PP straddled between taxable and tax-deferred accounts

[BearBones]

I cannot imagine that this question has not been posted before. If so, my apologies; just point me to the conversation.

Most of my investments are outside of a tax-deferred account (TDA), so I am struggling with trying to keep the least tax friendly investments within the TDA.  In doing so, the problem arises that my TDA will primarily be made up of LTTs if I follow this logic, and about 15 years of accumulation stands to evaporate if yields rise significantly. I think that the solution is to create an unbalanced PP within the TDA such as 40/20/20/20. But even this could be nibbled away in a rising rate environment. Any thoughts on how best to handle this?

[Khisanth]

Not sure how others are doing it, but I have a huge difference between retirement and taxable amounts as well. In the end I decided not to straddle because I'm lazy, and rebalancing would be tedious if not extremely difficult.

In my taxable accounts, I've done 4x25 ETF style, with dividends going to cash.

In my IRA I simply chose PRPFX. I won't be touching that for at least 30 years, although the expense ratio is rather high and at some point I might just replicate 4x25 in there.

[BearBones]

In searching through the treads by search words, I found only 2 touching on this topic:
http://gyroscopicinvesting.com/forum/ht ... ic.php?t=8
http://gyroscopicinvesting.com/forum/ht ... ic.php?t=6
http://gyroscopicinvesting.com/forum/ht ... ic.php?t=9

Neither really adequately addresses my original question. If someone with 60/40 or 80/20 taxable/tax-deferred space is setting up a PP, should both spaces be set up nearly 4x25 (not realizing the tax advantages of placing LTTs in the tax-deferred space) or should the the tax-deferred space be biased toward less tax friendly investments (realizing that it is at risk of obliteration due to the fact that there are not adequate uncorrelated investments). There is a lot of discussion on this forum about which of the 4 asset classes are best in a tax-deferred account, but I have not seen anything about how to keep the relationship between the taxable and tax-deferred accounts complementary, predictable, and  "permanent."

This should be covered in the book, shouldn't it, Craig and MT? Can you give me a hint of your wisdom if you have given this thought? And how about you, Moda? You've given this a lot of thought already, given your previous posts and your knowledge of tax strategies.

[AdamA]

Should the the tax-deferred space be biased toward less tax friendly investments (realizing that it is at risk of obliteration due to the fact that there are not adequate uncorrelated investments).

I think there are a lot of right answers. 

If it were me, I would sacrifice the perfect 25% x 4 allocation to get the tax advantages.  I would also try to set things up in such a way as to minimize counterparty risk as much as possible.  Certainly with a 60/40 taxable/tax-deferred split I think a 30/30/20/20 would do just fine. 

An 80/20 40/40/10/10 is pushing it, but is still much better diversity than most people have.  If I had 80% in a taxable account and 20% in a tax-deferred account, I would probably overweight my cash position a little bit to level out the volatility.  Maybe 40% cash and 20% gold, stocks and bonds (this is always a safe option when you can't get your rebalancing math to workout exactly as you'd like). 

I also like the suggestion that Khisanth made about segregating the taxable account and the tax-deferred accounts between PRPFX and 25% x 4 (although I'd eventually want to add some long bond exposure in some way).

Does that help at all?

[MediumTex]

At any point in time, it's obvious which assets fit best within tax deferred space, as avoiding taxes on current dividends is normally more appealing than avoiding taxes on unrealized capital gains, which can already be deferred by not selling assets, and which are taxed at a lower rate when they are sold for a gain (though stock dividends are currently taxed at the same rate as capital gains).

To use t-bills as an example, the problem is that at one point in time t-bills might make sense in the tax deferred space when they are yielding 8%+, but at another time they wouldn't make sense at all in the tax deferred space when rates are near 0% (at least not to me).

Similarly, when the S&P 500 is yielding 4%, it would fit better in a tax deferred account than when it was yielding under 2%.

Gold would seem to always be a good fit outside tax deferred accounts, but it sure is nice to have some gold inside a tax deferred account at rebalancing time.

