Bonds and IRAs

Discussion of the Bond portion of the Permanent Portfolio

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KodoCastle
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Bonds and IRAs

Post by KodoCastle » Tue Jan 15, 2019 1:36 am

Hello all,

I'm new to investing and am trying to get my head around how to use IRAs with PP.

I have a plan of opening a Roth IRA account at Vanguard, and use their free service to buy US Treasuries (30-year bonds and 52-week T-bills).

For proper tax shelter from the interest payments, I'm I right in thinking I want a Roth IRA as opposed to a normal IRA, or does it not matter with respect to avoiding taxes on the earned interest? Related, this is a case where I want my interest to be sent/re-invested into my IRA, not my "settlement account", right?

And, am I allowed to sell the assets in my (Roth) IRA without penalty as long as the money I get from the sale goes into my (Roth) IRA? As in, I'll be able to sell my 30-year bonds after 10 years without much hassle?

Any info would be much appreciated!

EDIT: Apologies, thought of some questions about contribution limits. Do the interest payments made to the IRA count towards the contribution limit? Do sales/trades of bonds held in the IRA count to the contribution limit, or are they considered neutral?
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sophie
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Re: Bonds and IRAs

Post by sophie » Tue Jan 15, 2019 7:04 am

Before you go doing anything irreversible, you'd better read up on IRAs:

https://www.bogleheads.org/wiki/Traditional_IRA

https://www.bogleheads.org/wiki/Roth_IRA

https://www.bogleheads.org/wiki/Traditional_versus_Roth

This is a pretty good source, but you may wish to check out others, and to read the IRS instructions for each type of account.
KodoCastle
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Re: Bonds and IRAs

Post by KodoCastle » Tue Jan 15, 2019 9:29 am

From sophie's proper prodding for me to do more research, here are the answers I found. Would appreciate if people could confirm or correct my answers to give me some more confidence in my understanding.

KodoCastle wrote:
Tue Jan 15, 2019 1:36 am
For proper tax shelter from the interest payments, I'm I right in thinking I want a Roth IRA as opposed to a normal IRA, or does it not matter with respect to avoiding taxes on the earned interest?
It does not matter. Taxes on growth through selling (capital gains) or interest/dividends (income) are ignored year-to-year. Choosing a Roth over a traditional IRA is based on your current tax rates and your forecasted retirement tax rates. Given that I'm uncertain about this, I will split my investments between both an IRA and a Roth IRA.

KodoCastle wrote:
Tue Jan 15, 2019 1:36 am
Related, this is a case where I want my interest to be sent/re-invested into my IRA, not my "settlement account", right?
Seems to be a silly question? IRA interest/dividends automatically go into the IRA, because that's the point and doing otherwise invites a penalty.

KodoCastle wrote:
Tue Jan 15, 2019 1:36 am
And, am I allowed to sell the assets in my (Roth) IRA without penalty as long as the money I get from the sale goes into my (Roth) IRA? As in, I'll be able to sell my 30-year bonds after 10 years without much hassle?
Seems like a yes. An IRA is just like a normal account, except for the tax benefits / complications.

KodoCastle wrote:
Tue Jan 15, 2019 1:36 am
EDIT: Apologies, thought of some questions about contribution limits. Do the interest payments made to the IRA count towards the contribution limit? Do sales/trades of bonds held in the IRA count to the contribution limit, or are they considered neutral?
Interest paid and capital gains through selling are considered growth, not contributions.
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Xan
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Re: Bonds and IRAs

Post by Xan » Tue Jan 15, 2019 10:13 am

Sounds like you've learned a lot already!

As far as Roth vs traditional, for the most part it's a bet between your current marginal tax rate and your future overall tax rate. Note that marginal tax rates are typically higher than overall tax rates, so that favors the traditional.

Another thing is that you can put more money in a Roth than in a traditional. What I mean is that for a given IRA contribution limit of say $5,000, you get more mileage per dollar that goes into a Roth than goes into traditional. Contributing $5,000 into a Roth today will give you $5,000 + growth in the future. Contributing $5,000 into traditional only gives you $5,000 + growth - taxes in the future. If there weren't a contribution limit, it'd be a wash, but since there is, the contribution limit on a Roth is effectively higher.

