Gyroscopic Investing

It has been debated here how to allocate to taxable vs tax-deferred accounts.  Most believe that 1) bonds should stay in your tax-deferred account, and that 2) gold should stay in your taxable account.  Most of the debate is around stocks vs cash.  My general belief was that cash, given its main purpose as a buffer for recessions, should be “leaned”? towards your taxable accounts.  That may work fine now, but what about when interest rates rise?  

I’ve come up with a bit of a system for this. Obviously you can’t make this work with 100% of your stocks and cash, but for a decent portion of your portfolio you can play this “game”? and keep them where they belong.
First off:

If interest rates are high, start with your cash in a tax-deferred account, and your stocks in taxable.
If interest rates are low, start with your cash in a taxable account and your stocks in tax-deferred.

Then (PS, don’t go out of balance.  This is NOT a rebalancing device, simply a reallocation of existing accounts flip/flopping what they’re holding):

If interest rates go from low to high:  This is easy.  No matter what, at some interest rate point (3%?, 4%?), sell your stocks that are in your IRA into cash (whether at a loss or not), and buy stocks in your taxable account with the cash that is now bearing too much interest.

If interest rates go from high to low:  This one’s a bit trickier, so let’s break it down.

1) If your stocks in your taxable account have a loss or no gain associated with them (use individual security method), then sell them, harvest the losses into cash now bearing low interest, and switch your tax-deferred account to stocks.
2) If your stocks have gains associated with them, you’ll probably want to analyze the tax-effect of taking those gains vs holding extremely low-interest cash in a tax-deferred account.  At this point I’d probably be tempted to leave things as-is.

If you think about it, working through this decision tree shines a light on another opportunity that relates more to loss-harvesting than interest rate tax planning.  A lot of people here have heavy balances already in the PP, much of it with stocks in a taxable account and cash in a tax-deferred account.  2008 & 2009 (and maybe somewhat still) would have been great opportunities to loss-harvest your taxable stocks into cash (at the time paying pathetic interest, so you’d want to anyway) and buying up stocks in your IRA that was holding lots of cash or st bonds.  This really accomplishes all sorts of tax gains that I’ve never really noticed until I started analyzing how these movements should be made given the interest rate environment.   You accomplish a loss harvest and got a bunch of your cheap stocks purchased in a non-taxable account while the interest now being paid in your taxable account is pathetically low. Now that 2008 and 2009 are long gone, one can hardly take the advantage they once could have, but this could be a useful tax-planning test to apply to ones future PP balances.

To step back a bit, I’m not suggesting that this can be done with 100% of your cash and 100% of your stocks (you always want an emergency fund on hand, and other considerations including how many shares of stock you can sell before incurring a capital gain), but it can keep you always playing on the right of the tax-fence.   Further, the probable increase of dividend and capital gains rates makes keeping stocks in a tax-deferred account look more favorable than it once did.

Questions?  Comments?  Concerns?

One thing to add, if the trend of the past couple decades continues of our trend of lower stock markets combining with lower interest rates, this could provide a really slick system of complying with the PP, but being able to play the tax game in a super efficent manner.  When things are good, contribute your cash to your Roth IRA and your stocks in your taxable accounts.  When things go bad, sell your stocks into interest-bearing cash (low rates),  and sell your cash into tax-deferred stocks... you've acheived a loss-harvest and will never pay taxes on the stock gains from that point.  You've now got low-interest bearing cash in your taxable account.

As stocks inevetably rise from their duldrums, interest rates will probably too, and you'll want to get those back out of your taxable account, so do another swap.

This will result in a ballooning of your tax-deferred accounts to a degree that it wouldn't naturally, so contributions to your taxable funds FIRST would be advised, so you're not left in an illiquid situation.

This machine leaves you with loss harvests and low-taxable interest over the years, with a good chunk of your stock gains in tax-deferred accounts so as to eliminate the need to ever pay taxes on the redemption of those assets (Roth assumed).  Those loss harvests can even be used to offset some of those awful gold gains you have to realize sometimes (though they're better off offsetting ordinary income).

Cool train of thought.  I like where you're going with this.  To me, it's easy to toss LT bonds into tax-deferred accounts.  It's much more interesting afterward and this looks like a smart way to think about it.

I'll need to think through these ideas some more and comment further later on.

More thoughts:

If you do your prioritization, and due to the size of your IRA you decide that there's no room for stocks or gold, you might want to rethink.  If you have it chuck full of both cash and bonds, taking a little more cash out (nice to have in taxable accounts... maybe put it in i-bonds) to replace it with maybe some stocks and somewhat less of a gold etf.

This may seem dumb, but hear me out.  If you have a bond/cash IRA (maybe it's a high-interest period), but you toss some gold and stocks in there as well in small amounts (maybe 5/25 of your stock balance and 2/25 of your gold balance).  This can help you come rebalance time when you can buffer your "rebalance tax" by selling the assets in your IRA first.  Used with partial rebalances, this can work well as while your first stock sales in your taxable account may have a high basis (individual selection), after that you're going to see problems with finding high-basis purchases to sell.  Also, this helps the stability of your IRA balance.  This is more important than some people may think, as you can only contribute so much to these, and you can't necessarily take anything out, so if you only have them delegated to 2 assets it can create rigidities that you don't foresee with where you rebalance your funds.

While there is a bit of a tax penalty by moving more cash to your taxable account, it's not really that much of a penalty when you can use I-Bonds.  Likewise, if you had a LT/Stock heavy IRA (like I would do now), what do you really lose by moving some more stocks to your taxable account and letting some cash or more controvercially, gold, into your IRA?  You now have some taxable dividends, just like your taxable interest, and if you get a loss you can tax harvest it, but if you get a gain you don't sell your TAXABLE stocks, you sell your IRA stocks.  With gold, once again by adding a little bit to your IRA and paying tax on the resulting now-taxable dividends by having more taxable stocks, you've now "insulated" that gold from taxation and can use it as a starting point for rebalance sales.

For instance.  The dividends on $1,000 of stock will result in about $4 of tax per year in MN (fed & state).  If strategized right, this stock won't have to be sold until you're old and gray.  $1,000 of gold, on the other hand, will have a considerable gain along with it at rebalance time.  If that amount is $400, at a 32% combined tax rate, you've just saved $140 in taxes (7% state) by having $1,000 of your gold in an IRA and selling that with your rebalance.  

Basically, I think my last point hilights that because of the different nature of the income portion of tax considerations and the appreciation/gain portion of tax considerations, you should diversify, to some degree, where you're holding your assets and use each account for what it's good for. 

For instance, here's a way to think it through:

IRAs may be good for insulating you from income portion tax which is the most parasitic tax, but income is sometimes quite small compared to appreciation/gain, and sometimes you need those same assets in other accounts (cash is needed, stock not so much, but is pretty tax favorable).  If you keep some of your IRA space fully dedicated to these nasty appreciation/gain tax events (which are a necessity to the PP), you can have the best of both worlds.  This probably is most valuable to those who are later in their life and aren't contributing much to the weakest assets.

1) Use your IRA space for income producing assets for the most part, as those are the most parasitic in high-interest-rate environments.
2) Save some space for some "sacraficial lamb" portion appreciation assets like stocks and even gold, as using those for your (every-five-year?) rebalances that may yield very large gains and require the sale of part of the portfolio.