And so I think that the optimal taxable/tax deferred mix is a function of what dividends the various assets are throwing off and whether you like being able to rebalance with as few taxable gains as possible.

Given that the PP is supposed to be a long term strategy and over the long term the ratio of taxable to nontaxable accounts is going to fluctuate, I would be inclined to proceed based upon the following very loose guidelines:

1. Place a little of each PP asset in taxable and nontaxable acccounts.
2. If t-bills continue to yield near 0%, don't sweat an accumulation of cash in a taxable account (better yet, put these funds in savings bonds).
3. When presented with an opportunity to accumulate larger holdings outside of a tax-deferred account, opt for gold since physical bullion doesn't fit very well within a tax-deferred account anyway (even though American eagle bullion IRAs are available, I am assuming they are not a good long term option due to expense and general hassle).

As much as I would like to say there is some hard and fast rule when it comes to allocating between taxable and nontaxable accounts, about the only thing that I think would be a good idea in almost every case would be to keep enough of each PP asset in tax-deferred accounts to provide at least one tax-free rebalancing. 

[BearBones]

An 80/20 40/40/10/10 is pushing it, but is still much better diversity than most people have.  If I had 80% in a taxable account and 20% in a tax-deferred account, I would probably overweight my cash position a little bit to level out the volatility.  Maybe 40% cash and 20% gold, stocks and bonds (this is always a safe option when you can't get your rebalancing math to workout exactly as you'd like).  

Does that help at all?

Definitely helps. Thanks. Given the order of tax efficiency posted in other threads (Cash<LTT<Stock<Gold), I have been overweighted in cash and LTT. But in the post quoted above, Moda makes a good argument for stocks over cash in the tax deferred space, especially when yields are so incredibly low. This seems in accord with how MT has responded. So my latest thought has been something like 40% LTT, 25% Stocks, 25% Gold, 10% Cash. I may regret this, though, if yields rise, most of my 401K has melted away due to over-bias in LTTs, cash is spitting off increasing amounts of taxable interest in non tax-deferred accounts, and I have no way to increase funding of 401K enough to make very useful again. I can always underfund the 401K and increase my taxable savings, but I cannot do the reverse (maxed out).

This has to be a fairly common problem that people will encounter when setting up the PP, so I appreciate all angles. Craig, what about you? Do you just ignore the tax-deferred accounts since such a small percentage of your assets?

[Tyler]

I struggled with the same issue, and it's a little more compounded for me as I plan to retire by 40-45 and am not a big fan of the idea of the taxable and non-taxable accounts being individually volatile (even if they even out when seen as a pair) as that complicates my ER years.

You'll get some great input from others here on ways to minimize your tax impact.  But keep in mind that even if you just keep separate 4x25 PPs in the taxable and non-taxable accounts, you'll still be doing much better tax-wise than most active investors.  I personally prefer the laid back approach to getting too wrapped up in saving a few extra dollars in taxes a year.

[jackely]

Tell me about it.

It gets even more complicated when you introduce both ROTH and Traditional IRA's into the equation.

I just finished converting ALL of my assets to the PP and this meant juggling funds between 7 different accounts, including 3 ROTH IRA's, 2 Traditional 401Ks, a SEP-IRA, and a Taxable account.

This was quite a brain teaser because I was not able to move any of the money between any of those accounts except for being able to take an in-service withdrawal from one of the 401k's and deposit it in the SEP-IRA.

Putting your assets with the greatest short-term tax liabilities in the Traditional IRA is a no-brainer and a good starting point but I think it's not quite as simple deciding between ROTH and taxable. Seems to me you would ideally want the assets with the most growth potential in the ROTH accounts as the tax liability will be zero when it comes time to take withdrawals. That, to me, meant gold and stocks.

Before doing this chore I spent a whole Saturday working on a spreadsheet that allowed me to play what-if scenarios and I eventually concluded that there are just too many variables and possibilities to come up with any kind of algorithm likely to achieve the best outcome. So I ended up with smatterings of investments all over the place. I did manage to achieve perfect  25-25-25-25 balance, but it took a lot longer than HB's 30 minutes.

