Improving tax efficiency in retirement accounts

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Topic Author
uwbadgers
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Joined: Mon Aug 25, 2014 3:36 pm

Improving tax efficiency in retirement accounts

Post by uwbadgers »

Hi all,

I am looking to flip our ROTH IRA's into 100% stocks while swapping out some of our brokerage funds to be more bond heavy. My thinking here, and please correct me if I'm wrong on this, is to make our ROTHs gain as much as possible over time = 100% stocks. We will do bonds in accounts that aren't tax free like the ROTH.

Is this thinking correct?

We are 100% in vanguard so I believe I can just "exchange" one fund for another, with that day's price, correct?

While I know this probably could've been done better from the start, some things weren't "seen" until now :)
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Here's our info currently:

Age: 36/37, 2 kids

TOTAL FUNDS: 642k

His ROTH---86k----VTSAX (100% stocks)
Her ROTH---117k---VTHRX (2030 Target Fund = 65% stock, 35% bond currently)

His Solo401k---13k---VTSAX (100% stocks)
Her 401k---123k (2050 Target Fund = 90% stock/10% bond currently)
108k (2015 Target Fund = 35% stock/65% bond currently)

Brokerage 1---53k---VTSAX (100% stocks)
Brokerage 2---84k---VTSAX (100% stocks)
33k---VTTHX (2030 target fund = 75% stock/25% bond currently)

Cash Balance Pension: 25k (increases about 5k a year recently)
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NEW contributions yearly:

19.5k HER 401k
10k HIS 401k

13k ROTH IRAs (we may be borderline too much income for this soon, don't think backdoor is possible)

6k Brokerage 1
3k Brokerage 2

TOTAL = 51.5k
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My main thinking is that I'd "exchange" HER ROTH IRA into VTSAX, thus, going 100% stocks in our ROTH IRA to maximize the tax savings long term. Right?

Is my thinking correct in the tax efficiency?

And can I simply exchange 1 vanguard fund for another with no fees/penalties?
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Thanks for any thoughts on this!

We are fortunate to be in the position we are and I want to make the best of it long term.
petulant
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Re: Improving tax efficiency in retirement accounts

Post by petulant »

This is reasonable, but realize part of what you might be doing is taking on more equity risk.

For example, if you move $10,000 in the Roth account from bonds to stocks and $10,000 in the taxable account from stocks to bonds, you've increased total equity risk.

Think about what happens if stocks go down. You can tax loss harvest in the taxable account and get a tax write-off. If stocks go up, you do pay taxes, but you could avoid those in the future if the funds aren't necessary by leaving them for heirs or donating them. If you hold stocks in the Roth account, if stocks go down, you get no tax write-off. If stocks go up, you don't pay taxes there either. So stocks in the taxable account are fundamentally less risky due to tax losses and tax gain rules. Stocks in the Roth account are pure risk/reward.

To think clearly about that, you should look into tax-adjusted asset location on the wiki.

That said, you do have an asset location issue about where to put stocks and bonds. Assets held in the Roth account will not have tax drag, will not incur any tax if the money is needed to be spent, and can pass to heirs or charities without paying more tax, similar to taxable accounts. For these reasons, most BH recommend placing stocks in Roth first to place the highest-growing assets in the most-advantaged account. Given your unique, heavy Roth situation, you could get to a place where you might go the other way if bond yields rise quite a bit (placing the bonds where tax drag is lower), but I think that's a ways off.

Further, why do you believe backdoor Roth contributions will be unavailable in the future? And is there any reason you wouldn't invest more through your Solo 401(k) rather than adding brokerage funds? Seems like you should make use of that space as a pretax or Roth contribution.
livesoft
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Re: Improving tax efficiency in retirement accounts

Post by livesoft »

uwbadgers wrote: Thu Aug 06, 2020 5:11 pmI am looking to flip our ROTH IRA's into 100% stocks while swapping out some of our brokerage funds to be more bond heavy. My thinking here, and please correct me if I'm wrong on this, is to make our ROTHs gain as much as possible over time = 100% stocks. We will do bonds in accounts that aren't tax free like the ROTH.

