Tax efficiency or Asset Allocation

[coachd50]

In situations where you these might result in opposing choices, which would take precedence?

I currently have a 75/25 asset allocation, and I am working to bring it to 70/30 or 65/35 through new contributions in my 457b. My plan allows for both pretax and Roth contributions, So I have contributed to both in a manner to remain in the 12% bracket.
My breakdown is as follows

Taxable Broakerage 31% of total portfolio
Fidelity s&P fund 21.3%
Fidelity zero total stock market 3.9%
Fidelity Treasury MM fund 6.4% (about a year's worth of expenses)

Fidelity Roth IRA 38% of total portfolio
Fidelity S&P fund (same as above) 20.3%
Fidelity Extended market index 8.25%
Fidelity International index 4.0%
Fidelity US Bond Index 4.25%
Individual TIPS (bought small amount just to see how it works without any tax consequences) 1%

I Bonds- 7 % of total portfolio

Fidelity Traditional IRA 2% of total portfolio
Fidelity US Bond Index 1.3%
TIPS 0.7%

The remaining 22% of the portfolio is in the 457 accounts- which started in 2020 (prior to that, my school district's 457 options had over 3% in fees and no match so I didn't contribute.

457 Pre Tax Contributions about 15% of total portfolio.
Ishares Total US Stock 10%
*****Ishares US Aggregate Bond 3.75 ****
Ishares Total International 1.25%

457 Roth Contributions about 7% of total portfolio
Ishares Total US stock 4.1%
Ishares US Aggregate Bond 2%
Ishares Total International 0.7%

The simplest method to get to the desired 70/30 or 65/35 would be to exchange some of the Pretax ishares total US Stock with some of the Ishares us aggregate Bond. However, my particularly plan doesn't work that way. Exchanges or sales etc are done across both Pretax and Roth- meaning that if I do the exchange, while I reduce my equity holding and increase my bond holding in the tax efficient Pre Tax portion, I ALSO reduce my equity holding (and increase my bond holdings) in the Roth portion which is not really what I want to do.

What I am currently doing is making PreTax contributions and then only buying the Ishares US Aggregate Bond fund with 100% of the contribution. However, to go from 75/25 to 70/30 It would take the entire year of maxed out contributions. I only need about 6 months of pretax contributions to put myself at the top of the 12% bracket for the end of the year.

To make matters even a bit murkier, my rough draft tax return shows that I can contribute the full $7.000 to my Roth IRA- which would optimally be used to purchase an equity index fund- taking me further from the desired Asset

Any thoughts on this rambling, thinking out loud while composing post and situation?

[miket29]

Fidelity Roth IRA 38% of total portfolio
Fidelity S&P fund (same as above) 20.3%
Fidelity Extended market index 8.25%
Fidelity International index 4.0%
Fidelity US Bond Index 4.25%
Individual TIPS (bought small amount just to see how it works without any tax consequences) 1%

A side note, but since the Roth is tax-free forever and has no RMD it is better to put assets with the highest growth potential into it. That means no bonds. See the wiki entry https://www.bogleheads.org/wiki/Tax-eff ... _placement

[coachd50]

Fidelity Roth IRA 38% of total portfolio
Fidelity S&P fund (same as above) 20.3%
Fidelity Extended market index 8.25%
Fidelity International index 4.0%
Fidelity US Bond Index 4.25%
Individual TIPS (bought small amount just to see how it works without any tax consequences) 1%

A side note, but since the Roth is tax-free forever and has no RMD it is better to put assets with the highest growth potential into it. That means no bonds. See the wiki entry https://www.bogleheads.org/wiki/Tax-eff ... _placement

Yes, I am aware-- it is actually the crux of my post. I don't have the Pre Tax Space for the bonds. I am looking for ways to fix some past less optimal decisions

[retired@50]

Yes, I am aware-- it is actually the crux of my post. I don't have the Pre Tax Space for the bonds. I am looking for ways to fix some past less optimal decisions

To me, asset allocation should always be priority #1.

Asset location is a secondary decision. So, you want more bonds and they have to go in a "second best" place since there isn't room in a tax-deferred account. Your choices are Roth or taxable. If you're in a high tax bracket, then using a Vanguard tax-exempt muni bond fund in your taxable account could work. Otherwise, you're probably better off using some of your Roth space for the additional bond funds.

Regards,

[rockstar]

My take away these days is that asset allocation only matters if it gives the desired behaviors. You have a year plus of fixed income between your taxable and I bonds. If something bad happens, you can sell it. So the question is: is a year sufficient?

The rest of your fixed income will reduce volatility, but it’s not like you can easily access it and sell it. How does volatility impact your behavior?

