2055 Trust I (.07%)
Her Roth IRA-27k - at Vanguard - vanguard target 2055 (VFFVX) (.15%)
Using target-date funds works when everything is tax-sheltered, but once you add taxable to the mix the target-date funds are less optimal. Plus they don't have your desired AA.
Expected 2019 Contributions
19k his 401k +8.5k company match
19k her 401k +6k company match
28.5k his Aftertax/Roth 401k
28.5k his Aftertax/Roth 401k
6k his Roth IRA
6k her Roth IRA
First, you list "28.5k his Aftertax/Roth 401k" twice. Is one of them hers?

Second, are his or her 401k plans actually Roth 401k or do you mean the contributions will be pre-tax but the after-tax portion will be rolled "in plan" to a Roth 401k sub-account?

Third, you expect to be in the 37% federal tax bracket. That means you are way above the income limits for making direct Roth IRA contributions. Since she has no non-Roth IRA accounts she can easily use the Backdoor Roth IRA method. For him, his rollover IRA and traditional IRA will get in the way because of the dreaded pro-rata rule. He needs to find out if his new 401k will take incoming rollovers. If he rolls his two non-Roth IRA accounts over to his 401k he can use the backdoor method.
Funds available in her 401(k)
The best options are:
  • VANG INST INDEX PLUS (VIIIX) 0.02% -- Large caps, 80% of US stocks
  • VANG EXT MKT IDX INS (VIEIX) 0.06% -- Mid/small caps, 20% of US stocks
  • VANG TOT INTL STK IS (VTSNX) 0.09% -- Complete international stocks
  • VANG TOT BD MKT INST (VBTIX) 0.04% -- US bonds
  • or one of the target-date funds 0.07%
Where do our bonds go?
I have spent an inordinate amount of time reading on this topic, but it seems our high tax brackets and significant future ROTH contributions will make the situation somewhat unique.
My current thinking is to increase the bond allocation in our 401ks by switching to vanguard 2025 target funds, put only equities in the ROTH accounts, and then split the taxable account between total stock market funds and muni bonds to get the overall desired allocation. Thoughts on this?
Put bonds in the pre-tax accounts first and then the Roth accounts and only stocks in the taxable account.
Should the 150k cash sitting in the taxable account be invested all in one lump sum or should I try to do some dollar cost averaging over some short to medium term duration?
Is it $150K or $170K? I'd put a quarter in over the next four months.
Future 401k (both pre and after tax) contributions will be done monthly out of our paychecks, but contributions to our taxable account will be done in lump sums corresponding to bonuses and equity vesting. Does this affect the strategy at all? Is there any concern with buying into the market with lump sums of 30-40k a few times a year?
No.
Maintaining asset allocation as portfolio grows
One of the things I am most leery of is setting up the portfolio in a way that makes it simple to maintain the right AA in future years. With the rapid increase of funds in the ROTH and taxable accounts I’m nervous that the wrong 401k fund choice will make re-balancing in the future difficult, especially when considering tax efficiency.
If you decide that your 401k funds choices aren't what you want, change them. There are no tax consequences switching in a 401k.

After moving his rollover IRA and his traditional IRA into his 401k you would have:
  • Taxable at Vanguard -- $170K -- 36%
    His 401k at Vanguard -- $88K -- 19%
    Her 401k at Fidelity -- $157K -- 34%
    His Roth IRA at Vanguard -- $24K -- 5%
    Her Roth IRA at Vanguard -- $27K -- 6%

ltv
Posts: 3
Joined: Tue Nov 06, 2018 7:09 pm

Re: 30 - Portfolio Strategy - Tax efficiency questions

Post by ltv » Wed Nov 07, 2018 7:55 pm

Duckie, thanks for your response. This whole thing has been pretty overwhelming for me, so I appreciate you taking the time to respond.
Duckie wrote:
Wed Nov 07, 2018 6:54 pm
ltv, welcome to the forum.
Thanks! I've been lurking for quite a long time now, so it feels a bit liberating to come out of the shadows and create an account.


