Do you adjust your asset allocation for future taxes?

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Do you take the future taxes of your investments into consideration when calculating your AA?

No, I calculate my asset allocation purely based on the numbers that are in the accounts
52
76%
Yes, I calculate my asset allocation by first discounting tax-deferred accounts for the taxes I expect to pay, but I do not discount my taxable accounts for the capital gains I expect to pay.
6
9%
Yes, I calculate my asset allocation by first discounting both the tax-deferred accounts for the taxes I expect to pay and my taxable accounts for the capital gains I expect to pay.
7
10%
Other
3
4%
 
Total votes: 68

Bfwolf
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Do you adjust your asset allocation for future taxes?

Post by Bfwolf » Fri Dec 20, 2013 8:30 pm

In tax deferred accounts, the government owns a percentage of your account. If you have $1,000,000 in a traditional IRA, the reality is that you own $750,000 and the government owns $250,000 (or whatever split your retirement tax bracket will entail).

In taxable accounts, capital gains you've earned will be taxable when you sell unless you're in the 15% federal bracket.

Do you take this into account in your asset allocation and discount tax-deferred $s and capital gains when calculating what percentage of your money is in each asset class? Thus, if you're like many Bogleheads and have tax-deferred accounts full of bonds and taxable accounts full of stocks, what might look like a 40/60 stock/bond split to the naked eye would actually be 50/50 after taking into account the taxes that will be owed.

longinvest
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Re: Do you adjust your asset allocation for future taxes?

Post by longinvest » Fri Dec 20, 2013 8:38 pm

"Other": I opted to use an equal location across my taxable, tax-deffered, and tax-free accounts as it eliminates this problem and simplifies rebalancing.

Edited: I change my answer to no. This has effectively nothing to do with asset location.
Last edited by longinvest on Fri Dec 20, 2013 11:16 pm, edited 2 times in total.
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LadyGeek
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Re: Do you adjust your asset allocation for future taxes?

Post by LadyGeek » Fri Dec 20, 2013 8:40 pm

I don't adjust my allocation for taxes. We've got 6+ pages of discussion in this thread: Delete Wiki [Article] on Tax-Efficient Asset Location

Take a look at the notices at the top of: Principles of tax-efficient fund placement
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longinvest
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Re: Do you adjust your asset allocation for future taxes?

Post by longinvest » Fri Dec 20, 2013 8:45 pm

Here's another Wiki entry: http://www.bogleheads.org/wiki/Tax-Adju ... Allocation

Maybe this one needs a critics section, as I suspect many Bogleheads to disagree with it.

Edited: Or maybe I should read the warning at the top: "Adjusting your asset allocation based on taxation may have significant unintended consequences. Tax rates change, tax brackets change, or your tax preferences may change. What was a logical tax location one year may turn out to be a poor choice a few years later. Consider the implications carefully." :)
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manwithnoname
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Re: Do you adjust your asset allocation for future taxes?

Post by manwithnoname » Fri Dec 20, 2013 8:59 pm

Even though I am in the 25% bracket my effective tax rate is 5%. Posters who believe that the IRS owns 25% of your income because you are in the 25% marginal bracket are vastly overstating how much will be paid in taxes. According the AARP median income in retirement is 50 to 65% of preretirement income for retirees age 65.

I don't know how anyone could reliably determine that a retiree with a $1M retirement account would be paying 25% in taxes instead of the 15% rate without more information. RMD at 70 1/2 would be about 36.6K. A married couple with $92.5k in taxable income claiming the standard deduction would pay an effective rate of less than 11%.

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Re: Do you adjust your asset allocation for future taxes?

Post by Bfwolf » Fri Dec 20, 2013 9:14 pm

Manwithnoname,

Shouldn't the tax-deferred account withdrawals be viewed as the last $s out when thinking about effective taxation rate? The alternative to pulling out the tax-deferred $s would be to pull out $s from accounts that have already been taxed. Thus, by having tax-deferred accounts and taking distributions from them (I realize these are often RMDs), you are incurring the last bit of taxable income that you wouldn't have incurred otherwise. As opposed to other taxable income sources in retirement like Social Security and pensions which should be viewed as the first items in the bucket from a tax rate perspective.