[BearBones]

The more I am sitting on this, the more I am moving in your direction, Tyler. It may be best not to asymmetrically divide the PP among the accounts but rather to replicate the 4x25 in each. Problem is that if there are unbalanced assets in the tax-deferred account, there could be a draw down to the extent that it becomes rather useless for rebalancing. I also don't want to take the risk of either the taxable or tax deferred account to being so severely depleted that I cannot rely on it exclusively in retirement. Which one I draw from may depend on the nature of taxation at the time. Better plan on this now rather than get stuck later on. This may not be applicable to you, Jack, since you have so many accounts to play with.

Gonna see if I can get Moda to weigh in before I change my tactic.

[moda0306]

BearBones,

There's a lot of moving pieces in these conversations, so I'm just going to give my 2 cents and hope that it can help, rather than specifically address everyones points.

First, Max out these things as much as you can.  As long as you're including a Roth in your tax deferred accounts for tax-diversification, you're almost guaranteed to be able to have the liquidity you need, and acquire greater Net Realizable Wealth as a result.  Looking at income limits and contribution limits for IRA's and Roth IRA's can help bring this into focus, as well.  Remember, when you are making good money, you're contributing at your highest tax bracket.... when you lose a job, you would be distributing at a lower tax bracket (likely), leaving you very likely even with a lower bracket distribution even if you incur the 10% penalty, if you've been out of a job for long enough where your 20XX taxable income will have you down a couple brackets.  The Roth and your emergency fund should be plenty to keep you from distributing an IRA EVER from a high tax bracket.  Being properly insured helps a ton too so you don't have full income AND have to liquidate wealth in the same year!

Seconds, scratch enough out of my first point to get the following: Enough cash at Treasury Direct, cash at home, and physical gold at home and in a deposit box as makes you feel comfortable.  It's good to have at least 6 months of liquid cash in TD IMO, and a couple weeks worth in green stuff in a safe at home.

Third, I tend to have the attitude that to the degree you can't get your wealth into tax-deferred accounts, and you're complying with the PP, look at the tax-efficiency of the assets involved at the time of allocation, and allocate accordingly, considering, though, that you don't want your retirement accounts, especially your Roth accounts, to drop significantly in value, screwing up your retirement/liquidity allocation (That said, I think Roth's are a good place for stocks to get good long-term return).  This doesn't mean avoiding any LTT's in your taxable accounts for the life of you, but simply, as you've suggested, overweighing them into your tax-deferred accounts (which are unfortunately, if held in a 401k, often very difficult to get ahold of).  Today's environment would also lend itself to keeping a more solid chunk of cash in your taxable acounts, realizing that if rates rise, you can sell the stocks in your 401k/Roth/IRA for cash, and invest your now high-interest taxable cash in more tax-efficient stocks.

I think, though, that as long as you 1) shove as much as you can into these accounts, with a healthy dose of Roth for tax-diversification and liquidity, 2) properly diversify those accounts to avoid large losses in the Roth, and 3) keep a heavy weighting of LTT's in tax-deferred accounts in todays environment, you'll be just about as good as you can be.  If/when interest rates rise, it will probably be a result of recovery, not "Volkerization," so I think at that point your tax-deferred accounts will be ok (stocks doing well), and you can do the swap as the tax load on cash becomes too high.

Remember, i-bonds (and ee bonds if you like them now that it looks like we may have a 0% i-bond 6-month period) make it even more attractive to keep cash in taxable accounts, and store other assets elsewhere.

401k choices come into play (in my case, pretty much forces my 401k to hold my stock portion... the rest is crap). 

Lastly, for whatever volatile assets you hold in your taxable accounts, making sure you maximize loss-harvesting can help.  I tend to like to put my 2 favorite PP assets in my Roth, and hope that nothing too horrible can happen with 2 PP assets at once (plus I'm young, so this is all not real enough for me anyway).

