After-tax AA and shifting money between traditional and Roth

Discuss all general (i.e. non-personal) investing questions and issues, investing news, and theory.
Post Reply
Topic Author
markcoop
Posts: 1165
Joined: Fri Mar 02, 2007 8:36 am

After-tax AA and shifting money between traditional and Roth

Post by markcoop » Sat Aug 01, 2020 6:32 am

If I do my AA on an after-tax basis, then I think moving money around becomes a neutral event. For example, if I use a 15% tax rate, then I could shift $100 in my traditional from stock to bond and correspondingly shift $85, or 85%, in my Roth from bond to stock. That would keep my AA in the exact same position. My question has to do with the state of the market when you do that. If the market is really high, or really low, when I make such a neutral transaction, does that affect anything? It would seem it would affect balances in those accounts. If I shift money during a down time, I would effectively permanently lower the balance of the traditional account. My point here is even if you adjust your AA to do it after-tax, the timing of shifting money can still be important. Am I thinking about that correctly? I do understand that picking a tax-rate to use for after-tax values is a bit of a crap shoot. I also understand that waiting to shift some money is a form of market timing as well.
Mark

Topic Author
markcoop
Posts: 1165
Joined: Fri Mar 02, 2007 8:36 am

Re: After-tax AA and shifting money between traditional and Roth

Post by markcoop » Sat Aug 01, 2020 10:52 am

Thoughts?
Mark

Juice3
Posts: 198
Joined: Sun Nov 05, 2017 7:40 am

Re: After-tax AA and shifting money between traditional and Roth

Post by Juice3 » Sat Aug 01, 2020 10:58 am

markcoop wrote:
Sat Aug 01, 2020 6:32 am
If I do my AA on an after-tax basis, then I think moving money around becomes a neutral event.
You do not want it to be neutral.
You want to use tax efficient placements of investments.
You want to to have defined out of balance rules for you AA and re-balance times.

sycamore
Posts: 877
Joined: Tue May 08, 2018 12:06 pm

Re: After-tax AA and shifting money between traditional and Roth

Post by sycamore » Sat Aug 01, 2020 11:26 am

markcoop,

A few questions for you...

Backing up a bit, why would you shift assets (stocks to bonds in Trad, and bonds to stocks in Roth) anyway?

To clarify, you're talking about the case where you adjust your Trad IRA to be bond-heavy and simultaneously adjust Roth to be stock-heavy, and then the stock market crashes? If so, yes, your Roth value will drop correspondingly. This will happen when you tax-adjust or not, but the impact may be greater (or lesser) by the amount you tax-adjust. To avoid "regret" from this scenario happening, you could use a mirrored asset allocation.

Also, how much are you shifting around, just a few % of the total, or 30+% ? If it's just a few %, I don't think it makes much difference - there are too many variables in life (expenses) that will have a bigger impact on your portfolio.

User avatar
grabiner
Advisory Board
Posts: 27390
Joined: Tue Feb 20, 2007 11:58 pm
Location: Columbia, MD

Re: After-tax AA and shifting money between traditional and Roth

Post by grabiner » Sat Aug 01, 2020 12:46 pm

If you tax-adjust your allocation, and your tax-adjustment rate is correct, then the move is always neutral. That is, if your traditional withdrawals are taxed at 25%, then moving $40K from stock to bonds in a traditional account and $30K from bonds to stocks in a Roth account is always break-even. One way to view this is that the IRS owns 25% of your traditional account, so you moved only $30K of your own money from stock to bonds in that account. It doesn't matter what happens in the future; you will be able to spend $90K if the stock market doubles and the bonds don't change valye, or $45K if it halves.

The caveat is "if your tax-adjustment rate is correct". If you have stock in the traditional account and the stock market booms, you may have to withdraw at a higher tax rate than you expected, or take RMDs which are more than you need to spend and move money to a taxable account. This is the advantage of holding stocks in the Roth account if all else is equal. (But if all else isn't equal, such as an employer 401(k) with better bond than stock options or vice versa, that is a more important issue.)
Wiki David Grabiner