So while the tax-deferred $s coming out may not all be at your marginal tax bracket (e.g. you are only $10K into the 25% tax bracket but have $30K of IRA distributions), they would at least be the MOST taxed of your income $s.

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Re: Do you adjust your asset allocation for future taxes?

Post by Bfwolf » Fri Dec 20, 2013 9:25 pm

Just to be clear, as a couple of posts seemed confused:

This poll is not about which asset class should you put in which asset location.

It's about whether you take the future taxes inherent in asset location into account when calculating your asset allocation percentages.

manwithnoname
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Re: Do you adjust your asset allocation for future taxes?

Post by manwithnoname » Fri Dec 20, 2013 9:36 pm

Bfwolf wrote:Manwithnoname,

Shouldn't the tax-deferred account withdrawals be viewed as the last $s out when thinking about effective taxation rate? The alternative to pulling out the tax-deferred $s would be to pull out $s from accounts that have already been taxed. Thus, by having tax-deferred accounts and taking distributions from them (I realize these are often RMDs), you are incurring the last bit of taxable income that you wouldn't have incurred otherwise. As opposed to other taxable income sources in retirement like Social Security and pensions which should be viewed as the first items in the bucket from a tax rate perspective.

So while the tax-deferred $s coming out may not all be at your marginal tax bracket (e.g. you are only $10K into the 25% tax bracket but have $30K of IRA distributions), they would at least be the MOST taxed of your income $s.

How do you know what is taxed at the highest marginal rate if you are receiving minimum retirement distributions, SS benefit and investment income all distributed though out the year? Any portion of the income from the above sources can be taxed at the highest or lowest tax rates. That's why effective tax rate Is only way to determine what the actual tax rate is because it averages the income taxed at a level tax rate.

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Re: Do you adjust your asset allocation for future taxes?

Post by Johm221122 » Fri Dec 20, 2013 9:43 pm

I don't adjust my portfolio for taxes.Either I will adjust when I can roll over my 401 or have a plan to pay as little tax as possible
John

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TheTimeLord
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Re: Do you adjust your asset allocation for future taxes?

Post by TheTimeLord » Fri Dec 20, 2013 9:48 pm

Bfwolf wrote:In tax deferred accounts, the government owns a percentage of your account. If you have $1,000,000 in a traditional IRA, the reality is that you own $750,000 and the government owns $250,000 (or whatever split your retirement tax bracket will entail).

In taxable accounts, capital gains you've earned will be taxable when you sell unless you're in the 15% federal bracket.

Do you take this into account in your asset allocation and discount tax-deferred $s and capital gains when calculating what percentage of your money is in each asset class? Thus, if you're like many Bogleheads and have tax-deferred accounts full of bonds and taxable accounts full of stocks, what might look like a 40/60 stock/bond split to the naked eye would actually be 50/50 after taking into account the taxes that will be owed.
Since I can change the location of the assets by selling and purchasing funds I fail to see the real value. Besides who knows what tax brackets or capital gains rates will be in 15 or 20 years. There definitely seems to be a push to tax unearned income more aggressively.
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market timer
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Re: Do you adjust your asset allocation for future taxes?

Post by market timer » Fri Dec 20, 2013 10:08 pm

I view $1 in a Roth the same as $1.20 in taxable or $1.20 in tax deferred. Will calculate exchange rates again in a few years, as more information arrives about my wealth and tax rate in retirement.

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Re: Do you adjust your asset allocation for future taxes?

Post by cfs » Fri Dec 20, 2013 10:17 pm

Thanks for asking. No, I calculate my asset allocation purely based on the numbers that are in the accounts. Thanks for reading and have a Merry Christmas.
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Re: Do you adjust your asset allocation for future taxes?

Post by abuss368 » Fri Dec 20, 2013 10:18 pm

I voted for "no". I balance based on the fund values.
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Re: Do you adjust your asset allocation for future taxes?