[moda0306]

Two more things... look at cash and gold for what they are, and make sure they can do their job if need be.  I've already expressed my opinion about cash at home, gold at home, and cash in a liquid account, but there are a couple other points:

- Cash that exists somewhere that you can't get it or invest it in something you want to is pointless... it's the weakest PP asset, so make it count where you use it.  Have some in both your Roth & IRA as dry powder.  Don't let it sit somewhere that you won't be able to use it on a dime in some useful way.

- Gold is a hedge against government failure, which is why we try to keep some physical.  With that, if push comes to shove, we can hopefully avoid having to realize abusive taxes in the future.  That said, we know we're going to hold a lot in ETF's, so I think we should make sure that our "monetary tomfoolery hedge" has a decent stake in our Roth account.  Roth's provide this nice pocket of non-taxable growth that I think we want to make sure we're aligning with our favorite anti-government asset, which is gold.  Negative real returns, which wake gold from a slumber like no other, tend to be even more painful once taxes are taken out.  If society can't  walk away with real returns partially as a result of our tax system, I'd love to have the world's best hedge to that in my Roth account.

Any questions?... ask away.

[AdamA]

With that, if push comes to shove, we can hopefully avoid having to realize abusive taxes in the future...Roth's provide this nice pocket of non-taxable growth that I think we want to make sure we're aligning with our favorite anti-government asset, which is gold. 

That's a good point that I hadn't really thought about.  Having some gold in an ETF in a Roth IRA actually adds some good diversification to the PP, and is also convenient for rebalancing. 

[FarmerD]

Here’s my 2 cents….
You want to put your most volatile assets in your IRA/401 so you can get the most growth in your retirement accounts as well as take advantage of tax-free rebalancing.  That means stocks, bonds, and gold.  With cash paying essentially zero interest, you probably want to park your cash in a taxable account. 

It’s probably safest to hold unencumbered physical gold under your direct control.  So that means holding gold outside of your tax advantaged accounts.  Therefore, I would devote the vast majority of my IRA/401K to stocks and bonds with only a small amount of ETF gold in my IRA/401 and use that solely for rebalancing. 
 
Should cash holding’s yield/interest rise dramatically, then you can consider rebalancing some of your cash into your tax advantaged accounts. 

[BearBones]

I think, though, that as long as you 1) shove as much as you can into these accounts, with a healthy dose of Roth for tax-diversification and liquidity, 2) properly diversify those accounts to avoid large losses in the Roth, and 3) keep a heavy weighting of LTT's in tax-deferred accounts in todays environment, you'll be just about as good as you can be.  If/when interest rates rise, it will probably be a result of recovery, not "Volkerization," so I think at that point your tax-deferred accounts will be ok (stocks doing well), and you can do the swap as the tax load on cash becomes too high.

Thanks to all! This point quoted above I still don't get. If I keep a "heavy weighting of LTTs" in the tax deferred act (TDA) and if yields rise, say from 4 to 8% (not predicting, just giving an example), then would't the TDA take a big hit (potentially not recoverable if at the wrong time in career) even in the event of "recovery, not "Volkerization?" For example, if the TDA is 40% LTTs, 30% stocks, 30% gold, the latter 2 assets might not carry the portfolio.

Assume the following, as is the case in my example:
Roth is trivial (I do a non-deductible IRA with Roth conversion each year, but this is small % assets)
TDA significantly smaller than taxable despite maxed out contributions
TDA self directed with virtually unlimited options

[moda0306]

BearBones,

I understand your concern, but it's not like your retirement accounts are your "retirement funds," while the rest are for pre-retirement consumption... if your TDA's are really a smallish part of your overall portfolio, I wouldn't get overly concerned that they are in a position to fall in value if rates rise, and 40/25/25/10 is giving yourself plenty, of diversification in those accounts, IMO.  What matters is your overall wealth at, during and until retirement.  TDA's simply allow you to avoid taxes in different ways.  If yields rise to 7%, holding LTT's at even 25% isn't going to be fun, anywhere, especially as taxes eat away at an asset that's actually losing value.  It sounds like you'll still have plenty of LTT's outside your TDA's, so I think you will be in an ok position.

