I'm hearing conflicting advice on putting bonds in tax-protected accounts....?

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TheBogleWay
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I'm hearing conflicting advice on putting bonds in tax-protected accounts....?

Post by TheBogleWay » Wed May 17, 2017 2:43 am

Hey Guys,

So. On this forum I have heard the following:

1) In your tax protected accounts, specifically your Roth IRA, that's where your bond allocation should go. The reason? Because BND gives you dividend gains routinely, and if it's in something like a Roth IRA, you don't have to claim those gains as income, and you don't have to pay taxes on them. Makes sense right....

However on a call with Vanguard a few weeks ago, one very nice person gave me an alternative point of view, which is this:

2) In your tax-protected account, specifically your Roth IRA, you want the 'best performing' funds. The reason? Because a Roth IRA is designed so that you can claim gains tax free.. therefore, you want the most gains possible in your Roth. That also makes sense...



If it matters, I'm a single guy, as an employee, young, just saving for the long term future like anyone else. I also think my split is 60/30/10 US, INTL, and BND. Why? I don't know, it sounds good and the forum doesn't tell me it's a bad idea lol.



What do I do? Should I split up my Roth IRA investments to mimic my taxable accounts, as in.. 60% total US, 30% total international, and 10% bond? Or, should I go 100% bonds in my Roth IRA and make that my entire bond allocation, keep things like total US and total International in my normal taxable account?

Lou354
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Re: I'm hearing conflicting advice on putting bonds in tax-protected accounts....?

Post by Lou354 » Wed May 17, 2017 4:51 am

You're right. There is no clear answer whether it's best to put all bonds in tax-advantaged accounts. It depends a lot on the difference in expected returns of stocks vs bonds; how long-term capital gains, qualified dividends, and ordinary income are taxed now and at various times in the future; and the tax rates of you and maybe your beneficiaries and heirs at different points in time. So, in other words, a lot of guess work.

You mention a Roth IRA and a taxable account. Do you have a tax-deferred account like a 401k as well? If the choice is between putting bonds in a tax-deferred or a tax-free account, tax-deferred is better. Though even then some would say it doesn't matter as long as you properly account for differences in how the accounts are taxed.

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JonnyDVM
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Re: I'm hearing conflicting advice on putting bonds in tax-protected accounts....?

Post by JonnyDVM » Wed May 17, 2017 5:17 am

Past bond returns were decent, meaning they threw off a lot of taxable dividends so it was logical to keep them in tax advantaged. Presently the returns on bonds are modest at best. Since the gains are small, keeping them in taxable space is not the sin it was once considered.

While I keep bonds in both taxable and tax advantaged I don't keep any in my ROTH.
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celia
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Re: I'm hearing conflicting advice on putting bonds in tax-protected accounts....?

Post by celia » Wed May 17, 2017 5:30 am

I have not heard of the term "tax-protected" and wonder what it could be. Perhaps you mean "tax-advantaged"? That term could apply to any account that is not a plain old "taxable" account.

In general, there are 3 kinds of accounts as far as taxes go:
1. Taxable. This account is taxed each year on interest, dividends, and capital gains. Examples: checking, savings that you want to be able to spend at any time, or a trust account.
2. Tax-deferred. This account accepts contributions that haven't been taxed. Distributions from this account will be taxed instead, unless the money is used for some goal, such as a Health Savings Account that is to be used for health costs, and retirement plans such as a 401K, 457, 403(b), traditional IRA.
3. Roth. This account accepts contributions that have already been taxed. Distributions from this account are tax-free if the account has been open 5 years and the account owner is over 59.5.

As far as bonds, you can put them in any of these accounts. If you only have one kind of account, of course, that is where your bonds will be. But if you have all three kinds of accounts, it is more tax-efficient to put the bonds in the tax-deferred account, because bonds will not be taxed favorably in taxable, compared to dividends and long term capital gains. They would also take up space in the Roth that probably can be better used for stocks that will grow more.