Post by grabiner » Fri Dec 20, 2013 10:47 pm

market timer wrote:I view $1 in a Roth the same as $1.20 in taxable or $1.20 in tax deferred. Will calculate exchange rates again in a few years, as more information arrives about my wealth and tax rate in retirement.
That would be a 17% tax rate; do you expect your rate to be that low, and are you adjusting for average or marginal rates?

I figure my allocation based on a 25% federal tax rate (my expected retirement bracket; I'm now in the 28% bracket) and 8% state tax rate (Maryland's tax is almost flat), so that's a 31% net tax rate on ordinary income, 21% on qualified dividends and capital gains. I adjust by marginal rates because this is relevant to my asset allocation decisions; if I gain $1000 in my traditional retirement account and lose $690 in my Roth, I will have the same amount to spend in retirement. This leads me to discount my traditional accounts by 31%, and my taxable by 28%.
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LH
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Re: Do you adjust your asset allocation for future taxes?

Post by LH » Fri Dec 20, 2013 11:12 pm

No

As far as I can tell, the best expectation for a boglehead, is to pay near zero taxes at withdrawal, to around 10 or 15 percent.

HSA money
Roth money

taxable money with basis, then pay cap gains of 15-20 on the gain part

IRA money - taxed at marginal rate, BUT taxable basis money, and I think Roth money, doesnt count. and first X thousand of money is taxed at zero.

etc.
etc.

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Re: Do you adjust your asset allocation for future taxes?

Post by letsgobobby » Sat Dec 21, 2013 12:25 am

I don't numerically adjust anything. But since most of my fixed income is in traditional, and my Roths are all small caps and value, I just keep in mind that my asset allocation looks a little less risky than it actually is. Since my 'on the surface' AA is pretty conservative, it kind of works out to be 'about right'. I try not to obsess about this particular issue.

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market timer
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Re: Do you adjust your asset allocation for future taxes?

Post by market timer » Sat Dec 21, 2013 1:05 am

grabiner wrote:
market timer wrote:I view $1 in a Roth the same as $1.20 in taxable or $1.20 in tax deferred. Will calculate exchange rates again in a few years, as more information arrives about my wealth and tax rate in retirement.
That would be a 17% tax rate; do you expect your rate to be that low, and are you adjusting for average or marginal rates?

I figure my allocation based on a 25% federal tax rate (my expected retirement bracket; I'm now in the 28% bracket) and 8% state tax rate (Maryland's tax is almost flat), so that's a 31% net tax rate on ordinary income, 21% on qualified dividends and capital gains. I adjust by marginal rates because this is relevant to my asset allocation decisions; if I gain $1000 in my traditional retirement account and lose $690 in my Roth, I will have the same amount to spend in retirement. This leads me to discount my traditional accounts by 31%, and my taxable by 28%.
I'm intentionally using the term exchange rate to avoid confusion with tax rates--the two issues are separate in my mind. What I mean by the exchange rate is the number of extra dollars in a taxable account or 401K that would make me indifferent to losing $1 in a Roth. Therefore, it is a marginal concept, not based on averages. This exchange rate certainly depends on expected marginal tax rates, but there are other aspects as well. For example, in the case my income falls, I can convert my 401K to a Roth at a lower tax rate. In other words, my 401K becomes relatively more valuable in bad scenarios; since I'm risk averse, that means I should value the 401K above what would be implied by expected tax rates. It is also worth considering various means-testing programs (Social Security, college tuition, student loan repayment, Obamacare, etc.) in this exchange rate calculation.

Your calculation appears to make sense for your situation. I believe you have a more stable career and more years of savings. In my case, there is a reasonably good chance I'll be able to convert my 401K to a Roth at close to 0% tax. However, it's also possible I'll end up in a significantly higher bracket. I view my scalar of 1.2 as my best guess of first decimal point precision, but will definitely calculate with more precision when the time comes to convert to a Roth or withdraw.
Last edited by market timer on Sat Dec 21, 2013 1:15 am, edited 1 time in total.

