Bond Allocation Doesn’t Fit In Tax-Deferred Accounts

[CityOfAngels]

Hi everyone. I've come up with the following asset allocation but had a couple of questions. I only have $200k in my tax-deferred accounts, which won't meet the 20% bond allocation ratio. I can either continue with a smaller than 20% bond allocation or move some bonds into my taxable accounts. Any thoughts on what's preferred?

[delamer]

Bonds in taxable.

Tax optimization is a good goal, but it should not force you to deviate from your preferred allocation.

[retiredjg]

If it does not fit, you need to hold bonds or other fixed income assets (CD's) in taxable.

See if I bonds might work for you (info in the Wiki).

[Artsdoctor]

You'd want to choose your desired asset allocation first, and then decide where you're going to the money.

If your bond fund choices are good in your 401k, then you can put your fixed income there.

However, many would choose the Roth as a place to put assets which might appreciate the most since you'll be paying nothing to take those funds out later in life.

There's nothing wrong at all with putting bonds in a taxable account but you'll need to figure out what your marginal investment rate might be (federal and state) in order to decide if you're better off with tax-exempt bonds in the taxable account.

[sometimesinvestor]

Are you from California.? IF so it seems likely that you should have tax free bonds from California . Your Portfolio seems large enough that you are ina bracket where tax free isa good idea.OF course if we knew the stock market will continue to up a do nothing strategy will work best but of course we don't know that.i

[zztr87]

1. That's right ... if bonds have to spill over into the taxable portion, so be it.
2. Tax free bonds (e.g. munis) may or may not help you. It all depends on your marginal tax brackets. Calculate the tax-equivalent yields and compare.

[stan1]

What are your ages? What tax bracket federal and state are you in? What are your annual contributions to each account?

The difference between 20% bonds and 16% bonds won't make a difference in the short term. If you are working and will be maxing out two retirement accounts for decades more the "problem" may take care of itself just because you'll be contributing more to the retirement accounts. This might be the case for example if the assets in the taxable account are from a windfall.

If you are retired and your marginal tax rate is 22% ... that might be a different answer.

[StevieG72]

I have the same issue, use Vangaurd High Yield Tax Exempt bonds in my taxable account.

[CityOfAngels]

What are your ages? What tax bracket federal and state are you in? What are your annual contributions to each account?

The difference between 20% bonds and 16% bonds won't make a difference in the short term. If you are working and will be maxing out two retirement accounts for decades more the "problem" may take care of itself just because you'll be contributing more to the retirement accounts. This might be the case for example if the assets in the taxable account are from a windfall.

If you are retired and your marginal tax rate is 22% ... that might be a different answer.

We're in our early 30s. The highest tax bracket for this year and likely the next few years. We both max out our IRA/401(k).

[Artsdoctor]

If you're in the highest marginal tax bracket, it's not unusual to fill up your tax-advantaged accounts and need taxable space. You'll almost certainly benefit from tax-exempt bond funds in your taxable account. You probably won't have much in the Roth because of limitations related to income anyway although your age should convince you that growing your assets in your Roth as much as possible would probably dictate equities in the Roth, at least for now.

[nix4me]

Bonds? 30 years old? No way I would invest in bonds that young.

[stan1]

We're in our early 30s. The highest tax bracket for this year and likely the next few years. We both max out our IRA/401(k).

So $19K x 2 plus $6000 x 2 = $50K per year into the retirement accounts. So you'd have to be putting at least $200K/year into your taxable account each year to be losing ground on getting to your desired 80/20 allocation.

Does either of your employers allow after tax contributions to a retirement plan (up to $56,000 in total each, but many employers do not offer this).

If you still want to buy bonds in taxable I'd probably use CA or NY muni bond funds if you are in either state because they are exempt from both federal and state tax and you'd be up very close to 50% marginal tax rate if you are in California. Other choices are national muni bonds (exempt from federal tax), treasury bonds (exempt from state tax) or total bond market (fully taxable). You can look at tax equivalent yield for your tax rates but which one is "best" changes with time and a lot of the time they are close.

[grabiner]

We're in our early 30s. The highest tax bracket for this year and likely the next few years. We both max out our IRA/401(k).

In CA in that tax bracket, I would prefer holding CA munis in taxable and stock in tax-deferred.

The reason is that you pay 33.1%-36.1% tax (depending on your CA tax bracket of 9.3%-12.3%) on the qualified dividends and long-term gains you get from stock index funds; this is more than twice the normal tax cost. Meanwhile, your effective tax cost for holding CA munis is the same as anyone else's; it is the difference between yields of munis and taxable bonds of the same risk level.

If CA munis are priced to break even with taxable bonds at a 25% tax rate, then the effective tax cost of Vanguard CA Long-Term Tax-Exempt Admiral Shares (1.66% SEC yield) is 0.53%. The tax cost of Vanguard Total Stock Market (1.96% yield) is 0.65%-0.71%, plus the tax on capital gains when you sell.

[clown]

Time will fix this. At your age, you have plenty of time. Direct your tax-efficient contributions into BND. Problem solved.

Poster NIX4ME has stated that an investor in his 30's should have Zero in Bonds. With all due respect to NIX4ME, his/her opinion may work for him/her but is immaterial with regards to you. Pick the allocation that you believe is right FOR YOU, and ignore posters who feel compelled to impose their opinion upon you as if they had THE only answer. No other poster can tell you what's right FOR YOU.

[Dandy]

I prefer having some fixed income (and equities)in both taxable and tax advantaged accounts. Muni's or Treasuries mitigate (if you have state income tax) some tax concerns. It also helps to give you options to rebalance either account type. Naturally you usually want mostly fixed income in tax advantaged and mostly equities in taxable.

[quisp65]

I know nothing .... but what I have an opinion on is... people invest too much in bonds during their working years considering what bonds are making. If you still got 7-10 years of work left, have it all in equity.

Note since 1949 the market has at least hit a high at least every 7 years..... so at about 7-10 years away from retirement... that's when it makes sense to put some in fixed income.

https://en.wikipedia.org/wiki/Closing_m ... _S%26P_500

[nix4me]

I know nothing .... but what I have an opinion on is... people invest too much in bonds during their working years, considering what bonds are making. If you still got 7-10 years of work left, have it all in equity.

Note since 1949 the market has at least hit a high at least every 7 years..... so at about 7-10 years away from retirement... that's when it makes sense to put some in fixed income.

https://en.wikipedia.org/wiki/Closing_m ... _S%26P_500

Exactly.