Investment locations?

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vnatale
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Investment locations?

Post by vnatale » Wed Oct 09, 2019 3:24 pm

I’ll soon be investing as part of the Permanent Portfolio in the following four investments

1) Cash (T-Bills no longer than one year)
2) Stocks (Vanguard Total Stock Market Fund)
3) Gold (ETFs and coins)
4) Bonds (Long-term, no shorter than 20 year maturities)

I have a choice of three locations to put them:

a) Outside of a Retirement Plan
b) Traditional IRA
c) Roth IRA

Could you give me your opinion of the optimal location for each investment and rank order them? Also, if you can, your reasons?

And, you can do it as easy as:

1. c, b, a
Above provided by: Vinny, who always says: "I only regret that I have but one lap to give to my cats." AND "I'm a more-is-more person."
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Re: Investment locations?

Post by LittleDinghy » Tue Oct 15, 2019 10:49 am

In setting up asset locations for our Golden Butterfly-like (GB) portfolio back in the last week of June of this year when I completed it, I tried to follow the advice in Chapter 13 of The Permanent Portfolio by Rowland and Lawson (TPP). However, there were limitations of investments in my 401k (especially) but also in my wife's 403b, 457b and 401a, and in our respective HSA offerings, that caused quite a bit of variation from what Rowland and Lawson recommend.
1) The only GB asset in my 401k was an S&P 500 index fund, so 20% of the GB portfolio is in my 401k in this fund.
2) And my wife's 401a, 403b and 457b had only small cap value funds (some VSIAX, some home grown by the plan) that would work in the GB. The remainder of our small cap value allocation is outside of a retirement plan
3) The above means I ended up with the long (25-30 year) treasury bonds in our respective Roth accounts and in a traditional IRA.
4) Our longer term cash (1-3 year T-Note ladder) is both in an inherited IRA and outside of a retirement plan. Our short term cash (T-bill ladder) is both in a traditional IRA and outside of a retirement plan.
5) Gold is roughly 25% physical, 40% in ETFs (AAAU) outside of a retirement plan, and 35% (also AAAU) in a Roth for re-balancing purposes.

The asset locations above are quite different from what is recommended in Chapter 13 of TPP, but I had little choice due primarily to having to put the equity allocations in our retirement accounts at work (401k for me; and 401a, 403b, and 457b for my wife).

I do have a related asset location question for the list. Before year end I anticipate rolling over (and paying taxes on) about 4% of the total portfolio's value from my 401k to my Roth (I anticipate doing this every year through 2022 when I retire - just to get more assets into Roth for retirement - I don't anticipate our marginal tax rate decreasing after retirement). Recall from above that the 401k is invested in an S&P 500 index, and that the Roth consists of 25-30 year treasuries (that I purchased on the secondary market) and a gold ETF. As of 9/30 when I last checked, portfolio fractions were 0.2111 S&P500, 0.2039 Small Cap Value, 0.1990 LT Treasury Bonds, 0.1920 Cash, and 0.1939 Gold. I see three things I can do with the 4% in the Roth:
1) put the 4% into equities, probably a Total Stock Market index fund rather than the S&P 500, where it had been in in the 401k.
2) put it all into cash, as Harry Browne may have recommended (per pages 204-205 of TPP)
3) use the 4% to re-balance the entire portfolio back to 20% for each asset class (also mentioned on page 204 of TPP, although in the context of adding new money to the portfolio, which this 4% is not).
Which of the three would those of you experienced with this kind of thing do? Or would you do something else?
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Re: Investment locations?

Post by ochotona » Tue Oct 15, 2019 2:52 pm

vnatale wrote:
Wed Oct 09, 2019 3:24 pm
I’ll soon be investing as part of the Permanent Portfolio in the following four investments

1) Cash (T-Bills no longer than one year)
2) Stocks (Vanguard Total Stock Market Fund) - try to put in Roth IRA / 401k or Taxable, not Traditional IRA
3) Gold (ETFs and coins) - try to put in Roth IRA / 401k or Taxable, not Traditional IRA
4) Bonds (Long-term, no shorter than 20 year maturities) - try to put in Traditional IRA

I have a choice of three locations to put them:

a) Outside of a Retirement Plan
b) Traditional IRA
c) Roth IRA

Could you give me your opinion of the optimal location for each investment and rank order them? Also, if you can, your reasons?