We have a wiki page that talks about WHERE each type of asset should be placed. Before trying to figure that out, you should already know your desired Asset Allocation, like 80% stocks, 20% bonds. See: https://www.bogleheads.org/wiki/Tax-eff ... _placement

dcabler
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Re: I'm hearing conflicting advice on putting bonds in tax-protected accounts....?

Post by dcabler » Wed May 17, 2017 5:54 am

One thing I haven't seen addressed is whether placing bonds in tax advantaged accounts while in distribution phase still makes sense, especially for an early retiree who isn't yet at the point of taking RMDs. Sort of combining two themes of which accounts(s) to withdraw from first and in which accounts to hold different types of assets...

livesoft
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Re: I'm hearing conflicting advice on putting bonds in tax-protected accounts....?

Post by livesoft » Wed May 17, 2017 6:51 am

If you don't pay income taxes, then it almost doesn't matter what you have in what account, but ...

Be VERY CLEAR that there are at least THREE kinds of accounts with tax consequences and they were listed by celia. Two of them are included in the tax-advantaged term: tax-deferred and Roth.

livesoft wrote:I put this in another thread and it applies to you as well:

Here are some guiding principles that I use:

1. If you have a taxable account:
Only a few funds in taxable that are tax-efficient and their tax-loss harvesting partners:
Total US / Large-cap US (a TLH partner)
Total Int'l / and a TLH partner
IJS (small-cap value) this one is reasonably tax efficient, but may not be needed in taxable if small-cap value fits in your Roth IRA (see next)
Nothing else in taxable [but see point 4 below about tax-exempt bond funds]

2. If you have Roth IRAs:
The Roths can have bond funds, but probably should not. So Roths have the same things as taxable [see above], but also as needed your tilts [if you want them]: REITs, small-cap emerging, small-cap value, small-cap foreign

3. If you have Tax-deferred (401(k), traditional IRA:
All your fixed income (bond funds)
Plus any and all funds found in your taxable account and Roths [see above] as needed to fulfill your desired asset allocation as needed and for rebalancing purposes
All rebalancing will be done in your LARGEST tax-deferred account. The smaller tax-deferred accounts will have one fund in them, probably a bond fund.

4. In case one's bond allocation is so high that it completely fills tax-deferred, then do that. This means more bonds go in taxable as tax-exempt bonds and some in Roth IRAs. The tax-deferred accounts become mostly set-and-forget bond funds and rebalancing is done in Roth IRAs and some in taxable.

Those are the guiding principles, so what can YOU come up with?


So if you don't have a taxable account, see what happens?

And if you don't have a Roth account, see what happens?

And if you don't have a tax-deferred account, see what happens?

If you understand and fill out your own tax returns, then I think you will have a better understanding of taxes incurred by investment accounts. (Yes, that's saying if you understand taxes, then you understand taxes.)
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Re: I'm hearing conflicting advice on putting bonds in tax-protected accounts....?

Post by LukeHeinz57 » Wed May 17, 2017 7:13 am

In this interest rate environment, I'm in the "Bonds go in taxable camp" now you shouldn't do this because I do it. You should continue to read until you know what you are doing and why. If unsure and you need to make a decision today splitting it up is fine or going with the classic asset location strategy cited in the Bogleheads wiki above.

But I believe there is something to be said for putting your investments with the highest expected return in your tax free Roth and HSA accounts.

Further complicating matters is this: What funds are available to you in your company 401k? If the only bond funds are wretched with expense ratios over .50% but you have access to a low-cost index fund in the 401k, then that's really going to push you to keep your bonds in taxable...and vice versa. So gather up all the variables and think on it for a little bit you'll come to a sensible conclusion I'm sure.

Here's a good link that will walk you through some of the math to figure out what's best for your situation.

https://whitecoatinvestor.com/asset-loc ... n-taxable/
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Re: I'm hearing conflicting advice on putting bonds in tax-protected accounts....?

