Priority of sectors to taxable/non-taxable accounts

[meamakim]

Dear PP gurus:

I am trying to understand allocation of the four sectors to taxable vs. tax-deferred accounts. However, I am getting conflicting info, which also does not make sense:

HB says to use the tax-deferred accounts first for sectors in the following order of priority 1) Treasuries, 2) Bonds, 3) Stocks, 4) Gold.

The Permanent Portfolio book by CR says to use the following order: 1) Bonds, 2) Treasuries, 3) Stocks, 4) Gold

However, why would one want to put cash/treasuries in a non-taxable account? It is not generating much (if any) taxable income, so isn' t it wasting the space that could be better used by something that is generating income?

Also, since stocks generate dividends (income), why aren't stocks assigned sooner to the tax-deferred accounts?

Then I recently learned that profits from commodities like gold are taxed at a higher rate when they are sold (28%), so why should they be the lowest priority for a non-taxable account?

SO- it seems like the priority order for non-taxable  accounts would be 1) Stocks, 2) Bonds, 3) Gold 4) Treasuries. But this is very different than what HB and CR recommend.

If anyone can shed light on this I would greatly appreciate it!

[dualstow]

Cash was earning a lot more interest when Harry Browne mentioned keeping that in tax-deferred. When interest rates rise again, go back to Harry's advice. :-)

I don't want to speak on others' behalf, and I really don't want to misquote, but I believe:

Medium Tex suggested buying gold coins in taxable and maybe keeping some gold ETFs to sell. Depending on the specific investment, you might not get hit with that 28% rate. Even if you do, you won't rebalance that often. (But this is in other threads).

Bonds often produce much higher interest than the dividends paid for holding stocks, so...

Some people do just keep separate pp's in taxable and in tax-deferred. Look for threads on that. I didn't start out this way, but now I have all four assets in both kinds of accounts. (Very little cash in tax-deferred, though).

You do want to have some cash in taxable. Easier to contribute to tax-deferred than to take money out of tax-deferred and pay a penalty.

[Pointedstick]

In general, I'd say that cash is the most important to keep in a taxable account (with rates this low, that's a no-brainer, plus it can act as an emergency fund), followed by gold so you can buy and take possession of individual bullion coins. Then ideally you'd want as much of everything else in tax deferred/tax-free because stocks and bonds are constantly generating payments that the tax man otherwise loves to skim a little off the top from.

Eventually, you'll probably wind up with a mini-PP in each account as you rebalance and buy and sell where it makes the most sense to avoid the tax hit. You probably want to fill up your tax-free and tax-deferred accounts before buying bonds in taxable, especially a fund like EDV which has a tendency to throw off huge dividends. Not that huge dividends are bad of course, but a bit of judicious tax planning a day keeps the tax man away. Or something like that.

[notsheigetz]

However, why would one want to put cash/treasuries in a non-taxable account? It is not generating much (if any) taxable income, so isn' t it wasting the space that could be better used by something that is generating income?

There isn't any such thing as a non-taxable account except for Roth-IRA's if you think they will continue to hold that status . You probably mean tax-deferred account.

Given the knowledge I have today about future tax liabilities I would rather have my lowest performing assets in my tax-deferred accounts (to eventually be taxed as ordinary income), the next best in my taxable accounts (to be taxed as capital gains), and the very best in my ROTH IRA's (which will never be taxed according to current law).

I am actually working towards this goal as I near retirement. Right now Cash and Bonds are a drag so I want them heavily weighted in my IRA which is going to become taxable income soon enough as I am forced to liquidate via MRD's and pay tax on whatever gains have been realized. The better performing assets go into my taxable accounts and my Roth IRAs which I can currently hold onto as long as I want without government coercion.

[meamakim]

Thanks all!

Dualstow: So is it possible the tax allocations HB recommended are not appropriate these days, with interest rates so low? Should one adjust the allocations as conditions change?

notsheigetz: yes, sorry I meant tax-deferred.

Pointedstick: Are suggesting that each account have it's own 4x25% allocation, regardless of its tax status? (BTW: is your username from monty python?)

Much appreciated.

[BearBones]

Pointedstick: Are suggesting that each account have it's own 4x25% allocation, regardless of its tax status? (BTW: is your username from monty python?)

Some of us have definitely done this. Several reasons:
1. Easier
2. Do not have to worry about a tax deferred account losing lots of its assets, such as what might happen with one loaded with TBonds in a rising rate environment. When I get to retirement, I want the flexibility of being able to draw from lots of buckets (e.g., taxable, tax-deferred, Roth).

I just did a 30/30/30/10 (cash) tax deferred and 20/20/20/40 taxable. Each will have its own rebalancing bands. And if cash starts to earn serious interest again, i will rethink allocations.

[dualstow]

Thanks all!

Dualstow: So is it possible the tax allocations HB recommended are not appropriate these days, with interest rates so low? Should one adjust the allocations as conditions change?

Sorry for the late reply. I lost track of this thread.
The short answer to your question is yes. I would look to the new book and this forum.

Some members here use earnings from the pp to help with living expenses, so you might want to consider that. If you're not going to spend dividends or interest but instead reinvest it, I think it makes sense to go with your instinct to put that in tax-deferred.

Still, someone just posted a Morninstar article over at the bogleheads forum on asset location, that is "what to put where." One point in the article is that things change. For example, the end of heavy tax cuts on dividends (ugh, I hate to think about that. :-) )
http://news.morningstar.com/articlenet/ ... ?id=586513

[sophie]

Dualstow: So is it possible the tax allocations HB recommended are not appropriate these days, with interest rates so low? Should one adjust the allocations as conditions change?

HB's reasoning for putting cash as top priority for tax-deferred was that all the earnings for that asset are taxed like ordinary income, at the federal rate.  With interest rates so low AND with I/EE savings bonds as a great tax-deferring vehicle for cash, that's not as much of a consideration now.

Gold was considered lowest priority for tax deferred because 1) ideally you want it in the form of physical bullion, which is hard to do in tax-deferred, and 2) it throws off no interest or dividends.  That said, many of us keep gold ETFs in tax deferred to allow rebalancing without having to take a huge tax hit. 

That leaves stocks and bonds.  Of the two, bonds generate more income and benefit less from reduced taxes on dividends, so they should be higher priority.  But, there's a good rationale for keeping some of each asset in taxable.  First, you can tax loss harvest if they go down in value.  Second, the long term capital gains rate beats the taxes you'll eventually have to pay on 401K or IRA withdrawals.

For simplicity plus all the above reasons, several people here (PointedStick in particular, or Bearbones with the creative cash modification) keep separate PP's in each type of account.  I'm a bit of an anomaly since I started out that way and have since been migrating toward having more cash and gold in taxable.  But then I'm in an extraordinarily high tax location (NYC), so I have good reason to be as tax efficient as humanly possible.  The PP really woke me up to the tax implications of all the horrible investment advice I'd gotten in years past.