And, you can do it as easy as:

1. c, b, a
Traditional IRAs / 401k convert cap gains to ordinary income, which is poison. You want it tax free in a Roth IRA or 401k, or at least you want long-term capital gains treatment.

Collectibles tax treats gold like ordinary income, but at least it's capped at 28%, which might be a good thing in a possible high tax rate future, we all might be wishing for 28%. And you can give your gold to charity, if you talk to the charity involved and show them how easy it is for them to cash in the physical metal at a local dealer. And even better if you have taxable ETF... just donate your appreciated shares. ZING... you've made a donation, your cap gains problem and tax went away never to be seen again. A few years ago I gave away probably ten thousand dollars of S&P-500 capital appreciation to my church. I rebought new shares with the cash I did not give to church. No waiting period. Just rebuy.

Interest and dividend generating things you keep in Traditional IRA or 401k.
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Re: Investment locations?

Post by mathjak107 » Tue Oct 15, 2019 3:39 pm

I would not waste valuable space in tax deferred accounts to hold any interest bearing instruments with no potential for large gains at any where near these levels .that space is way to valuable to take up with investments that pay so little
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Re: Investment locations?

Post by ochotona » Tue Oct 15, 2019 6:15 pm

mathjak107 wrote:
Tue Oct 15, 2019 3:39 pm
I would not waste valuable space in tax deferred accounts to hold any interest bearing instruments with no potential for large gains at any where near these levels .that space is way to valuable to take up with investments that pay so little
No. Tax deferred accounts expose your gainful investments to ordinary income tax rates when you spend them, instead of long term cap gains.

Must read - The Overtaxed Investor: Slash Your Tax Bill & Be a Tax Alpha Dog, Phil DeMuth
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Re: Investment locations?

Post by vnatale » Tue Oct 15, 2019 6:42 pm

Thank you for this wonderful recommendation. I am about to buy the Kindle version. However, curious as to your response to this one Amazon reviewers' comment (from last month): "It was well written and obviously well researched for it’s time, but laws have changed since it was written and it was not current."

Vinny
ochotona wrote:
Tue Oct 15, 2019 6:15 pm
mathjak107 wrote:
Tue Oct 15, 2019 3:39 pm
I would not waste valuable space in tax deferred accounts to hold any interest bearing instruments with no potential for large gains at any where near these levels .that space is way to valuable to take up with investments that pay so little
No. Tax deferred accounts expose your gainful investments to ordinary income tax rates when you spend them, instead of long term cap gains.

Must read - The Overtaxed Investor: Slash Your Tax Bill & Be a Tax Alpha Dog, Phil DeMuth
Above provided by: Vinny, who always says: "I only regret that I have but one lap to give to my cats." AND "I'm a more-is-more person."
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Re: Investment locations?

Post by ochotona » Tue Oct 15, 2019 8:54 pm

vnatale wrote:
Tue Oct 15, 2019 6:42 pm
Thank you for this wonderful recommendation. I am about to buy the Kindle version. However, curious as to your response to this one Amazon reviewers' comment (from last month): "It was well written and obviously well researched for it’s time, but laws have changed since it was written and it was not current."

Vinny
Tax laws change all the time, especially the rates, but the general principles of the book are still intact.

The current tax laws are interesting, because they have me in a slow race against time to convert as much of my IRA to Roth IRA before 12/31/2025, when the current low rates for individuals expire. If Democrats get elected in 2020, I may speed up my process significantly.

Believe this - we are going to face confiscatory tax rates eventually due to our crushing national debt, and our demographics, and given how poorly most people have prepared for retirement. I don't know when eventually is. Five, ten, twenty years. Time to get ready is now.
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Re: Investment locations?

Post by vnatale » Tue Oct 15, 2019 9:05 pm

I was suspecting that the person who wrote that book did not realize that as you stated, "the general principles of the book are still intact".

The person who wrote that criticism made me think that person is the type who thinks he or she knows more than he or she actually does. And, someone who also takes a narrow, specific view rather than a broader one.

Vinny
ochotona wrote:
Tue Oct 15, 2019 8:54 pm
vnatale wrote:
Tue Oct 15, 2019 6:42 pm
Thank you for this wonderful recommendation. I am about to buy the Kindle version. However, curious as to your response to this one Amazon reviewers' comment (from last month): "It was well written and obviously well researched for it’s time, but laws have changed since it was written and it was not current."

