Placement of cash (vs other PP assets)
Posted: Sun Feb 25, 2024 11:11 am
Hey all,
I got an interesting question from one of the forum members and thought I'd answer it with a new thread. If only because I don't necessary have the best answers and it's certainly a topic ripe for discussion.
Like everyone else, I loaded up on cash in my taxable accounts and my Roth account with stocks, because cash was returning almost nothing (thus not generating taxable income) while stocks had the best outlook for increasing their value.
Because of all the personal and work issues I've been dealing with the for the past few years, I hadn't taken a good look at this policy and had just let things ride...in part because I felt like I had to make sure to have easy access to cash in case my mother ran short for her very expensive Alzheimer care costs. But then came my 2023 tax filing. Those interest payments (and the high tax rate they command) really add up. I definitely now have to DO SOMETHING. Many others I'm sure are in a similar situation.
To start with, I have (and you all do as well) 4 types of accounts: 1) taxable, which comes with preferred treatment of qualified dividends and capital gains, 2) tax-deferred savings, which is treated like ordinary income, 3) accounts where the capital is post-tax and the gains are taxed as ordinary income, i.e. nondeductible IRAs and savings bonds, and 4) tax-free savings vehicles, i.e. Roth and HSA accounts.
If you have a PP or GB that includes your emergency fund and sprawls over all four types of accounts, you have a good opportunity for some tax arbitrage. This involves attempts to predict the future to some extent, which means you could get it wrong, but what you ideally want is for taxable and tax-free accounts to grow the most, and for tax-deferred accounts to take as many of the losses as you can manage.
Anyway, the question was about cash vs. stocks. Harry Browne's simplified guidance on the matter suggested that cash and bonds (i.e. Treasuries of all stripes) are best in tax-sheltered accounts, while stocks are the best option for taxable. Between 2008 and 2 years ago, that was not necessarily the best plan, but it's good advice now. Here's some additional thoughts on that:
Stocks are optimal for taxable, because of the preferred tax treatment of gains/dividends, and also because you can take advantage of tax loss harvesting. Many have pointed out that this only defers tax costs, but that's not quite true. If you can get enough capital losses in any one year, you get to offset up to $3,000 in ordinary income.
Gold is good for taxable because it doesn't generate interest or dividends, but I'd only hold it in physical form. I've got most of mine at Texas Bullion Depository. Keep track of the depository's fees for when it comes time to sell. Or - this only just occurred to me, can you claim those fees as a capital loss every year?? Damn, didn't think of that before.
At current interest rates, you can argue that cash is best held anywhere but taxable. Roth and HSA accounts are good, obviously. US Savings bonds are good too, if you expect to benefit by deferring taxes on the interest. This is only true if you are less than 30 years from retirement, and also if you can avoid selling them until after retirement. It may be a BAD idea for a young person just starting out on a 30-40 year career, because their tax bracket is likely to be higher in 30 years than currently.
Cash can work well in tax-deferred accounts too. You won't be hurt by the tax costs because they are exactly the same as if you kept the cash in taxable, as long as your tax bracket doesn't change. And, if you think cash has less future growth potential than the other PP assets, that's good too because you want the least amount of growth in those accounts. That isn't necessarily true in the short term, but over the long term it almost certainly is.
Anyway, there's a Boglehead Wiki page on "placing cash needs in tax-advantaged accounts", that suggests the following strategy: Swap cash vs. stocks in your taxable vs. Roth IRA accounts. To do this, you sell stocks in the Roth to raise the cash you need, and use the cash in your taxable account to buy an equal amount of stocks (beware of wash sales). Then buy those T bills or whatever you want in the Roth. If/when you sell stocks to raise cash, you compensate by buying stocks with the cash in the Roth.
Couple of gotchas to be aware of. First, be aware of restrictions on Roth cash withdrawals. This is why that Bogleheads wiki recommends keeping at least twice the amount in taxable stocks as what you think you need for emergency funds, because of the possibility of having to sell stocks after a big market drop. Second, beware of funds which throw off a lot of capital gains. I've found that small cap value and Fidelity Zero funds are the worst offenders, so check prospectuses carefully and do this only with the most tax-efficient funds or individual stocks (if you're so inclined).
Finally for those with very high tax brackets, there's the option of municipal money market funds. These are NOT a good idea if your Federal tax bracket is below 32%, because the tax-equivalent yield is not as good as just buying a T bill and paying the taxes. They're also technically not as safe as T bills, so you want to limit what you put in them. But, they could be just the thing for the cash that you decide you really do need to keep in taxable.
Anyway as you can see...this can get complicated! Appreciate further thoughts, and also what have others on the forum done to protect interest from getting killed with taxes?