Post by LukeHeinz57 » Wed May 17, 2017 7:34 am

Gilgamesh, thank you for the link to the Kitces article above. I'd not seen that one and after skimming, it looks like he really covers all the bases in analyzing this topic. Including accounting for After Tax values of your accounts in keeping an allocation consistent with your desires. Which is often neglected.

I think this is actually a sneaky advantage of keeping Bonds in tax-deferred, it "tricks" investors into maintaining a little more aggressive asset allocation without feeling like they are. You may think you are 60/40 and rebalance accordingly, but in a real sense you are actually 67/33 if all of your bonds are in your 401k and you're going to be in a 25% bracket...

Finally, I do think there is a real psychological difference between seeing your liquid after tax investments fluctuate wildly and your "I'm not going to touch this for 30 years retirement money" going up and down. That leads to real behavioral considerations which I think for some investors favors bonds in taxable. I know my own mother who is 60 now never sold equities in her 401k. Through 2000-2002 and 2008-2009 and up until just a few years ago she was 100% Stocks in her 401k. That money wasn't to be touched in any way in her mind. But when her "safe" bonds in her relatively speaking, very small after-tax account went down 5% she was asking me why. :shock:
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Re: I'm hearing conflicting advice on putting bonds in tax-protected accounts....?

Post by rkhusky » Wed May 17, 2017 8:54 am

I have most of my bonds in tax-deferred (mainly AAA & Gov't), some in Roth (mainly corporate), and some tax exempt bonds in taxable because of 30% marginal tax rate. The latter are part of my short term and intermediate term emergency fund, but are also counted as part of my asset allocation.

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celia
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Re: I'm hearing conflicting advice on putting bonds in tax-protected accounts....?

Post by celia » Wed May 17, 2017 3:25 pm

dcabler wrote:One thing I haven't seen addressed is whether placing bonds in tax advantaged accounts while in distribution phase still makes sense, especially for an early retiree who isn't yet at the point of taking RMDs. Sort of combining two themes of which accounts(s) to withdraw from first and in which accounts to hold different types of assets...

Yes, It can be challenging when just starting your career or starting your retirement. I have been doing Roth conversions and don't have much left in traditional IRAs. The little I have is in bonds but I also now have bonds in Roth.

A lot of people also make their Asset Allocation more conservative when near or in retirement. So that can mean more bonds than they are used to. But once you are retired and have a comfortable Asset Allocation, you probably want to take withdrawals or RMDs such that you will still maintain your desired Asset Allocation. Since stocks tend to grow faster than bonds, you will probably withdraw more in stocks.
A dollar in Roth is worth more than a dollar in a taxable account. A dollar in taxable is worth more than a dollar in a tax-deferred account.

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Re: I'm hearing conflicting advice on putting bonds in tax-protected accounts....?

Post by ray333 » Wed May 17, 2017 3:36 pm

100% equity in Roth
100% equity taxable

Bonds will go in my tIRA when I can no longer contribute to Roth. As I age, I'll reallocate in the Roth to maintain what I've gained over 10-20 years

dcabler
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Re: I'm hearing conflicting advice on putting bonds in tax-protected accounts....?

Post by dcabler » Wed May 17, 2017 8:32 pm

celia wrote:
dcabler wrote:One thing I haven't seen addressed is whether placing bonds in tax advantaged accounts while in distribution phase still makes sense, especially for an early retiree who isn't yet at the point of taking RMDs. Sort of combining two themes of which accounts(s) to withdraw from first and in which accounts to hold different types of assets...

Yes, It can be challenging when just starting your career or starting your retirement. I have been doing Roth conversions and don't have much left in traditional IRAs. The little I have is in bonds but I also now have bonds in Roth.

A lot of people also make their Asset Allocation more conservative when near or in retirement. So that can mean more bonds than they are used to. But once you are retired and have a comfortable Asset Allocation, you probably want to take withdrawals or RMDs such that you will still maintain your desired Asset Allocation. Since stocks tend to grow faster than bonds, you will probably withdraw more in stocks.