Vinny
Tax laws change all the time, especially the rates, but the general principles of the book are still intact.

The current tax laws are interesting, because they have me in a slow race against time to convert as much of my IRA to Roth IRA before 12/31/2025, when the current low rates for individuals expire. If Democrats get elected in 2020, I may speed up my process significantly.

Believe this - we are going to face confiscatory tax rates eventually due to our crushing national debt, and our demographics, and given how poorly most people have prepared for retirement. I don't know when eventually is. Five, ten, twenty years. Time to get ready is now.
Above provided by: Vinny, who always says: "I only regret that I have but one lap to give to my cats." AND "I'm a more-is-more person."
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Re: Investment locations?

Post by jacksonm2 » Tue Oct 15, 2019 11:06 pm

ochotona wrote:
Tue Oct 15, 2019 6:15 pm
mathjak107 wrote:
Tue Oct 15, 2019 3:39 pm
I would not waste valuable space in tax deferred accounts to hold any interest bearing instruments with no potential for large gains at any where near these levels .that space is way to valuable to take up with investments that pay so little
No. Tax deferred accounts expose your gainful investments to ordinary income tax rates when you spend them, instead of long term cap gains.

Must read - The Overtaxed Investor: Slash Your Tax Bill & Be a Tax Alpha Dog, Phil DeMuth
I generally follow this strategy trying to keep the investments with the most potential for long term gains in Roth or taxable and put the others in tax-deferred to minimize RMD's of which I'll be taking my first one this year based on the value of my IRA at the end of last year.

It seemed to be working well but this year has so far completely blown that idea out of the water. My IRA still showed a significant loss in my gold and some of my bonds at the end of last year but this year everything is showing up in green. So next year my RMD is probably going to be significantly higher unless something changes by the end of the year.

Not really a bad problem to have so I'm not going to complain about too much growth in my IRA.

I'm thinking right now that this whole idea goes against the PP strategy which basically says you have no idea what investments are going to do well in the long term.
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Re: Investment locations?

Post by mathjak107 » Wed Oct 16, 2019 3:04 am

one of the problems we end up with thinking we will place our dividend paying stocks in a taxable account is depending on the length of time you will own it even a 2% dividend over time wipes out any tax advantage if you are not in the zero capital gains bracket . plus any other distributions make it worse . so utilizing tax advantage space is very important ... at these interest rate levels it is not a good idea filling up valuable space with low interest paying investments .

most investors don't realize the effect of paying taxes on dividends in a taxable account because they think the reduced rates are helping them .. but kitces found it takes as little as a 2% dividend to wipe out any tax savings over decades of time plus there could be taxes from fund turnover . plus any rebalancing or selling can have big tax consequences during your working years when combined with other income .

so these long term capital gain rates can be great if you have no dividends spinning off . dont forget , dividends are very tax inefficient ... you pay tax on an entire dividend .. the same dollars from a portfolio of non div payers only taxes the gain portion . so you need to not be blinded with the mirage of these lower tax rates on long term capital gains if you spin off any income from dividends ....you likely would be ahead by keeping the dividends tax deferred in a tax advantaged retirement account .
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Re: Investment locations?

Post by ochotona » Wed Oct 16, 2019 4:04 am

Dividend payers are a case which isn't quite the Permanent Portfolio's S&P 500. My remarks don't treat high dividend stocks.

Yeah, RMDs... Another problem when the IRA gets too large, another reason not to put growth assets in the IRA.

RMDs will force you to sell gold even if you don't want to. I think of my gold as the last thing I want to let go of, I will only sell when I hit the PP rebalance band... 35%.

From year to year no one knows what does well. You can just have a PP in each type of account. That's not my choice because I have opinions about what will do well over decades, and that's the timescale my tax strategy works on.
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Re: Investment locations?

Post by sophie » Wed Oct 16, 2019 7:32 am

jacksonm2 wrote:
Tue Oct 15, 2019 11:06 pm
I generally follow this strategy trying to keep the investments with the most potential for long term gains in Roth or taxable and put the others in tax-deferred to minimize RMD's of which I'll be taking my first one this year based on the value of my IRA at the end of last year.

It seemed to be working well but this year has so far completely blown that idea out of the water.
I do the same thing. My tax-deferred Keogh is loaded up on gold and bonds. There have been time frames as long as 10 years where this account would have outperformed the stock-heavy taxable and Roth accounts, but for 20 year+ time frames it should underperform.