ltv wrote:Current retirement assets
All accounts are Vanguard except her 401k
Taxable-170k - cash
His Rollover IRA-77.5k - vanguard target 2055 (VFFVX) (.15%)
His 401k-0- at Vanguard - job starts next week
His Roth IRA-24k - vanguard target 2055 (VFFVX) (.15%)
His Traditional IRA-11k - vanguard target 2055 (VFFVX) (.15%)
Her 401k at Fidelity
110k - Vanguard Target Retirement 2060 Trust I (.07%)
47k Vanguard Target Retirement 2055 Trust I (.07%)
Her Roth IRA-27k - at Vanguard - vanguard target 2055 (VFFVX) (.15%)
Duckie wrote:
Wed Nov 07, 2018 6:54 pm
Using target-date funds works when everything is tax-sheltered, but once you add taxable to the mix the target-date funds are less optimal. Plus they don't have your desired AA.
This makes sense. I will plan on putting together a comprehensive plan with fund selection once my (his) 401k selections are available for my viewing.


ltv wrote:Expected 2019 Contributions
19k his 401k +8.5k company match
19k her 401k +6k company match
28.5k his Aftertax/Roth 401k
28.5k his Aftertax/Roth 401k
6k his Roth IRA
6k her Roth IRA
Duckie wrote:
Wed Nov 07, 2018 6:54 pm
First, you list "28.5k his Aftertax/Roth 401k" twice. Is one of them hers?
Yes, this has been corrected in the original post.
Duckie wrote:
Wed Nov 07, 2018 6:54 pm
Second, are his or her 401k plans actually Roth 401k or do you mean the contributions will be pre-tax but the after-tax portion will be rolled "in plan" to a Roth 401k sub-account?
The 401k plans are pretax, the after tax portion will be rolled over in-plan (mega back door roth). This has been clarified in the original post.
Duckie wrote:
Wed Nov 07, 2018 6:54 pm
Third, you expect to be in the 37% federal tax bracket. That means you are way above the income limits for making direct Roth IRA contributions. Since she has no non-Roth IRA accounts she can easily use the Backdoor Roth IRA method. For him, his rollover IRA and traditional IRA will get in the way because of the dreaded pro-rata rule. He needs to find out if his new 401k will take incoming rollovers. If he rolls his two non-Roth IRA accounts over to his 401k he can use the backdoor method.
Yes, sorry for not being clear. Current intent is to roll over his non-roth IRAs to his 401k and then use the backdoor method for him and her. This has been clarified in the original post.


ltv wrote:Funds available in her 401(k)
Duckie wrote:
Wed Nov 07, 2018 6:54 pm
The best options are:
  • VANG INST INDEX PLUS (VIIIX) 0.02% -- Large caps, 80% of US stocks
  • VANG EXT MKT IDX INS (VIEIX) 0.06% -- Mid/small caps, 20% of US stocks
  • VANG TOT INTL STK IS (VTSNX) 0.09% -- Complete international stocks
  • VANG TOT BD MKT INST (VBTIX) 0.04% -- US bonds
  • or one of the target-date funds 0.07%
Thanks for the insight. I will use this info when compiling the comprehensive plan


ltv wrote:Where do our bonds go?
I have spent an inordinate amount of time reading on this topic, but it seems our high tax brackets and significant future ROTH contributions will make the situation somewhat unique.
My current thinking is to increase the bond allocation in our 401ks by switching to vanguard 2025 target funds, put only equities in the ROTH accounts, and then split the taxable account between total stock market funds and muni bonds to get the overall desired allocation. Thoughts on this?
Duckie wrote:
Wed Nov 07, 2018 6:54 pm
Put bonds in the pre-tax accounts first and then the Roth accounts and only stocks in the taxable account.
Is this cut and dry or is this a matter where there will be differing opinions?


ltv wrote:Should the 150k cash sitting in the taxable account be invested all in one lump sum or should I try to do some dollar cost averaging over some short to medium term duration?
Duckie wrote:
Wed Nov 07, 2018 6:54 pm
Is it $150K or $170K? I'd put a quarter in over the next four months.
170k - this has been corrected. I assume this means you'd invest 42.5 per month for the next 4 months?


ltv wrote:Maintaining asset allocation as portfolio grows
One of the things I am most leery of is setting up the portfolio in a way that makes it simple to maintain the right AA in future years. With the rapid increase of funds in the ROTH and taxable accounts I’m nervous that the wrong 401k fund choice will make re-balancing in the future difficult, especially when considering tax efficiency.
Duckie wrote:
Wed Nov 07, 2018 6:54 pm
If you decide that your 401k funds choices aren't what you want, change them. There are no tax consequences switching in a 401k.
Not sure why I didn't get this earlier. This makes much more sense, and makes the prospect of self managing my funds and allocations outside of a target dat fund much more manageable.