It's "conventional wisdom" to place bonds in tax advantaged accounts and stocks in taxable accounts. I can see how that might make some sense during the accumulation years, though there are some practical issues with that. For example, suppose that 60% of your holdings are in taxable accounts and 40% of your holdings are in your tax advantaged accounts, but you want an overall asset allocation of 40% stocks and 60% bonds. It means that you can't 100% follow the conventional wisdom and will need to hold some bonds in your taxable account. Such are guidelines vs. "rules", I suppose. :D

Anyway, my real point had to do with once you're in retirement and are now withdrawing. Specifically, if you retire early and want to wait until age 70 1/2 before starting RMD's. There are many articles about which accounts to withdraw from first, second, etc. But they never discuss the asset allocation of each of those accounts. If, for example, I have a 50/50 portfolio and follow the conventional wisdom of 50% bonds in tax advantaged accounts and 50% stock in taxable accounts AND I follow a second conventional wisdom of withdrawing from taxable accounts first, then I'm withdrawing only from my stock allocation. Each time I do that, I must then sell some bonds in my tax advantaged accounts to buy more stock in order to get my overall AA back to 50/50. Over time, my tax advantaged account will eventually match my desired 50/50 allocation as my taxable account depletes. It does work, but it isn't at all clear to me that this is the best way to go. In my case, I-ORP, for example, shows withdrawals from both taxable and tax advantaged accounts (albeit not a huge amount from the tax advantaged account) pretty early on once retirement starts.

I guess I'm looking for something comprehensive that both takes into account the location of each asset type (taxable or tax advantaged) when one is withdrawing from accounts after retirement, if it happens that there is a different answer for one who is in accumulation mode vs. decumulation mode. I'd love to be in the situation where I could drain everything in my IRAs into Roths over time, but based on when I plan to retire and running several calculators and spreadsheets on my own, there doesn't appear to be a big in advantage in my case for the Roth conversions. ...sigh...

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celia
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Re: I'm hearing conflicting advice on putting bonds in tax-protected accounts....?

Post by celia » Wed May 17, 2017 9:02 pm

dcabler wrote:Anyway, my real point had to do with once you're in retirement and are now withdrawing. Specifically, if you retire early and want to wait until age 70 1/2 before starting RMD's. There are many articles about which accounts to withdraw from first, second, etc. But they never discuss the asset allocation of each of those accounts. If, for example, I have a 50/50 portfolio and follow the conventional wisdom of 50% bonds in tax advantaged accounts and 50% stock in taxable accounts AND I follow a second conventional wisdom of withdrawing from taxable accounts first, then I'm withdrawing only from my stock allocation. Each time I do that, I must then sell some bonds in my tax advantaged accounts to buy more stock in order to get my overall AA back to 50/50. Over time, my tax advantaged account will eventually match my desired 50/50 allocation as my taxable account depletes. It does work, but it isn't at all clear to me that this is the best way to go. In my case, I-ORP, for example, shows withdrawals from both taxable and tax advantaged accounts (albeit not a huge amount from the tax advantaged account) pretty early on once retirement starts.

I guess I'm looking for something comprehensive that both takes into account the location of each asset type (taxable or tax advantaged) when one is withdrawing from accounts after retirement, if it happens that there is a different answer for one who is in accumulation mode vs. decumulation mode. I'd love to be in the situation where I could drain everything in my IRAs into Roths over time, but based on when I plan to retire and running several calculators and spreadsheets on my own, there doesn't appear to be a big in advantage in my case for the Roth conversions. ...sigh...

I hear you. And everyone's situation is different.

In general, if a person (couple) has all three accounts, they likely shouldn't be withdrawing from one type of asset class only (taxable, tax-deferred, Roth). I think there should be some kind of tax diversity to help level out your taxes/tax brackets over the years. For example, I cringe when someone says they will live off of taxable assets in the early retirement years and pay no taxes. This can be short-sighted on their part. Then, when they turn 70.5 and start RMDs along with SS, their tax rate is huge! Rather than going from one extreme to another, it could be better to level out their tax hit over all their remaining years as tax laws will likely change several times during their remaining years. What many people also don't acknowledge is that their tax rate will also go up when one of the spouses dies, since the space in each tax bracket for a Single person is about half of what it is for Married Filing Jointly.

