Do bonds belong in a Roth IRA

[Mr.BB]

Do bonds (index fund) belong in a Roth IRA?

[asif408]

It depends.

[Mr.BB]

sorry, I should of clarified that statement

[02nz]

Depends on many factors. Generally the preference is to keep bonds in tax-advantaged, which can be Roth IRA or traditional IRA/401k. Many people prefer to draw down Roth IRA last, for several reasons: 1) to fill up lower tax brackets with withdrawals from trad'l 401k/IRA; 2) because of RMDs on trad'l accounts; and 3) to pass Roth IRAs to heirs if not spent. If Roth IRA will be drawn after traditional, it would be better to put investments with higher anticipated returns in Roth IRA.

[ruralavalon]

Do bonds (index fund) belong in a Roth IRA?

Bond funds are not very tax-efficient so ordinarily should be held in a tax-advantaged account, preferably a tax-deferred account.

So in general bond funds preferably in a traditional IRA or 401k, rather than a Roth IRA. But in general bond funds in a Roth IRA rather than a taxable account.

[chevca]

sorry, I should of clarified that statement

You still can.

But, bonds can go in a Roth. When I used my Roth as my emergency fund, I held it all in the intermediate bond index.

As said above, it depends.

[retiredjg]

I prefer to put little to no bonds in Roth IRA, but there are circumstances when it does make sense to hold bond there. What are your circumstances? Can you put the bonds into a tax-deferred account such as a 401k or traditional IRA?

[Alexa9]

Roth dollars are worth more. You could argue that maximum growth potential assets belongs there. However, you probably still want some bonds to rebalance in a severe downturn. If you're in or close to retirement, you also probably want a significant allocation to bonds in your IRA to minimize risk.

"Some investors see bonds or bond funds as tax-inefficient because almost all of the return comes from the dividend yield, which is fully taxed as ordinary income. [note 3] In contrast, stocks get most of their return from price appreciation, which is not taxed until the stocks are sold and is taxed at the capital-gains tax rate. Therefore, these investors regard bonds as being less tax-efficient than stock index funds (which rarely sell stock) and hold bonds in tax-advantaged accounts when possible. However, low-yielding bonds do not have much return to be taxed, and since they do not grow as fast as other investments, an equal percentage lost from an investment is a smaller dollar loss; this makes low-yielding bonds somewhat more tax-efficient. Therefore, some other investors do just the opposite: they hold stocks with a higher expected return in tax-advantaged accounts when possible. You have to strike a balance between the expected return and the tax rate."
https://www.bogleheads.org/wiki/Tax-eff ... _placement

[Thesaints]

Since a Roth is not subjected to taxation, then the highest return vehicle should be kept there, everything else being equal.
For tax deferred accounts the story can be different.

[Rupert]

If the bond offerings in your tax-deferred account(s) (401k or 403b) are terrible or just expensive, that's another good reason to hold them in your Roth.

[bluquark]

One way of thinking about this is as an AA decision. The Roth is worth more in the end than traditional. If your retirement tax rate will be 33% and you have 100k in Roth and 100k in traditional, and you target a nominal 50/50 AA. If the equity is in Roth, your net AA is 60/40, and with bonds in Roth your net AA is 40/60. The advice to hold stocks in Roth actually loads up on both risk and return because you are investing “bigger dollars”, and just as it’s sweeter to earn returns it’s more painful to lose them in a market drop.

There’s a subtle but important difference between the “free lunch” of tax-free yield, and the “more money, but with the usual Sharpe ratio” of tax-free withdrawal. Personally, I eat free lunches whenever I find them and I have a lot of room to adjust to my AA in taxable, so I hold bonds in Roth.

[Epsilon Delta]

I believe there is a real free lunch, or at least a free breath mint, to putting risky assets in a Roth rather than traditional. This is due to progressive tax rates.

Consider the particular case where withdrawals from the bonds will exactly match your deductions and coincidentally this is also the size of your traditional IRA. If you put bonds in tIRA and stocks in Roth you will never owe any taxes. Your net returns will be the same as your gross returns no matter how stocks do.

If you put stocks in tIRA if stocks do poorly you owe no taxes and net returns equal gross returns. But if stocks do well you will owe some taxes and so net returns are less than gross returns.

So bonds in tIRA is always as good and sometimes better than bonds in Roth. I suspect you can generalize this to other cases, although the advantaege may be probabilistic instead of absolute.