From a PP perspective, the big debate is whether to do one big PP which spans all your accounts, or whether to do smaller, individual PPs inside each tax treatment. Broadly, there are three tax treatments:
* taxable
* Roth IRA
* traditional IRA

Personally, I prefer to have a separate PP in each of the three. That way I'm not making any guesses about what's going to do well and what isn't, and there isn't any "interaction" between my sheltered money and my taxable money. Others have come to different conclusions.
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Re: Bonds and IRAs

Post by stuper1 » Tue Jan 15, 2019 1:44 pm

If your marginal tax rate is 10% or 12% in 2018, then a Roth IRA seems very attractive. If your marginal tax rate is 22% or more, then the decision gets harder. You have to forecast what you think your tax rate in retirement might be.
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Xan
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Re: Bonds and IRAs

Post by Xan » Tue Jan 15, 2019 1:48 pm

stuper1 wrote:
Tue Jan 15, 2019 1:44 pm
If your marginal tax rate is 10% or 12% in 2018, then a Roth IRA seems very attractive. If your marginal tax rate is 22% or more, then the decision gets harder. You have to forecast what you think your tax rate in retirement might be.
But again, you need to compare your current marginal rate against your future overall rate, unless you plan on having a lot of other income in retirement. This makes Roth look pretty bad in most scenarios, IMHO.
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InsuranceGuy
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Re: Bonds and IRAs

Post by InsuranceGuy » Tue Jan 15, 2019 3:10 pm

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stuper1
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Re: Bonds and IRAs

Post by stuper1 » Tue Jan 15, 2019 3:22 pm

If you have room to do Roth at 12% or lower taxes now, I would jump all over that. Odds seem high that tax rates will be headed up at some point. Even if that turns out to be incorrect, you will have lost little or nothing by doing Roth at 12% taxes. The only caveat would be if you are in a high-tax state now and foresee yourself possibly moving later.
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Re: Bonds and IRAs

Post by KodoCastle » Tue Jan 15, 2019 3:32 pm

Xan wrote:
Tue Jan 15, 2019 10:13 am
... From a PP perspective, the big debate is whether to do one big PP which spans all your accounts, or whether to do smaller, individual PPs inside each tax treatment. Broadly, there are three tax treatments:
* taxable
* Roth IRA
* traditional IRA

Personally, I prefer to have a separate PP in each of the three. That way I'm not making any guesses about what's going to do well and what isn't, and there isn't any "interaction" between my sheltered money and my taxable money. Others have come to different conclusions.
To you other points, I'm not going to have saved up for a few months to implement this plan (due to fund minimums and wanting to go "all in" when I start), so I have some time to figure out my plans re: Roth vs. traditional IRA, but I'm leaning more towards Roth.

Either way, I like the idea of shielding the most taxable assets first, and figured I can do that and be able to balance well by keeping at least 20--30% of my bonds (or whatever asset you have in your IRA) outside of my IRA. The issue comes up when bonds go high, because you don't want to have to sell out of your IRA to fund your other accounts, but by keeping 20--30% (depending on your balancing strategy) you'll be able to cover yourself.

So, say your doing a 20--30 balancing strategy. Then when bonds get to 31% of your total portfolio you'll need to be able to sell that 6% overage the golden 25%. Some quick algebra will show that 20% of your bonds makes up 6% of your total portfolio (20% * 31% = 6.2%). So, by keeping 20% of bonds outside the IRA, you can always re-balance if bonds shoot up. And if you're doing a 15--35 balancing strategy, you'll need 28% outside the IRA to sell the 10% overage (28% * 36% = 10.08%).