If you suspect you will have lots of money left over for your heirs after you die, there is also the question of which kind(s) of assets you want to leave them. Some people say, "Let me do what is best for myself--I don't care what kind of taxes my heirs will have to pay." Others will say "If I leave Roth to my heirs, then they won't have to pay taxes when they withdraw, plus they can stretch the withdrawals out." If your heirs are charities, it would be best to leave them tax-deferred accounts as neither you nor they will have to pay taxes on it. Some people will also leave taxable assets that have a large unrealized capital gain to charities for the same reason. All of these are "good problems to have" from the viewpoint of the person owning the assets before dying.

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Re: I'm hearing conflicting advice on putting bonds in tax-protected accounts....?

Post by 2015 » Thu May 18, 2017 3:17 pm

celia wrote:
dcabler wrote:Anyway, my real point had to do with once you're in retirement and are now withdrawing. Specifically, if you retire early and want to wait until age 70 1/2 before starting RMD's. There are many articles about which accounts to withdraw from first, second, etc. But they never discuss the asset allocation of each of those accounts. If, for example, I have a 50/50 portfolio and follow the conventional wisdom of 50% bonds in tax advantaged accounts and 50% stock in taxable accounts AND I follow a second conventional wisdom of withdrawing from taxable accounts first, then I'm withdrawing only from my stock allocation. Each time I do that, I must then sell some bonds in my tax advantaged accounts to buy more stock in order to get my overall AA back to 50/50. Over time, my tax advantaged account will eventually match my desired 50/50 allocation as my taxable account depletes. It does work, but it isn't at all clear to me that this is the best way to go. In my case, I-ORP, for example, shows withdrawals from both taxable and tax advantaged accounts (albeit not a huge amount from the tax advantaged account) pretty early on once retirement starts.

I guess I'm looking for something comprehensive that both takes into account the location of each asset type (taxable or tax advantaged) when one is withdrawing from accounts after retirement, if it happens that there is a different answer for one who is in accumulation mode vs. decumulation mode. I'd love to be in the situation where I could drain everything in my IRAs into Roths over time, but based on when I plan to retire and running several calculators and spreadsheets on my own, there doesn't appear to be a big in advantage in my case for the Roth conversions. ...sigh...

I hear you. And everyone's situation is different.

In general, if a person (couple) has all three accounts, they likely shouldn't be withdrawing from one type of asset class only (taxable, tax-deferred, Roth). I think there should be some kind of tax diversity to help level out your taxes/tax brackets over the years. For example, I cringe when someone says they will live off of taxable assets in the early retirement years and pay no taxes. This can be short-sighted on their part. Then, when they turn 70.5 and start RMDs along with SS, their tax rate is huge! Rather than going from one extreme to another, it could be better to level out their tax hit over all their remaining years as tax laws will likely change several times during their remaining years. What many people also don't acknowledge is that their tax rate will also go up when one of the spouses dies, since the space in each tax bracket for a Single person is about half of what it is for Married Filing Jointly.

If you suspect you will have lots of money left over for your heirs after you die, there is also the question of which kind(s) of assets you want to leave them. Some people say, "Let me do what is best for myself--I don't care what kind of taxes my heirs will have to pay." Others will say "If I leave Roth to my heirs, then they won't have to pay taxes when they withdraw, plus they can stretch the withdrawals out." If your heirs are charities, it would be best to leave them tax-deferred accounts as neither you nor they will have to pay taxes on it. Some people will also leave taxable assets that have a large unrealized capital gain to charities for the same reason. All of these are "good problems to have" from the viewpoint of the person owning the assets before dying.


Not necessarily.