User avatar
Duckie
Posts: 6016
Joined: Thu Mar 08, 2007 2:55 pm

Re: 30 - Portfolio Strategy - Tax efficiency questions

Post by Duckie » Thu Nov 08, 2018 5:18 pm

ltv wrote:His Rollover IRA-77.5k - vanguard target 2055 (VFFVX) (.15%) [this account will get rolled into his new 401k plan before EOY]
His 401k -0- at Vanguard - job starts next week
His Roth IRA-24k - vanguard target 2055 (VFFVX) (.15%)
His Traditional IRA-11k - vanguard target 2055 (VFFVX) (.15%) [this account will get rolled into his new 401k plan before EOY]
Since you haven't started the new job yet, are you sure you can roll your two IRAs into the new 401k right away? Some companies make you wait months to even be eligible to open a 401k.
ltv wrote:
Duckie wrote:Put bonds in the pre-tax accounts first and then the Roth accounts and only stocks in the taxable account.
Is this cut and dry or is this a matter where there will be differing opinions?
Most people can agree on bonds in pre-tax first. The choice between taxable bonds in Roth accounts versus tax-exempt bonds in taxable will get different opinions.

In general it's better to put assets with higher expected growth (stocks) in Roth accounts and assets with lower expected growth (bonds) in pre-tax accounts. That's because you've already paid the taxes in the Roth accounts so future growth is tax-free.

But tax-exempt bond funds have lower growth than taxable bond funds and can trigger the AMT.

In your case the two of you have plenty of room in your pre-tax accounts to cover your 20% bonds for a while, so it's not an issue yet.
ltv wrote:
Duckie wrote:Is it $150K or $170K? I'd put a quarter in over the next four months.
170k - this has been corrected. I assume this means you'd invest 42.5 per month for the next 4 months?
Yes.

ltv
Posts: 3
Joined: Tue Nov 06, 2018 7:09 pm

Re: 30 - Portfolio Strategy - Tax efficiency questions

Post by ltv » Sun Nov 11, 2018 2:04 pm

ltv wrote:His Rollover IRA-77.5k - vanguard target 2055 (VFFVX) (.15%) [this account will get rolled into his new 401k plan before EOY]
His 401k -0- at Vanguard - job starts next week
His Roth IRA-24k - vanguard target 2055 (VFFVX) (.15%)
His Traditional IRA-11k - vanguard target 2055 (VFFVX) (.15%) [this account will get rolled into his new 401k plan before EOY]
Duckie wrote:
Thu Nov 08, 2018 5:18 pm
Since you haven't started the new job yet, are you sure you can roll your two IRAs into the new 401k right away? Some companies make you wait months to even be eligible to open a 401k.
Yes, I've spoken with HR about this.
ltv wrote:
Duckie wrote:Put bonds in the pre-tax accounts first and then the Roth accounts and only stocks in the taxable account.
Is this cut and dry or is this a matter where there will be differing opinions?
Duckie wrote: Most people can agree on bonds in pre-tax first. The choice between taxable bonds in Roth accounts versus tax-exempt bonds in taxable will get different opinions.

In general it's better to put assets with higher expected growth (stocks) in Roth accounts and assets with lower expected growth (bonds) in pre-tax accounts. That's because you've already paid the taxes in the Roth accounts so future growth is tax-free.

But tax-exempt bond funds have lower growth than taxable bond funds and can trigger the AMT.

In your case the two of you have plenty of room in your pre-tax accounts to cover your 20% bonds for a while, so it's not an issue yet.
Makes sense. Thanks for the insight. Really appreciate your help with this.

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