Topic Author
markcoop
Posts: 1165
Joined: Fri Mar 02, 2007 8:36 am

Re: After-tax AA and shifting money between traditional and Roth

Post by markcoop » Sat Aug 01, 2020 3:32 pm

sycamore wrote:
Sat Aug 01, 2020 11:26 am
Backing up a bit, why would you shift assets (stocks to bonds in Trad, and bonds to stocks in Roth) anyway?
So here's my situation. I have always tax-adjusted my AA. I know people have different views about whether this makes sense, but it has always made sense to me. Given that I do that, I have not really cared about where my stocks lived and where my bonds lived. It was always based on convenience or asset availability. For example, when I wanted to buy some individual TIPS a few years back, I bought them in my Roth IRA because I didn't have that option in my 401K. Recently, however, I started to think about retirement. I have come to the conclusion that my traditional 401K balance is going to cause future RMDs to be higher than I want (not such a bad problem to have) potentially affecting SS taxation/tax bracket when one spouse dies. So, I've been wanting to lower my 401K balance, or at least slow it down from growing. I have already thought about Roth conversions and plan to do some of those. But I'm also thinking about shifting any bonds I have in my Roth to stock and correspondingly shifting stocks to bonds in my 401K. The plan is to make a neutral move as far as my AA is concerned, with the goal of ending up with a smaller balance in my 401K. I have about $200K in my Roth to move from bonds to stock. So, I'm just trying to get my arms around whether to just do it now or wait a bit. I know this is market timing, but I really think that we have some choppy waters ahead the rest of this year. So, I thought I may want to wait for a down swing. In thinking about this, I have convinced myself that it really doesn't matter at times, but at other times was thinking it may have more of an impact. So, made this post to make sure I'm looking at this problem correctly.

Thanks for any input
Mark

yog
Posts: 59
Joined: Wed Jan 15, 2020 12:57 pm

Re: After-tax AA and shifting money between traditional and Roth

Post by yog » Sun Aug 02, 2020 12:06 pm

markcoop wrote:
Sat Aug 01, 2020 3:32 pm
sycamore wrote:
Sat Aug 01, 2020 11:26 am
Backing up a bit, why would you shift assets (stocks to bonds in Trad, and bonds to stocks in Roth) anyway?
So here's my situation. I have always tax-adjusted my AA. I know people have different views about whether this makes sense, but it has always made sense to me. Given that I do that, I have not really cared about where my stocks lived and where my bonds lived. It was always based on convenience or asset availability. For example, when I wanted to buy some individual TIPS a few years back, I bought them in my Roth IRA because I didn't have that option in my 401K. Recently, however, I started to think about retirement. I have come to the conclusion that my traditional 401K balance is going to cause future RMDs to be higher than I want (not such a bad problem to have) potentially affecting SS taxation/tax bracket when one spouse dies. So, I've been wanting to lower my 401K balance, or at least slow it down from growing. I have already thought about Roth conversions and plan to do some of those. But I'm also thinking about shifting any bonds I have in my Roth to stock and correspondingly shifting stocks to bonds in my 401K. The plan is to make a neutral move as far as my AA is concerned, with the goal of ending up with a smaller balance in my 401K. I have about $200K in my Roth to move from bonds to stock. So, I'm just trying to get my arms around whether to just do it now or wait a bit. I know this is market timing, but I really think that we have some choppy waters ahead the rest of this year. So, I thought I may want to wait for a down swing. In thinking about this, I have convinced myself that it really doesn't matter at times, but at other times was thinking it may have more of an impact. So, made this post to make sure I'm looking at this problem correctly.

Thanks for any input
To stick with your current tax-adjusted AA strategy, consider mirroring your asset placement and allocation across all your accounts. If you don't have the exact same asset available in every account, like you mentioned for your 401k, mirror with a similar asset from the same asset class (stocks, bonds, treasuries/cash). It should be relatively painless to re-balance all the accounts once, and then maintain the mirrored asset AA going forward. From the Wiki: Mirrored Asset Allocation

Intellectually, Roth conversion optimization strategies based on tax timing do have inherent benefits, and it is certainly OK to cherry pick your conversions during a planned conversion year. Practically, once you follow the math to the extreme, you can only materially benefit consistently from the strategy over the longer term if you are a phenomenal stock picker. Every normal portfolio construction diversifies away all the real opportunities to materially benefit from the arbitrage unless you have returns which consistently beat the market, and volatility which consistently exceeds the market. There aren't too many who have the risk tolerance and skill (or luck) to possess a market beating portfolio with a 90/10 AA with at least 1M+ in a single-stock position, and who can also materially benefit from timing larger than expressly needed Roth conversions.

Topic Author
markcoop
Posts: 1165
Joined: Fri Mar 02, 2007 8:36 am

Re: After-tax AA and shifting money between traditional and Roth

Post by markcoop » Sun Aug 02, 2020 3:31 pm

yog wrote:
Sun Aug 02, 2020 12:06 pm
To stick with your current tax-adjusted AA strategy, consider mirroring your asset placement and allocation across all your accounts.
I have never even considered doing a mirror strategy, although I can understand how it makes re-balancing easier. I read the link but don't think it is something that I want to do. Thanks.

I am comfortable with my plan and will feel better when I have gotten all my bonds out of my Roth accounts and correspondingly have less stock in my 401K. If the market just keeps going up from here and the best time to make this neutral switch is right now, then I am willing to accept that risk since an up stock market will overall be a nice win.
Mark

Post Reply