Is this thinking correct?
That sentiment is often expressed at Bogleheads.org, but my personal experience is that the things that are expected to go up the most are also the things that actually go down the most. My tax-deferred IRAs and Roth IRAs with some bond funds available for rebalancing into equities when the market tanks are doing better than my 100% equities Roth accounts.

Therefore, I suggest that you do NOT make your Roth IRAs 100% equities, but maybe 75:25 or 80:20 until such times like March 23, 2020 happen.
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Topic Author
uwbadgers
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Re: Improving tax efficiency in retirement accounts

Post by uwbadgers »

petulant wrote: Thu Aug 06, 2020 5:42 pm
Further, why do you believe backdoor Roth contributions will be unavailable in the future? And is there any reason you wouldn't invest more through your Solo 401(k) rather than adding brokerage funds? Seems like you should make use of that space as a pretax or Roth contribution.
Thank you for the advice.

I believe my wife’s company doesn’t allow the additional contributions that make the back door roth possible. So, not the future, but more so what we are capable of account wise?

Also, my solo 401k is created as of about a month ago. It’s for my small LLC that is my side income. Mostly likely can’t contribute more as I don’t have enough income.

The brokerage funds are newly created as we sold a paid off rental and had around 225k to disperse. They typically will only be funded slightly, at least currently.
petulant
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Re: Improving tax efficiency in retirement accounts

Post by petulant »

uwbadgers wrote: Thu Aug 06, 2020 6:04 pm
petulant wrote: Thu Aug 06, 2020 5:42 pm
Further, why do you believe backdoor Roth contributions will be unavailable in the future? And is there any reason you wouldn't invest more through your Solo 401(k) rather than adding brokerage funds? Seems like you should make use of that space as a pretax or Roth contribution.
Thank you for the advice.

I believe my wife’s company doesn’t allow the additional contributions that make the back door roth possible. So, not the future, but more so what we are capable of account wise?

Also, my solo 401k is created as of about a month ago. It’s for my small LLC that is my side income. Mostly likely can’t contribute more as I don’t have enough income.

The brokerage funds are newly created as we sold a paid off rental and had around 225k to disperse. They typically will only be funded slightly, at least currently.
I don't think you need anything at your spouse's work to do a backdoor Roth contribution. You just make a nondeductible traditional IRA contribution at a brokerage and then perform a Roth conversion on that balance (which is tax-free since the contribution was nondeductible). You may be thinking of a "mega backdoor Roth" that does require work cooperation.
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Duckie
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Re: Improving tax efficiency in retirement accounts

Post by Duckie »

uwbadgers wrote:
petulant wrote:Further, why do you believe backdoor Roth contributions will be unavailable in the future?
I believe my wife’s company doesn’t allow the additional contributions that make the back door roth possible.
A standard backdoor Roth does not involve employer plans. It is making a non-deductible contribution to a TIRA and quickly converting to a Roth IRA. Since you show no non-Roth IRAs there should be no problem.

A Mega backdoor Roth involves making after-tax contributions to an employer plan like a 401k and then rolling those contributions either in-service to a Roth IRA or in-plan to a Roth 401k.

Even if she cannot use the mega backdoor method both of you can use the standard backdoor Roth method.
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beyou
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Re: Improving tax efficiency in retirement accounts

Post by beyou »

livesoft wrote: Thu Aug 06, 2020 5:46 pm
uwbadgers wrote: Thu Aug 06, 2020 5:11 pmI am looking to flip our ROTH IRA's into 100% stocks while swapping out some of our brokerage funds to be more bond heavy. My thinking here, and please correct me if I'm wrong on this, is to make our ROTHs gain as much as possible over time = 100% stocks. We will do bonds in accounts that aren't tax free like the ROTH.

Is this thinking correct?
That sentiment is often expressed at Bogleheads.org, but my personal experience is that the things that are expected to go up the most are also the things that actually go down the most. My tax-deferred IRAs and Roth IRAs with some bond funds available for rebalancing into equities when the market tanks are doing better than my 100% equities Roth accounts.

Therefore, I suggest that you do NOT make your Roth IRAs 100% equities, but maybe 75:25 or 80:20 until such times like March 23, 2020 happen.
+1

I sold stocks in taxable at loss (where I had losses) on the large corrections, to reduce taxes. Bought in tax def to buy on dip to correct AA. As market bounced back sold in tax advantaged accts avoiding cap gains taxation mostly.