In your case it's a bit more of a gamble since you're already in the RMD phase, but the odds are certainly in your favor.
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Re: Investment locations?

Post by Xan » Wed Oct 16, 2019 9:16 am

ochotona wrote:
Wed Oct 16, 2019 4:04 am
You can just have a PP in each type of account.
That's what I do, not least because it's so much simpler than spreading everything across everything. One PP in Roth, one PP in traditional, one PP in taxable.
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Re: Investment locations?

Post by mathjak107 » Wed Oct 16, 2019 9:42 am

ochotona wrote:
Wed Oct 16, 2019 4:04 am
Dividend payers are a case which isn't quite the Permanent Portfolio's S&P 500. My remarks don't treat high dividend stocks.

Yeah, RMDs... Another problem when the IRA gets too large, another reason not to put growth assets in the IRA.

RMDs will force you to sell gold even if you don't want to. I think of my gold as the last thing I want to let go of, I will only sell when I hit the PP rebalance band... 35%.

From year to year no one knows what does well. You can just have a PP in each type of account. That's not my choice because I have opinions about what will do well over decades, and that's the timescale my tax strategy works on.
Rmds always require assets to be sold ...but all that means is you rebuy them again in the taxable account ... nothing changes. It is just switching pockets.

Big gains in assets that are taxable can present all kinds of problems in retirement.. everything from getting ss taxed , to what you pay for Medicare to aca subsidies count on your ability to control your taxable cash flow .

Tax advantaged accounts are very valuable for that .... even as little as that 2% dividend from an s&p fund can wipe out any tax savings in a taxable account over time .... so pretty much anything with potential for big gains should be in the retirement accounts ..anything that spins off these low levels of interest should be in a taxable account
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Re: Investment locations?

Post by vnatale » Wed Oct 16, 2019 8:21 pm

I am reading the book that was previously recommended. What you are doing is NOT recommended by the book:

"Researchers find that people typically fill their taxable and tax-deferred accounts arbitrarily with the same kinds of assets in each. Individuals do this out of ignorance; investment advisors do it for their convenience. Nevertheless, it is wrong. Bad dog!

Here are the guiding principles to give you an approximate fit. There is a fair consensus of professional opinion on this point. The answer in one sentence is that you want to put stocks in taxable accounts and bonds in tax-deferred accounts.

If your situation allows, consider all your assets as part of one big happy household portfolio. Then park each one in whichever account is most advantageous tax-wise for that particular type of asset."

Vinny
Xan wrote:
Wed Oct 16, 2019 9:16 am
ochotona wrote:
Wed Oct 16, 2019 4:04 am
You can just have a PP in each type of account.
That's what I do, not least because it's so much simpler than spreading everything across everything. One PP in Roth, one PP in traditional, one PP in taxable.
Above provided by: Vinny, who always says: "I only regret that I have but one lap to give to my cats." AND "I'm a more-is-more person."
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Re: Investment locations?

Post by Pet Hog » Wed Oct 16, 2019 8:45 pm

This topic is so fundamental to PP investing, I think we need to reach a definitive consensus. I need some numbers to understand the complexity, and I would love it if you all would correct me if I make a mistake below. Thanks.

Let's consider a PP investor, who invests in the four assets, but let's consider each asset alone for optimizing its tax consequences. Let's make her female so I don't have to write "he/she" repeatedly!

Over the working years (let's say 40 years), our investor invested a total of $100,000 in stocks ($2500 per year), and also reinvested all dividends, which yielded 2% each year. She was always in the 24% tax bracket during those working years. After 40 years, she now has $2,000,000, a handsome return. For more simplicity, I'm going to guess an average balance of $500,000 over the 40 years, so the average dividend each year was $10,000.

Our investor chooses to retire on $100,000 per year, and -- again, for simplicity -- doesn't take social security or get a pension, just lives off her investments.

Considering a single person, with 2019 tax brackets all the way from today to 40 years back (yeah, it's a stretch, but, again, for simplicity -- or consider this scenario a future prediction with rates staying the same for the next 40 years):

10% $0+
12% $9,700+
22% $39,475+
24% $84,200+ (<-- assuming our investor was always in this bracket during earning years)
32% $160,725+
35% $204,100+
37% $510,300+

Long-term capital gains and qualified dividends, taxed at following rates based on taxable income:

0% $0+
15% $39,375+ (<-- assuming our investor was always in this bracket during earning years)
20% $434,550+

Standard (and only) deduction: $12,200

There are three possible locations for these investments, and she chooses only one:

(1) Taxable account
(2) Taxable retirement account (Traditional IRA, SEP IRA, traditional 401k...)
(3) Tax-free retirement account (Roth IRA, Roth 401k...)

