rebalance based on pre or post tax values?

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Bucknuts
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rebalance based on pre or post tax values?

Post by Bucknuts »

Thanks for taking the time to reply and I appreciate any input. I did a quick search on the forum and couldn't find the answer to my question. I recently rebalanced my portfolio for the first time. When you look at different asset class values to determine relative percentages and whether you need to rebalance or not, do you look at each class's current value or expected value after future tax treatment (for tax advantaged accounts)?

For example, say your desired AA is 63% US stock/27% Intl Stock/10% Bonds. For simplicity sake, say you have 63K in US stock index in a 401k (expected tax bracket upon withdrawal 25% for argument's sake), 27K in Intl stock index in a roth IRA (0% tax upon withdrawal), and 10K in total bond index in a 401K (25% tax upon withdrawal). The pre-tax AA is spot on at 63/27/10. The post-tax AA is actually 58/9/33.

When you do your rebalance, do you account for the future tax treatment and use after tax expected values, or do you use current values as they show on your account now?

Thanks
Bucknuts
dbr
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Re: rebalance based on pre or post tax values?

Post by dbr »

Read this, go to Reichenstein's paper in the references, if you understand that paper and agree it applies to you, then follow his prescribed procedure. Otherwise just go with actual present values: https://www.bogleheads.org/wiki/Tax-adj ... allocation
Soon2BXProgrammer
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Re: rebalance based on pre or post tax values?

Post by Soon2BXProgrammer »

personally, i don't, but only because i am hoping to pay less than 10% on average takes for pretax funds.... (some taxed at 0, etc)..

Do you think all your funds will come out at 25%? or are some in lower brackets? one wiki article mentions it:

https://www.bogleheads.org/wiki/Tax-eff ... te_note-10
For simplicity, many people manage their asset allocation without regard to taxes. When Roth IRA accounts are much smaller than tax-deferred accounts this approximation works well. But it can be noted that moving the asset with the greatest expected future value from tax-deferred to a tax-free account does increase the risk/return of the investor. A simple way to view this tax-adjusted allocation for an investor in the 25% tax bracket is that the government is a 25% owner of the tax-deferred account. When moving an asset increases the investor's ownership of a high risk/return asset from 75% to 100% (in a Roth IRA), the overall portfolio risk-return increases as well.
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grabiner
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Re: rebalance based on pre or post tax values?

Post by grabiner »

I manage my allocation based on post-tax values, using my marginal tax rates, because that is how I adjust for risk.

I expect to retire at a 31% marginal tax rate. Therefore, if a foreign stock fund in my employer plan is worth $20,000 and loses half its value, I will have $6900 less to spend in retirement. If a US stock fund in my Roth IRA is worth $13,800 and loses half its value, I will also have $6900 less to spend in retirement. These two holdings have the same risk.
Wiki David Grabiner
marklar13
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Re: rebalance based on pre or post tax values?

Post by marklar13 »

I use actual account values (not adjusted) for my targets / triggers... but I also estimate the adjusted allocation so that I at least know what it looks like. I'm also pretty far from retirement, though, so the tax picture is not so clear anyway. I think it matters more for someone closer to actually withdrawing the funds.

If you perform your search using "tax adjusted allocation" you'll probably get some hits on previous discussions as well. I remember reading some debates regarding placing riskier assets in Roth IRAs (vs traditional), and whether or not that is considered tax efficient or just taking more risk.

Personally, I decided to put the higher expected return (riskier) assets in Roth, and just loosely take this into consideration in constructing my overall asset allocation, knowing that it might be a little riskier than the pre-tax numbers appear. It's all an inexact science anyway, so I don't stress too much over the couple percentage points that it might shift my "real" allocation.
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Bucknuts
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Re: rebalance based on pre or post tax values?

Post by Bucknuts »

Thanks for the advice. I didn’t see that wiki article before. Now I have some reading to do.
dbr
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Re: rebalance based on pre or post tax values?

Post by dbr »

The issue comes down to how you find the right asset allocation. The Reichenstein paper takes the bull by the horns by optimizing a utility function in the presence of taxes. Your or my method to specify asset allocation might not require such an elaborate approach.
ryman554
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Re: rebalance based on pre or post tax values?

Post by ryman554 »

Unless you are talking about taxable account, it doesn't matter.

You can always exchange $$ between account with no penalty with tax advantage accounts, so it really is one big lump of cash.
KlangFool
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Re: rebalance based on pre or post tax values?

Post by KlangFool »

OP,

I expect to pay 0% tax when I retired. I am paying less than 5% effective tax now.

viewtopic.php?t=87471

Please read above thread.

KlangFool
MindBogler
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Re: rebalance based on pre or post tax values?

Post by MindBogler »

If you plan to do no Roth conversions prior to taking elective or compulsory distribution then you should rebalance on post tax values. If you do plan to do Roth conversions, it is very difficult to predict the effective tax rate you will pay. For this reason I choose to keep things simple and rebalance based on the literal value of each fund.
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