(Gold stuff moved to Gold Storage thread — > https://www.gyroscopicinvesting.com/for ... =5&t=13173 )
I got an interesting question from one of the forum members and thought I'd answer it with a new thread. If only because I don't necessary have the best answers and it's certainly a topic ripe for discussion.
Like everyone else, I loaded up on cash in my taxable accounts and my Roth account with stocks, because cash was returning almost nothing (thus not generating taxable income) while stocks had the best outlook for increasing their value.
Because of all the personal and work issues I've been dealing with the for the past few years, I hadn't taken a good look at this policy and had just let things ride...in part because I felt like I had to make sure to have easy access to cash in case my mother ran short for her very expensive Alzheimer care costs. But then came my 2023 tax filing. Those interest payments (and the high tax rate they command) really add up. I definitely now have to DO SOMETHING. Many others I'm sure are in a similar situation.
To start with, I have (and you all do as well) 4 types of accounts: 1) taxable, which comes with preferred treatment of qualified dividends and capital gains, 2) tax-deferred savings, which is treated like ordinary income, 3) accounts where the capital is post-tax and the gains are taxed as ordinary income, i.e. nondeductible IRAs and savings bonds, and 4) tax-free savings vehicles, i.e. Roth and HSA accounts.
If you have a PP or GB that includes your emergency fund and sprawls over all four types of accounts, you have a good opportunity for some tax arbitrage. This involves attempts to predict the future to some extent, which means you could get it wrong, but what you ideally want is for taxable and tax-free accounts to grow the most, and for tax-deferred accounts to take as many of the losses as you can manage.
Anyway, the question was about cash vs. stocks. Harry Browne's simplified guidance on the matter suggested that cash and bonds (i.e. Treasuries of all stripes) are best in tax-sheltered accounts, while stocks are the best option for taxable. Between 2008 and 2 years ago, that was not necessarily the best plan, but it's good advice now. Here's some additional thoughts on that:
Stocks are optimal for taxable, because of the preferred tax treatment of gains/dividends, and also because you can take advantage of tax loss harvesting. Many have pointed out that this only defers tax costs, but that's not quite true. If you can get enough capital losses in any one year, you get to offset up to $3,000 in ordinary income.
Gold is good for taxable because it doesn't generate interest or dividends, but I'd only hold it in physical form. I've got most of mine at Texas Bullion Depository. Keep track of the depository's fees for when it comes time to sell. Or - this only just occurred to me, can you claim those fees as a capital loss every year?? Damn, didn't think of that before.
At current interest rates, you can argue that cash is best held anywhere but taxable. Roth and HSA accounts are good, obviously. US Savings bonds are good too, if you expect to benefit by deferring taxes on the interest. This is only true if you are less than 30 years from retirement, and also if you can avoid selling them until after retirement. It may be a BAD idea for a young person just starting out on a 30-40 year career, because their tax bracket is likely to be higher in 30 years than currently.
Cash can work well in tax-deferred accounts too. You won't be hurt by the tax costs because they are exactly the same as if you kept the cash in taxable, as long as your tax bracket doesn't change. And, if you think cash has less future growth potential than the other PP assets, that's good too because you want the least amount of growth in those accounts. That isn't necessarily true in the short term, but over the long term it almost certainly is.
Anyway, there's a Boglehead Wiki page on "placing cash needs in tax-advantaged accounts", that suggests the following strategy: Swap cash vs. stocks in your taxable vs. Roth IRA accounts. To do this, you sell stocks in the Roth to raise the cash you need, and use the cash in your taxable account to buy an equal amount of stocks (beware of wash sales). Then buy those T bills or whatever you want in the Roth. If/when you sell stocks to raise cash, you compensate by buying stocks with the cash in the Roth.
Couple of gotchas to be aware of. First, be aware of restrictions on Roth cash withdrawals. This is why that Bogleheads wiki recommends keeping at least twice the amount in taxable stocks as what you think you need for emergency funds, because of the possibility of having to sell stocks after a big market drop. Second, beware of funds which throw off a lot of capital gains. I've found that small cap value and Fidelity Zero funds are the worst offenders, so check prospectuses carefully and do this only with the most tax-efficient funds or individual stocks (if you're so inclined).
Finally for those with very high tax brackets, there's the option of municipal money market funds. These are NOT a good idea if your Federal tax bracket is below 32%, because the tax-equivalent yield is not as good as just buying a T bill and paying the taxes. They're also technically not as safe as T bills, so you want to limit what you put in them. But, they could be just the thing for the cash that you decide you really do need to keep in taxable.
Anyway as you can see...this can get complicated! Appreciate further thoughts, and also what have others on the forum done to protect interest from getting killed with taxes?
(Gold stuff moved to Gold Storage thread — > https://www.gyroscopicinvesting.com/for ... =5&t=13173 )