Let's start...

(1) Taxable account (no special tax advantages)

Our investor payed $24,000 in tax (24% of $100,000) on the earned money that went into stocks (no tax advantage, no retirement account). Let's say her bank balance is -$24,000, the initial stock basis is $100,000, and the government gained $24,000.

Each year, she earned an average of $10,000 in dividends, which were taxed at 0%. These dividends were reinvested, adding $400,000 to the tax basis over 40 years. So total stock tax basis is $500,000. That's 25% of the total current stock value at retirement of $2,000,000.

Now, in retirement, she wants to live off $100,000. At 2%, the dividends earned this year total $20,000. That means our investor has to sell $80,000 worth of stock. That amount has a tax basis of $20,000 (25%). So the capital gain of that $80,000 is $60,000.

The standard deduction is $12,200, making the taxable income $87,800. So the highest tax bracket for the dividends and capital gains is 15%. The $20,000 in dividends is less than $39,375, so it's all taxed at 0%. The $60,000 in capital gains is made up of $39,375 taxed at 0% and the rest ($20,625) taxed at 15%, or $3094.

So our investor would have to pay only $3094 in tax each year. But has a bank balance of -$24,000. That's a surprisingly low amount of tax, don't you think? The Roth IRA version of this story would be pretty similar, but end up paying zero tax in retirement, instead of $3000. It's not that different!

Have I made a mistake anywhere? Please let me know. I'll work on other examples in future and hopefully I can compile all the info into one big report for future reference.
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Re: Investment locations?

Post by vnatale » Wed Oct 16, 2019 8:55 pm

Thank you for this! Because I am continuing to read this (wonderful) recommended book (The Overtaxed Investor), I will not respond right now. But I will go through all you have below in detail and will respond.

Vinny
Pet Hog wrote:
Wed Oct 16, 2019 8:45 pm
This topic is so fundamental to PP investing, I think we need to reach a definitive consensus. I need some numbers to understand the complexity, and I would love it if you all would correct me if I make a mistake below. Thanks.

Let's consider a PP investor, who invests in the four assets, but let's consider each asset alone for optimizing its tax consequences. Let's make her female so I don't have to write "he/she" repeatedly!

Over the working years (let's say 40 years), our investor invested a total of $100,000 in stocks ($2500 per year), and also reinvested all dividends, which yielded 2% each year. She was always in the 24% tax bracket during those working years. After 40 years, she now has $2,000,000, a handsome return. For more simplicity, I'm going to guess an average balance of $500,000 over the 40 years, so the average dividend each year was $10,000.

Our investor chooses to retire on $100,000 per year, and -- again, for simplicity -- doesn't take social security or get a pension, just lives off her investments.

Considering a single person, with 2019 tax brackets all the way from today to 40 years back (yeah, it's a stretch, but, again, for simplicity -- or consider this scenario a future prediction with rates staying the same for the next 40 years):

10% $0+
12% $9,700+
22% $39,475+
24% $84,200+ (<-- assuming our investor was always in this bracket during earning years)
32% $160,725+
35% $204,100+
37% $510,300+

Long-term capital gains and qualified dividends, taxed at following rates based on taxable income:

0% $0+
15% $39,375+ (<-- assuming our investor was always in this bracket during earning years)
20% $434,550+

Standard (and only) deduction: $12,200

There are three possible locations for these investments, and she chooses only one:

(1) Taxable account
(2) Taxable retirement account (Traditional IRA, SEP IRA, traditional 401k...)
(3) Tax-free retirement account (Roth IRA, Roth 401k...)

Let's start...

(1) Taxable account (no special tax advantages)

Our investor payed $24,000 in tax (24% of $100,000) on the earned money that went into stocks (no tax advantage, no retirement account). Let's say her bank balance is -$24,000, the initial stock basis is $100,000, and the government gained $24,000.

Each year, she earned an average of $10,000 in dividends, which were taxed at 0%. These dividends were reinvested, adding $400,000 to the tax basis over 40 years. So total stock tax basis is $500,000. That's 25% of the total current stock value at retirement of $2,000,000.