[Navillus1968]

I currently have a 75/25 asset allocation, and I am working to bring it to 70/30 or 65/35 through new contributions in my 457b.

How far out from retirement are you?
There is essentially no difference between your current 75/25 AA and your desired 70/30 and only a small difference when you reach 65/35. Assuming you are not planning on retiring in the next 5 years or so, I wouldn't sweat the small details of AA.

What I am currently doing is making PreTax contributions and then only buying the Ishares US Aggregate Bond fund with 100% of the contribution. However, to go from 75/25 to 70/30 It would take the entire year of maxed out contributions. I only need about 6 months of pretax contributions to put myself at the top of the 12% bracket for the end of the year.

This plan makes a lot of sense to me- it allows you to buy more bonds in pre-tax 457 without buying any in your Roth 457.

If making Roth IRA contributions leads to your AA drifting towards 80/20, then I would just rebalance into bonds in your Roth IRA. You are in the enviable position of having a ~45% Roth portfolio while still working, prior to any Roth conversions! One of the minor downsides is that your pre-tax space is limited, since taxable is another 31%. Talk about your First World Problems...
In the 12% bracket, tax-free municipal bonds in taxable are definitely not the answer, so bonds in Roth IRA is how you fix your AA.

ETA- I noticed you mentioned making a $7,000 Roth IRA contribution- that implies you are under age 50, yes? Unless you are a candidate for FIRE, I wouldn't worry about having a 75/25 AA in my 40s.
Additionally, your maxed out Trad 457 contribution is more than 3 times larger than your Roth IRA contribution, so your AA should move towards 70/30 even if you put the Roth IRA money in a stock ETF/MF. I think you're OK with your current plan.

[bonesly]

Exchanges or sales etc are done across both Pretax and Roth- meaning that if I do the exchange, while I reduce my equity holding and increase my bond holding in the tax efficient Pre Tax portion, I ALSO reduce my equity holding (and increase my bond holdings) in the Roth portion which is not really what I want to do.

This proportional forced allocation among Trad and Roth 401k sub-accounts does not also apply to purchases? That's a new case to me then... I've heard where either: a) they're tied together for everything (contributions, rebalancing, and withdrawals), or they're completely separate. I've not yet heard of one where only exchanges and withdrawals (presumably that is "sales" that are withdrawn from the account) are tied, but new money going in can be allocated independently of Trad vs Roth.

Anyway, since that's some weird situation you've got there, I'd take advantage of the fact that you can allocate contributions independently to get to your desired AA. I agree with Retired@50 that getting the right AA is higher priority than Tax-Efficient Fund Placement of those fund (it's important but I wouldn't let tax-efficiency trump being on-target for desired AA).

[retiredjg]

As often happens, I agree with retired@50 and bonesly.

Your asset allocation (stock to bond ratio) determines your risk level. It is far more important than asset location.

It is nice, when all things are equal, to have only stocks in your Roth accounts. But other things are often not equal. When it needs to be done, having some bonds in a Roth account is of too little importance to worry about. It's like not having sprinkles on your cake.

Do whatever you need to do to get to your desired stock to bond ratio.

[coachd50]

Exchanges or sales etc are done across both Pretax and Roth- meaning that if I do the exchange, while I reduce my equity holding and increase my bond holding in the tax efficient Pre Tax portion, I ALSO reduce my equity holding (and increase my bond holdings) in the Roth portion which is not really what I want to do.

This proportional forced allocation among Trad and Roth 401k sub-accounts does not also apply to purchases? That's a new case to me then... I've heard where either: a) they're tied together for everything (contributions, rebalancing, and withdrawals), or they're completely separate. I've not yet heard of one where only exchanges and withdrawals (presumably that is "sales" that are withdrawn from the account) are tied, but new money going in can be allocated independently of Trad vs Roth.

I may not be explaining it well.
For example, right now I am contributing roughly the max amount ($1280, twice a month= 30720- just under the 31,000 max allowed for a 50 year old. Currently all of my contributions are Pre Tax- and right now, I am using 100% of each contribution to purchase the ishares aggregate bond fund.

In the Past, I had those purchases proportionally allocated 75/25 bewtween the Ishares total US stock, the ishares international, and the Ishares aggregate bond fund.

Generally the beginning of the year was all Pretax contributions, then once I had contributed enough (usually about half of the allowed max) to ensure I would be at the top of the 12% tax bracket, I would elect for the contributions to be Roth. This practice has left me with the portfolio I desccribed

[coachd50]

I currently have a 75/25 asset allocation, and I am working to bring it to 70/30 or 65/35 through new contributions in my 457b.

How far out from retirement are you?
There is essentially no difference between your current 75/25 AA and your desired 70/30 and only a small difference when you reach 65/35. Assuming you are not planning on retiring in the next 5 years or so, I wouldn't sweat the small details of AA.