I am in early retirement, with approx. 2 out of every $3 in taxable, and am/will be withdrawing only from taxable until SS begins at age 70. This year, I purposely engaged in TGH (offset by carryover losses) to migrate to a 3 fund PF. I have 100% equities in taxable (for TLH opportunities), 100% bonds in tax-deferred (to attenuate RMD's) , and some bonds/more equities mixture in Roth. I have run tax software through end of PF life to account for annual roth conversions until SS begins (and possibly after as well), delayed SS, and RMD's. I pay only $600 now and will continue to do so til end of PF life (using today's assumptions). I find modeling using tax software much more helpful than using i-orp, and probably more accurate as well. It's been so thus far.

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Re: I'm hearing conflicting advice on putting bonds in tax-protected accounts....?

Post by dratkinson » Thu May 18, 2017 4:05 pm

ray333 wrote:100% equity in Roth
100% equity taxable

Bonds will go in my tIRA when I can no longer contribute to Roth. As I age, I'll reallocate in the Roth to maintain what I've gained over 10-20 years


+1

tax-deferred (401k,...): equities
tax-free (Roth IRA,...): equities
taxable: municipal bonds + equities

It's called "shooting for the moon".
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Re: I'm hearing conflicting advice on putting bonds in tax-protected accounts....?

Post by BolderBoy » Fri May 19, 2017 9:51 am

dratkinson wrote:tax-deferred (401k, tIRA...): equities
tax-free (Roth IRA,...): equities
taxable: municipal bonds + equities

I like this delineation of the three types of accounts:
    Tax-Deferred, Tax-Free, Taxable

Would like to encourage the wiki folks to use these categories as well. It looks more tidy.
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Re: I'm hearing conflicting advice on putting bonds in tax-protected accounts....?

Post by SeeMoe » Fri May 19, 2017 1:43 pm

The idea of having 100% bond funds in a DCP is to significantly reduce volatility. Especially during the distribution phase of life. Or so the experts contend, and I , reluctantly at first, agree. Experts say stocks are 4 times more volatile than bonds.

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Re: I'm hearing conflicting advice on putting bonds in tax-protected accounts....?

Post by dratkinson » Fri May 19, 2017 4:34 pm

Believe the Wiki/forum uses this understanding:

tax-advantaged
--tax-deferred (401k, tIRA...)
--tax-free (Roth IRA,...)
taxable

Why? Didn't understand it before I got here. Do now. So must have learned it here. If not explicitly expressed, then I picked it up from context.
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Re: I'm hearing conflicting advice on putting bonds in tax-protected accounts....?

Post by grabiner » Fri May 19, 2017 10:11 pm

BolderBoy wrote:
dratkinson wrote:tax-deferred (401k, tIRA...): equities
tax-free (Roth IRA,...): equities
taxable: municipal bonds + equities

I like this delineation of the three types of accounts:
    Tax-Deferred, Tax-Free, Taxable

Would like to encourage the wiki folks to use these categories as well. It looks more tidy.


The reason that the wiki doesn't distinguish tax-deferred from tax-free is that it doesn't matter for asset location purposes. If you will retire in a 25% tax bracket, and you have $4000 in a traditional IRA and $3000 in a Roth IRA, the two accounts will have the same after-tax value if invested the same way. If you have $4000 in a traditional IRA and $4000 in a Roth IRA, you will have a higher expected after-tax value if you put equities in the Roth, but also more risk if the equities lose value, so this is really a change in risk, not a net benefit. See Tax-adjusted asset allocation on the wiki.
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Re: I'm hearing conflicting advice on putting bonds in tax-protected accounts....?

Post by trueblueky » Fri May 19, 2017 10:28 pm

BolderBoy wrote:
dratkinson wrote:tax-deferred (401k, tIRA...): equities
tax-free (Roth IRA,...): equities
taxable: municipal bonds + equities

I like this delineation of the three types of accounts:
    Tax-Deferred, Tax-Free, Taxable

Would like to encourage the wiki folks to use these categories as well. It looks more tidy.

Or you can think of them as taxable, taxed, and tax-deferred.

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