Now, in retirement, she wants to live off $100,000. At 2%, the dividends earned this year total $20,000. That means our investor has to sell $80,000 worth of stock. That amount has a tax basis of $20,000 (25%). So the capital gain of that $80,000 is $60,000.

The standard deduction is $12,200, making the taxable income $87,800. So the highest tax bracket for the dividends and capital gains is 15%. The $20,000 in dividends is less than $39,375, so it's all taxed at 0%. The $60,000 in capital gains is made up of $39,375 taxed at 0% and the rest ($20,625) taxed at 15%, or $3094.

So our investor would have to pay only $3094 in tax each year. But has a bank balance of -$24,000. That's a surprisingly low amount of tax, don't you think? The Roth IRA version of this story would be pretty similar, but end up paying zero tax in retirement, instead of $3000. It's not that different!

Have I made a mistake anywhere? Please let me know. I'll work on other examples in future and hopefully I can compile all the info into one big report for future reference.
Above provided by: Vinny, who always says: "I only regret that I have but one lap to give to my cats." AND "I'm a more-is-more person."
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Re: Investment locations?

Post by Pet Hog » Wed Oct 16, 2019 9:19 pm

Scenario (2): Stock investing in a Traditional IRA. Same background as before.

Our investor places $100,000 over 40 years into a Trad IRA. She gets a tax break on that money. She's in the 24% tax bracket, so there is a saving of $24,000 relative to the previous example. We can consider her to have a bank balance of $0.

She reinvests all the dividends. No tax on the dividends because all the trading is in a Trad IRA. The balance grows to $2,000,000.

After 40 years, our investor decides to retire and withdraw $100,000 each year from the Trad IRA. It's all considered ordinary income. The standard deduction is $12,200. So her taxable income is $87,800. That puts her in the 24% tax bracket. A reminder of the brackets:

10% $0+
12% $9,700+
22% $39,475+
24% $84,200+
32% $160,725+
35% $204,100+
37% $510,300+

She pays 10% on the first $9700, or $970.
She pays 12% on the next $29,775, or $3573.
She pays 22% on the next $44,725, or $9840.
She pays 24% on the next $3600, or $864.

In total she will pay $15,274 each year, but her bank balance is $0.

I hope I've made a mistake, because this scenario sucks! What's the advantage of tax deferral?
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Re: Investment locations?

Post by Xan » Wed Oct 16, 2019 9:33 pm

vnatale wrote:
Wed Oct 16, 2019 8:21 pm
I am reading the book that was previously recommended. What you are doing is NOT recommended by the book:
I didn't say it was recommended by the book. In this case, I'm the investment advisor, and I do it out of my own convenience.

It's just too much predicting the future for me to arrange things as one big PP. For example, does the professional consensus consider how negative interest rates will affect whether bonds should be in taxable or tax deferred? What will the tax regime look like in 40 years? Who knows!
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Re: Investment locations?

Post by Pet Hog » Wed Oct 16, 2019 9:36 pm

Scenario (3) : Roth IRA.

Same background as before. Our investor puts $100,000 into a Roth IRA. She gets no tax benefit for doing so. She pays 24% on that money earned before investment. We can consider her to have a bank balance of -$24,000.

Over 40 years she reinvests the dividends, averaging $10,000 a year, but it's all in a Roth account so there are no tax consequences.

She retires and decides to withdraw $100,000 each year from the Roth IRA. It's all tax free -- she pays no tax, but has a bank balance of -$24,000.

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Clearly, this scenario is the winner, as long as the lady lives for two years in retirement (she will have lost only $24,000 after two years of retirement). Otherwise, the Trad IRA wins (it loses about $30,000 after two years of retirement). Keeping the money in a taxable account will be about $3000 worse off each year than the Roth approach.

Of course, I have made many assumptions in this analysis, and each of our scenarios will be different, with different tax brackets and timeframes, and I haven't considered state taxes. But I think it's an interesting analysis. And I might have made some mistakes. Please correct me!

If I were to rank the strategies for stock investing, I would say Roth, followed closely by taxable, but definitely don't invest in a Trad IRA.

Thoughts?
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Re: Investment locations?