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Re: Do you adjust your asset allocation for future taxes?

Post by nedsaid » Sat Dec 21, 2013 1:12 am

I actually think this is a pretty good idea.

Don't do this myself for several reasons. 1) Most of my investments are in tax-deferred accounts. 2) Since most of my investments are in effect deferred wages, I want my future paychecks to be as large as possible. I invest for maximum gain within the level of risk I am willing to take. 3) Future tax rates and my future tax situation is pretty hard to predict. 4) I think investors sometimes get obsessed with taxes and take their eye off the investing ball. People sometimes tie themselves in knots over taxes. 5) This can needlessly complicate your investing decisions.

An alternative strategy would be tax diversification. Have taxable, tax-deferred, and tax free accounts. Picking which type of accounts to take distributions from and how much distribution to take from each type of account is a great way to manage your taxes in retirement. So open a Roth if you can. If you are over the income limits to contribute to a Roth, consider Roth conversions. But only do Roth conversions if they make sense in your situation.

So my short answer to the question is no I do not.
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Re: Do you adjust your asset allocation for future taxes?

Post by Rodc » Sat Dec 21, 2013 9:47 am

Almost all my investing is in tax deferred accounts so does not really apply.

So, No.
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Re: Do you adjust your asset allocation for future taxes?

Post by MooreBonds » Sat Dec 21, 2013 10:17 am

Bfwolf wrote:In tax deferred accounts, the government owns a percentage of your account. If you have $1,000,000 in a traditional IRA, the reality is that you own $750,000 and the government owns $250,000 (or whatever split your retirement tax bracket will entail).

In taxable accounts, capital gains you've earned will be taxable when you sell unless you're in the 15% federal bracket.

Do you take this into account in your asset allocation and discount tax-deferred $s and capital gains when calculating what percentage of your money is in each asset class? Thus, if you're like many Bogleheads and have tax-deferred accounts full of bonds and taxable accounts full of stocks, what might look like a 40/60 stock/bond split to the naked eye would actually be 50/50 after taking into account the taxes that will be owed.
I do try this to a certain degree indirectly. My goal is to fund a 50 year retirement by living off primarily from the dividends/distributions from my diversified investments (more individual stocks currently compared to Bogleheads, but will slowly transition to relatively more indexing as time goes on). As such, my focus is more on taxation of cash flow as opposed to overall allocation in mind (especially since I plan on keeping 85% equities for quite a while) - but I definitely allocate to minimize both my current and future net tax impact, and keep taxes in mind when looking at overall portfolio positions.

So, for those stocks/ETFs that pay 100% or nearly 100% qualified dividends AND yield below 3%, they're kept in my taxable accounts. I also keep foreign stocks/ETFs that have more than 12% foreign tax credits (and which have high % of qualified dividends) in my taxable accounts, as well as all MLP holdings. For qualified dividend payers that yield > 3% and all non-qualified dividend payers (REITs, BDCs, bond ETFs, foreign/domestic stock ETFs), I keep in my tax advantaged/tax-deferred accounts, with the highest yielding ones in my ROTH/HSA (since those have the potential to be tax-free upon withdrawal).

When I retire, I will move all qualified dividend payers (if they still have qualified dividends at that time) into my taxable accounts to utilize the 15% max tax rate on qualified dividends, and to fund my retirement, with a likely SEPP on some retirement accounts to provide supplemental income until 59 1/2.

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Re: Do you adjust your asset allocation for future taxes?

Post by Doc » Sat Dec 21, 2013 11:09 am

Why do we have an asset allocation anyway?

1) We want our stock allocation to be just high enough that we have enough retirement income without incurring any more risk than needed.

or

2) We want to control our risk/reward so it is on the "sweet spot" of the CAPM efficiency frontier and if that doesn't give enough for what we want for retirement we either save more or reduce our expectations for the good life.

If you are in the #1 camp use your expected future marginal tax rate to adjust. If you are in the #2 camp use current marginal tax rates (MTR) changing the rates as necessary along with your periodical rebalancing.