All that said, if I were in your position, (I'm not... I'm poor enough to be able to cram everything into TDA's  ;)) I'd feel your will to put assets you think will perform best into the TDA's, leaving the hopeful losers in taxable accounts.

If you are of the mindset that rates will rise, you could lose out on loss harvesting by having them in TDA's, and we are at a time when tax-efficiency isn't the concern it was when we had 5-7% interest rates and 3% dividend yields, so you really can't make a bad decision here, BB.

I think one of the more legitimate "tinkerings" of the PP is getting your favorite assets into a Roth (with enough diversification to prevent real big losses), and getting your least favorite into your Traditional IRA or maybe even taxable if you have space there (which you obviously have a bunch of).

With dividend yields tax-preferred and at 1.9%, and LTT's yielding 3.1%, I simply would  be making sure I was cramming LTT's pretty hard into tax-deferred accounts, with maybe a 50% max to allow for some diversification in those accounts.  It's tough with the PP though, becuase you are carrying assets you don't like sometimes, and that can play with your head about where to keep them.

[moda0306]

Sorry if that seemed like kind of a non-answer... we're really playing with a lot of weird what-ifs at this point, and trying to hedge in 8 different directions.

If it makes you feel better, you could cram the 40% LTT's into your traditional IRA, hopefully leaving the better rising-interest-rate performers for your Roth.

This way, you could at least look at the realignment in a world of rising rates as an adjustment to your future tax diversification, helping you avoid future taxes by positioning your Roth to grow in a time of high interest rates.

This could have the psychological success you desire, and to be honest, is kind of the philosiphy I'd follow if I didn't have so many stocks in my dang-nabbit 401k, leaving my Roth IRA the only place I can fit my LTT's (though it hasn't proven unsuccessful in the past 6 months!!).

I am of the philosophy that high-interest environments are most likely environments where getting around taxes are a much larger concern (I can't imagine investing in the '70's... high taxes AND high rates.

It's that environment you'll want a juiced-up Roth account... keep those LTT's out of your Roth if you can.

[BearBones]

Sorry if that seemed like kind of a non-answer... we're really playing with a lot of weird what-ifs at this point, and trying to hedge in 8 different directions.

Appreciate your time, Moda. That's helpful, and I don't expect an absolute answer. That would be like telling me how each asset class will behave over the next 20 years and what tax law will be in 2032.

[moda0306]

BB,

Much more importantly is maxxing out these accounts until retirement, as well as properly coordinating the planning of these accounts with the way Social Security works, as well as how it's taxed.

A couple can take $30k in SS, and (if I remember right) about another $15k in taxable IRA distributions before realizing ANY taxable income (because of how SS is taxed).

However, if they go past this point in required annual income, then you are quickly getting nicked (in other states it could be less) at an effective marginal 40% rate... this is because of how SS is taxed, and the phase-in of AGI it creates as you earn other income.

Avoiding this, if possible, is key.  Most accountants and financial planners don't do a particularly good job of identifying this zone of taxation, IMO.

[Tyler]

If all of the taxation possibilities are stressing you out, one healthy exercise is to figure out how much in taxes you're actually "sacrificing" by simply keeping separate 4x25 PPs and not worrying about it.  For me, it's in the ballpark of 0.15% of the total portfolio every year at current interest rates.   Since I'd be potentially willing to pay a financial planner about that much to optimize my taxes and taxable/TD volatility every year, I consider that an acceptable "fee" for relaxing and thinking about other stuff.

Right now, I prefer to spend my mental energy working on the best way to diversify for counter-party risk and acquire some physical gold.  I may start tinkering with tax allocations in the future as the situation changes, but I'm in no huge hurry.  The PP is a multi-layered beast, and I'm taking it one step at a time.

[moda0306]

Tyler,

Good observation, but in drawdown, these tax rates will get amplified as you need to start selling gold/stocks.  This is a consideration worth making... moreso to realize what the NRV of your investments are and properly fund retirement accounts as opposed to nit-picking exactly where your PP assets go.

[metta2006]

1. Place a little of each PP asset in taxable and nontaxable acccounts.
 

What percentage should this little of each pp asset be? 5% or 10%?