Post by Pet Hog » Wed Oct 16, 2019 10:03 pm

Pet Hog wrote:
Wed Oct 16, 2019 8:45 pm
Now, in retirement, she wants to live off $100,000. At 2%, the dividends earned this year total $20,000. That means our investor has to sell $80,000 worth of stock. That amount has a tax basis of $20,000 (25%). So the capital gain of that $80,000 is $60,000.
OK, I spotted one mistake already, but it means that our lady friend actually ends up paying even less tax.

In scenario (1), 2% of $2,000,000 in retirement means $40,000 a year in dividends, not $20,000. So she needs to sell only $60,000 in stocks (to live off $100,000), meaning $45,000 in capital gain ($15,000 was the tax basis of that $60,000). The 15% dividend and capital gain tax bracket is at $39,375, so she pays 15% capital gains tax on $5625 (that's just $844) and for dividends pays 15% tax on $625 (that's just $94) -- in total she pays only $938 per year (and has a bank balance of -$24,000).

Am I misinterpreting the tax on capital gains and dividends. Can they be considered separately, or should I add them up? In this case, it would be $85,000 in combined capital gains and dividends, so should I consider the first $39,375 as tax-free and the rest ($45,625) taxed at 15%, or $6844?
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Re: Investment locations?

Post by Pet Hog » Wed Oct 16, 2019 11:05 pm

OK, I'll do one more, for long-term treasuries.

Same situation and history for the lady investor. But now she is investing $100,000 only in LTTs. For a coupon yield, I'm going to pick 2%, close to what it is today.

The investor buys the LTTs in a taxable account, Scenario (1). Again, she reinvests all the dividends, but now there is no special tax rate for that money, it's all ordinary income (state tax exempt, but I'm ignoring state taxes -- assume she lives in Texas or wherever). Her bank balance is -$24,000.

In the stock scenario, the $500,000 tax basis grew to $2,000,000. I'm going to make an assumption that again the gain in portfolio value is triple the tax basis. It's a fudge, but I don't want to have to do complicated calculations. I think Excel would come in handy here -- I'm already seeing some problems

She gets a 2% coupon dividend annually. It's taxed at 24%, so there is an after-tax yield of 1.52%. She reinvests it in LTTs. That 1.52% is about a quarter less than the 2% stock dividend from last time. So she won't be adding as much to her tax basis and the portfolio won't grow as high as $2,000,000 (although long term, the returns on LTTs are similar to those for stocks, right?) I'm going to assume she adds a quarter less to her overall tax basis, so 75% of $400,000 (that was the increase in tax basis in the stock scenario), or $300,000. On top of the $100,000 she added in annual contributions, the total tax basis after 40 years is $400,000. And I'm assuming that quadruples to $1,600,000 with investment returns -- that's 20% less than in the stock case. So the average annual coupon payments will be 20% less than in the stock example, giving $8000. OK, fudging over.

Over 40 years, getting an average coupon of $8000, she pays 24% of that in tax, or $1920 annually. For 40 years, that's $76,000. (I think we can all already see that a Trad IRA or Roth IRA is going to be a wise choice!) Her bank balance totals -$100,800 before she retires. Wow!

Another complication with this analysis: As a PP devotee, she sells the bonds after 10 years and buys new 30-year treasuries, incurring a capital gains tax bill four times during the 40-year investment period. (Oh boy, I want to give up -- too complicated and tax-inefficient! I'm going to ignore this extra tax burden, "for simplicity.")

Upon retirement, she withdraws $100,000 annually from her LTT portfolio, valued at (probably much less than) $1,600,000 and earning a coupon of 2%. That's a dividend of $32,000 -- all considered ordinary income. She has to sell $68,000 of LTTs, with a cost basis (25%) of $17,000, so a capital gain of $51,000.

The capital gain of $51,000 would be taxed at 0% up to $39,375 and 15% thereafter (on $11,625). That's $1744 annually. The $32,000 in coupons is ordinary income, but there's the standard deduction of about $12,000 to consider, so that's a taxable income of about $20,000. That would be taxed at about 15%-ish, so perhaps another $3000. Total annual tax bill of around $4700. And a bank balance of -$100,000.

Even with all this fudging, and many potential mistakes, I conclude this investment approach is a complete failure.
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Re: Investment locations?

Post by Pet Hog » Wed Oct 16, 2019 11:16 pm

For some light relief, on to Scenario (2): Trad IRA.

Same history. $100,000 invested, and a tax break. Her bank balance is $0. She earns 2% in dividends and invests it all -- no taxes along the way. The portfolio grows to $2,000,000.