Guys, which rate probably doesn't matter. We can't define the effect of a five to ten percent difference in AA anyway. Take a stab at it. Use an average. But just because tax rates are uncertain doesn't mean that we shouldn't make the adjustment. It's an easy calculation to make. ROTH = 0; tIRA/401k = (1-MTR); Taxable = 1-UnrealizedGains*(LTCG taxrate). EXCEL is not required.
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Re: Do you adjust your asset allocation for future taxes?

Post by dbr » Sat Dec 21, 2013 11:17 am

You also have to argue why the "correct" asset allocation for a tax adjusted portfolio should be exactly the same as the "correct" asset allocation for the unadjusted portfolio. Unless you specify how you arrive at asset allocations first, it makes no sense to discuss whether or not you should tax adjust the assets. Reichenstein, for example, if I understand correctly, works within the context of optimizing an after tax utility function. That is perfectly rational, but is more than just telling people to tax adjust their allocations. He is also telling people how they should determine the allocation those adjusted assets should have.

I, for example, hold bonds in tax deferred at a higher imputed tax cost than my stocks in taxable. Hypothetically I have chosen a 50/50 allocation unadjusted and have a 60/40 allocation adjusted. However, I also feel that a 60/40 allocation is correct for an adjusted allocation because once the burden of paying taxes has been taken into account I feel I want to take more risk with my investments. The result is that if I add the perspective that I should tax adjust the allocation I do not arrive at the conclusion that I should therefore make any changes in the actual nominal amounts of money invested anywhere.

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Re: Do you adjust your asset allocation for future taxes?

Post by Van » Sat Dec 21, 2013 11:22 am

Come on man......relax. This seems like OCD to me.

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Re: Do you adjust your asset allocation for future taxes?

Post by dbr » Sat Dec 21, 2013 11:23 am

Van wrote:Come on man......relax. This seems like OCD to me.
You have that right, but it is just an interesting discussion to those who want to pursue it.

I think the results in the poll speak for themselves.

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Re: Do you adjust your asset allocation for future taxes?

Post by MooreBonds » Sat Dec 21, 2013 11:28 am

Van wrote:Come on man......relax. This seems like OCD to me.
If someone's portfolio is lopsided with 90% in taxable or 90% in tax deferred or 90% tax-free (ROTH and possibly HSA), then I don't think it's necessarily OCD, since we all know how taxes can play a large role in portfolio management and distributions, and spending just a few hours thinking about something like this can truly be worth tens of thousands of dollars in tax penalties or benefits that you otherwise wouldn't have encountered. Seems like a very worthwhile justification of time to me!!!

But if your assets are more balanced between taxable/tax-deferred/tax-free, then it's not as much of an issue.

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Re: Do you adjust your asset allocation for future taxes?

Post by stlutz » Sat Dec 21, 2013 11:35 am

Since I can change the location of the assets by selling and purchasing funds I fail to see the real value. Besides who knows what tax brackets or capital gains rates will be in 15 or 20 years.
Good point! This question really only impacts those in the distribution phase and who have significant retirement account assets. At that point, one will know what their tax rate will be and can easily make allocation adjustments as needed.

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Re: Do you adjust your asset allocation for future taxes?

Post by DonCamillo » Sun Dec 22, 2013 11:11 pm

I have enough Social Security to pay my Federal Taxes, and keep my state Vanguard Muni Bond Fund at a level that will pay my State and Local Taxes. If Federal tax liability exceeds SS, I will invest more in Treasuries and TIPS. So I allocate specifically for taxes. Most of my other bills are also matched with specific dividend paying investments in the appropriate industry, like utility stocks to pay my utility bills. I mostly did this just because I could. The majority of my savings are in index funds, allocated to US equity, foreign equity, and bonds, plus a real estate fund. I am in the process of moving future investments towards the three fund portfolio. I am also pretty well diversified between tax deferred, Roth, muni, and taxable accounts.

MooreBonds said that he is planning to fund a 50 year retirement. I am planning to fund a 15 year retirement from age 75 to age 90.
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