Did have very long term gains in taxable so when all stocks were sold in tax advantaged accts, eventually had to sell and pay cap gain in taxable, but that is a good problem and part of rebalancing to maintain risk level, but overall kept taxes reasonable.
lakpr
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Re: Improving tax efficiency in retirement accounts

Post by lakpr »

uwbadgers wrote: Thu Aug 06, 2020 5:11 pm NEW contributions yearly:

19.5k HER 401k
10k HIS 401k

13k ROTH IRAs (we may be borderline too much income for this soon, don't think backdoor is possible)

6k Brokerage 1
3k Brokerage 2

TOTAL = 51.5k
1. Why only $10k to "His 401k"? Why not the maximum of $19.5k too? Simply move the $9k you were planning to put in Brokerage-1 and Brokerage-2 into "His 401k"
2. If both spouses are younger than 50, the maximum that can be contributed to Roth IRAs is just $12k, not $13k as you are planning above
3. If you are indeed "borderline" for too much income, step-1 above will drag you at least $9.5k back into the green zone.
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grabiner
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Re: Improving tax efficiency in retirement accounts

Post by grabiner »

uwbadgers wrote: Thu Aug 06, 2020 5:11 pm I am looking to flip our ROTH IRA's into 100% stocks while swapping out some of our brokerage funds to be more bond heavy. My thinking here, and please correct me if I'm wrong on this, is to make our ROTHs gain as much as possible over time = 100% stocks. We will do bonds in accounts that aren't tax free like the ROTH.
Not necessarily. There are two different comparisons to make: traditional versus Roth, and taxable versus tax-favored.

For traditional versus Roth, moving an equal dollar amount in stocks to the Roth increases both risk and return, which is break-even; see Tax-adjusted asset allocation: Asset location on the wiki. If you retire in a 25% bracket, moving $4000 from stocks to bonds in a traditional account and $3000 from bonds to stocks in a Roth account is break-even. It is slightly better to have stocks in the Roth even at a fixed risk level, because stocks in a traditional account might have a higher tax bill than expected, if a stock market boom either pushes you into a higher bracket or forces you to take RMDs larger than you need.

For taxable versus tax-favored, it depends on the tax cost. At current tax rates, the tax cost of bonds in a taxable account is lower than the tax cost of stocks for most investors, but this will change if interest rates rise. (It also depends on how things are taxed by your state; in a high-tax state, Treasury bonds or in-state munis in taxable accounts are especially good.) Max out I-Bonds before holding any other bonds in your taxable account; 0% above inflation, tax-deferred for up to 30 years, is a good deal given current rates.
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petulant
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Re: Improving tax efficiency in retirement accounts

Post by petulant »

Another point--if the Solo 401(k) contribution is from a side business, it may be better to make that as a Roth contribution. Side business income can benefit from the Qualified Business Income deduction, which reduces taxable income by 20% for the business. You lose the benefit of this deduction if the business's income is made to a tax-deferred account, but you can keep it if the contribution is made to a Roth account.
realquadrant
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Re: Improving tax efficiency in retirement accounts

Post by realquadrant »

Is it possible to have a solo 401k even if one has a full time job with an a player and have the side income go to the 401k?
retiredjg
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Re: Improving tax efficiency in retirement accounts

Post by retiredjg »

uwbadgers wrote: Thu Aug 06, 2020 5:11 pm Hi all,

I am looking to flip our ROTH IRA's into 100% stocks while swapping out some of our brokerage funds to be more bond heavy. My thinking here, and please correct me if I'm wrong on this, is to make our ROTHs gain as much as possible over time = 100% stocks. We will do bonds in accounts that aren't tax free like the ROTH.

Is this thinking correct?
Up to a point.

I think it is fine to put only stocks in Roth IRA if you want, but don't put your bonds into taxable. Put the bonds into the 401k plans.