After 40 years, she retires. Withdraws $100,000 from her Trad IRA. It's all considered ordinary income. With a standard deduction of $12,200, she has an adjusted income of $87,800. That puts her in the 24% tax bracket and, just like in the stock Trad IRA scenario, she pays $15,274 each year. But her bank balance is $0.

This scenario might be better than keeping the LTTs in taxable, but the longer the retirement lasts the worse it might get in comparison.

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Quickly onto Scenario (3): Roth IRA.

It's the same as the stock Roth IRA situation. A bank balance of -$24,000, but zero tax liability upon retirement.

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Assuming I've made no mistakes (I doubt it), I'm going to conclude that this lady would benefit greatly from a Roth IRA for LTTs. The other two scenarios are pretty tax-heavy.
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Re: Investment locations?

Post by Pet Hog » Wed Oct 16, 2019 11:56 pm

This might be easier: gold. Same lady, same strategy and history.

She invests $100,000 in gold in taxable account, Scenario (1). She never sells for 40 years. There are no dividends. The gold goes up in value to $2,000,000. I think that, long term, gold has done almost as well as stocks, so it might not be a bad assumption. Her bank balance is -$24,000, having received no tax benefit for buying the gold outside a retirement account.

After 40 years, she retires and chooses to live off $100,000 withdrawn from her taxable account. Again, she has an adjusted income of $87,200, putting her in the 24% tax bracket. As a collectable, gold is taxed at her marginal tax rate (maximum of 28%), so she pays $15,274 each year, just as if it were all ordinary income. But her bank balance is -$24,000.

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Scenario (2): Trad IRA.

As above, but with a bank balance of $0, when she withdraws $100,000 from the Trad IRA the money is all ordinary income. So she pays $15,274 each year.

No bank balance makes this scenario better than that in (1) above. If she withdrew more and entered a higher tax bracket, this approach might be worse than that above, because gold has a favorable collectable tax rate of at most 28%. Ordinary income, not so favorable -- up to 37%.

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Scenario (3): Roth IRA

As in the stock and bond scenarios, she would have a -$24,000 bank balance, but pay no tax in retirement. So this strategy wins as long as the retirement lasts two years.

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For cash, I'm going to assume the results are pretty similar to those for LTTs. As in, don't put it in taxable.

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To conclude, Roth seems to win in each case, but stocks provide almost identical returns in taxable. Gold might be better in taxable than in Trad IRA if you withdraw a lot of it -- the 32% ordinary income bracket starts at $160,725. Lots of assumptions made in these analyses, so consider your own unique individual situation.

Please let me know if I have made big blunders. I'm sure I have. It was an interesting exercise for me. I never realized Roth IRAs were that good in every case. And I might have to reconsider taxable accounts for stock investing. I'm not expecting to withdraw $100,000 in retirement, so my own personal numbers will be different.

Finally, I guess there's at least one more analysis to conduct: an actual PP with all four assets in each type of investment account. I don't think it will be as easy as modeling a combination of the four individual components considered separately. But probably Roth wins, right?
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Re: Investment locations?

Post by mathjak107 » Thu Oct 17, 2019 2:10 am

i go by the research from michael kitces as far as location goes . as kitces found :

" the traditional asset location strategy “rule of thumb” is that tax-inefficient bonds go into an IRA, while equities eligible for preferential tax rates go into a brokerage account, the reality is that for investors with long time horizons the optimal solution may be the opposite. Once stock dividends and portfolio turnover are considered, the ongoing “tax drag” of the portfolio can be so damaging to long-term returns that placing equities into an IRA may be more efficient, even though they are ultimately taxed at higher rates!

In fact, it turns out that almost any level of portfolio turnover will eventually tilt equities towards being held in IRAs given a long enough time horizon (and especially while today’s low interest rates result in almost no benefit for bonds to gain tax-deferred growth inside of retirement accounts). Which means in the end, good asset location decisions depend not only on returns and tax efficiency, but an investor’s time horizon as well!"

https://www.kitces.com/blog/asset-locat ... e-horizon/


also not all index funds have the same tax efficiency .. most are not like spy which is the purest form in structure ...some dont own the index as is they swap minor stocks around , some loan equities out or buy and sell calls ... this list is an older list and the numbers have changed but it shows you even being an index fund the fund can have a pretty poor tax efficiency .

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