Actually, I am eligible for early retirement in 18 months, and full retirement in 5 and a half years.

What I am currently doing is making PreTax contributions and then only buying the Ishares US Aggregate Bond fund with 100% of the contribution. However, to go from 75/25 to 70/30 It would take the entire year of maxed out contributions. I only need about 6 months of pretax contributions to put myself at the top of the 12% bracket for the end of the year.

This plan makes a lot of sense to me- it allows you to buy more bonds in pre-tax 457 without buying any in your Roth 457.

If making Roth IRA contributions leads to your AA drifting towards 80/20, then I would just rebalance into bonds in your Roth IRA. You are in the enviable position of having a ~45% Roth portfolio while still working, prior to any Roth conversions! One of the minor downsides is that your pre-tax space is limited, since taxable is another 31%. Talk about your First World Problems...
In the 12% bracket, tax-free municipal bonds in taxable are definitely not the answer, so bonds in Roth IRA is how you fix your AA.

ETA- I noticed you mentioned making a $7,000 Roth IRA contribution- that implies you are under age 50, yes? Unless you are a candidate for FIRE, I wouldn't worry about having a 75/25 AA in my 40s.
Additionally, your maxed out Trad 457 contribution is more than 3 times larger than your Roth IRA contribution, so your AA should move towards 70/30 even if you put the Roth IRA money in a stock ETF/MF. I think you're OK with your current plan.

Yes, I am a candidate to retire early. Potentially in 18 months, if not than in 5 years and 6 months.

My first concern is that as I mentioned, getting to the asset allocation via contributions would take a full year of contributions. I wouldn't necessarily need to make a full year of PreTax contributions to ensure being in the 12% bracket. That's why it just isn't all simple and pretty. Right now, with the guarantee of the 12% bracket, I will probably only designate half of my 457 contributions as pre tax.

[Navillus1968]

I think the solution is to split your 401k contributions 50/50 between Trad & Roth & put 100% of the contributions into a bond fund until your desired 70/30 AA is reached. Your Roth IRA contribution could also be invested in bonds, if you wanted to reach your new AA a little faster.

Rules of thumb about keeping bond in tax-deferred always assume you have space available- in your case, I think bonds in Roth are better than bonds in taxable since your TIRA is already full of bonds.

Do you have a target AA at retirement? Depending on various factors (pension, portfolio of 25X vs 35X spending, spousal SS at 62, etc.), a 70/30 AA at the start of retirement could be a bit aggressive. You might consider further re-balancing/re-allocation towards 60/40? Just a thought. Retiring in your mid-50s puts additional stress on a portfolio vs doing it at 60-65.

[coachd50]

I think the solution is to split your 401k contributions 50/50 between Trad & Roth & put 100% of the contributions into a bond fund until your desired 70/30 AA is reached. Your Roth IRA contribution could also be invested in bonds, if you wanted to reach your new AA a little faster.

Rules of thumb about keeping bond in tax-deferred always assume you have space available- in your case, I think bonds in Roth are better than bonds in taxable since your TIRA is already full of bonds.

Do you have a target AA at retirement? Depending on various factors (pension, portfolio of 25X vs 35X spending, spousal SS at 62, etc.), a 70/30 AA at the start of retirement could be a bit aggressive. You might consider further re-balancing/re-allocation towards 60/40? Just a thought. Retiring in your mid-50s puts additional stress on a portfolio vs doing it at 60-65.

I also might purchase another $10,000 in I bonds- but that would come from my MM fund and so it wouldn't really shift the allocation.

I will be receiving (hopefully, who knows with the political climate) a teacher's pension. If I retire in 18 months, that will be early retirement, and the benefit payment will likely be just about my current annual expenses. The problem, the pension is not Cost of Living Adjusted. So covering 95% of my expenses in 2026 doesn't mean the same will be good in the future. Also, I anticipate some lumpy expenses down the road. Likely will be getting my "last" car - Prepping for home maintenance/repairs, ridiculously skyrocketing home owners insurance.

In 5 and 1/2 years, the pension will be more than 100% of my average expenses the last decade or so- and also my portfolio will hopefully have 2 commas. So clearly that is a better financial option, BUT man would it be nice to be free from work in June of 2026...lol.

[babystep]

I wouldn’t change much in this case for AA. Assets are about 15x. A pension worth 1x per year is equivalent to about 25x (or whatever multiple) in bonds. Even if it’s nominal, it would still be around 12x in bonds over 25 years with ~3% inflation.

Take an easy number for math, consider the pension as 15x then you are already about 50/50.

I would make sure to contribute to a Roth IRA due to the lower 12% tax bracket, all going to stocks. All 457 contributions could be allocated to bonds.