I think the above makes sense, but I'm not 100% how the bond market works, so maybe I'm missing something.
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Re: Bonds and IRAs

Post by InsuranceGuy » Tue Jan 15, 2019 3:35 pm

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KodoCastle
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Re: Bonds and IRAs

Post by KodoCastle » Tue Jan 15, 2019 4:50 pm

stuper1 wrote:
Tue Jan 15, 2019 3:22 pm
If you have room to do Roth at 12% or lower taxes now, I would jump all over that. Odds seem high that tax rates will be headed up at some point. Even if that turns out to be incorrect, you will have lost little or nothing by doing Roth at 12% taxes. The only caveat would be if you are in a high-tax state now and foresee yourself possibly moving later.
Not at the 12% level anymore, but thanks for mentioning state tax. I live in NYC, so there's a good amount of state/city/local tax levied against me now that will likely gone in the future, as I doubt I'll live here long-term. Man, there's a lot of things to consider. I've kept thinking I've had my plan set for 2 months now, but stuff keeps popping up. I was drawn to PP because of the DIY emphasis and the relative simplicity of the portfolio itself, but nailing execution regarding tax and long-term flexibility is a more complex needle to thread.

Not complaining. I like learning about all this and feeling more secure in my future, but I feel like I was way behind on savings/investment knowledge when I first started.
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Re: Bonds and IRAs

Post by InsuranceGuy » Tue Jan 15, 2019 5:18 pm

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sophie
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Re: Bonds and IRAs

Post by sophie » Wed Jan 16, 2019 7:53 am

Ah ha, another NYC denizen...you might be surprised to know that this city is fairly tax-friendly to retirees, and they're trying to position themselves . No tax on SS or the 1st $20K of pensions/tax-deferred account withdrawals (not sure if it's $40K for a couple or still $20K).

Also a comment about the tax situation outlined by InsuranceGuy. You need a chunk of savings in Roth or taxable to give yourself wiggle room to avoid getting stuck with a realized high income. One way to arrange this is to defer social security and, if possible, pension income as long as possible after retirement, while spending down tax-deferred accounts and Roth-converting as much as you can tolerate.

As far as the PP goes, I have mine sprawled out among various types of accounts. Works fine. Within this structure I hold some amount of all four assets in each account, but even if I didn't there's no issue with rebalancing. Just sell asset A in account B and buy asset C, as per plan. It definitely helps to follow tax-efficient placement strategies, like holding bonds and cash in tax-advantaged accounts. I also differ with conventional wisdom on gold; any gold that has to be held in tax-advantaged accounts goes into tax-deferred rather than the Roth. It effectively lets you tax loss harvest (you won't pay income tax on losses) and any gains would be taxed at 28% anyway.
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Re: Bonds and IRAs

Post by gull1 » Sun Sep 08, 2019 7:14 am

In Craig's PP book it says p245 - tax deferred accounts (401k/IRAs) should be used for lease tax-efficient assets first (those that produce interest and dividends). Assets should go into tax sheltered accounts int he following order: bonds, cash, stocks, gold.

Do folks generally agree with that? Complications from juggling multiple PPs and challenges gaging after tax performance aside?
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Re: Bonds and IRAs

Post by pmward » Sun Sep 08, 2019 2:10 pm

Yeah I also keep cash taxable. Maybe I'll change my mind if we ever go through another Volcker type of situation, but at these rates I would rather keep my cash reachable in taxable. Of course, I also have more taxable assets than tax advantaged due to a high savings rate so that has to be brought into account, as more than one asset needs to be held taxable (currently I also have all my gold and a good chunk of my stocks taxable as well).
KodoCastle
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Re: Bonds and IRAs

Post by KodoCastle » Tue Sep 10, 2019 4:44 pm

For me it depends on how much space I'll have in my IRA. I definitely try to use all $6000 for bonds if I can, but if I can't I don't see the issue in keeping some cash in there for a bit and protecting the interest from taxation. That's all with the plan to use the cash in the IRA to eventually fund a bond purchase in the future.

On a similar note, I realized my previous comment about needing bonds outside the IRA isn't really true. If bonds get above the 35% band, then I can sell them and convert that portion to cash assets within the IRA, and at the same time use my cash assets outside the IRA to purchase the lagging asset (if it wasn't cash). No need for all that algebra and more complex planning I thought I needed before. So there's no reason to have bonds outside a tax-deferred account, unless you've already contributed $6,000 that year (and if that's your problem, good for you!).
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