There are some possible exceptions - for example if you are in a high tax bracket and live in a high tax state. That could be a case where putting the bonds into taxable might be a better idea, at least while bond returns are so low.
livesoft
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Re: Improving tax efficiency in retirement accounts

Post by livesoft »

realquadrant wrote: Thu Aug 06, 2020 9:24 pm Is it possible to have a solo 401k even if one has a full time job with an a player and have the side income go to the 401k?
I will assume you mean a full-time job with an employer that provides a 401(k), too. Yes, one can have a solo 401(k) in addition to the employer-sponsored 401(k), but total contributions to both are not unlimited. So while some of the side income can go to the solo 401(k), it is less likely that ALL the side income can go to the solo 401(k).
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AnEngineer
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Re: Improving tax efficiency in retirement accounts

Post by AnEngineer »

You're best expected return is with bonds in traditional retirement accounts. The yearly tax drag of taxable hurts, and stocks do better in Roth from higher returns.

Also, depending on tax rates, return, and duration, stocks in taxable can beat being in traditional. Tax loss harvesting helps too.
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grabiner
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Re: Improving tax efficiency in retirement accounts

Post by grabiner »

AnEngineer wrote: Fri Aug 07, 2020 8:17 am Also, depending on tax rates, return, and duration, stocks in taxable can beat being in traditional. Tax loss harvesting helps too.
Note that this is not a reason to prefer taxable to traditional accounts. If you retire in a 22% tax bracket, you will lose 22% of the stock returns in your 401(k) to taxes, while you may lose less than 22% of the stock returns in your taxable account. However, if your marginal tax rate is 22% now, it costs you only $7800 to put $10,000 into your 401(k), and $10,000 in a 401(k) will outperform $7800 in a taxable account even if the taxable account is invested at a low tax cost.

But it is often a reason to hold stocks in your taxable account if you must invest in a taxable account because tax-advantaged savings are maxed out.
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AnEngineer
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Re: Improving tax efficiency in retirement accounts

Post by AnEngineer »

grabiner wrote: Fri Aug 07, 2020 6:25 pm
AnEngineer wrote: Fri Aug 07, 2020 8:17 am Also, depending on tax rates, return, and duration, stocks in taxable can beat being in traditional. Tax loss harvesting helps too.
Note that this is not a reason to prefer taxable to traditional accounts. If you retire in a 22% tax bracket, you will lose 22% of the stock returns in your 401(k) to taxes, while you may lose less than 22% of the stock returns in your taxable account. However, if your marginal tax rate is 22% now, it costs you only $7800 to put $10,000 into your 401(k), and $10,000 in a 401(k) will outperform $7800 in a taxable account even if the taxable account is invested at a low tax cost.

But it is often a reason to hold stocks in your taxable account if you must invest in a taxable account because tax-advantaged savings are maxed out.
Good point. I was talking about how to deploy assets in accounts that you have. TIRA beats taxable overall.
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uwbadgers
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Re: Improving tax efficiency in retirement accounts

Post by uwbadgers »

Thank you all for the replies. Definitely a bit more to it than I thought :) Still learning a lot, that's for sure.

A few things.

1. I do NOT have a 401k offered through my W2 job, thus, the solo 401k, but, am limited because I purely don't make a lot through the LLC and, unless I am not understanding it correctly, I can't put more into the solo401k than I NET make in the LLC. So, that's why this year was only 12k and I'm assuming 10k in the future each year guessing on my LLC income.

2. Thanks to many of you for breaking down what I'm looking to do and pros/cons each way. I have seen the TLH discussion many times here but never really understand who/why you'd use it. I see now that it's something I'll read about more.

3. If I understood correctly, at the end of the year, if our income puts us out of ROTH IRA contribution territory, which we did back in January, I can withdraw those contributions? and put them into a vanguard traditional IRA. Then, convert that to ROTH. Yeah?

Is that the best plan when you aren't sure if you qualify for roth? Wait and see?

Would it be worthwhile to do a "test" tax return right now using last year's data but adjust our incomes?
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Thanks again all!
retiredjg
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Re: Improving tax efficiency in retirement accounts

Post by retiredjg »

uwbadgers wrote: Sat Aug 08, 2020 7:55 am 3. If I understood correctly, at the end of the year, if our income puts us out of ROTH IRA contribution territory, which we did back in January, I can withdraw those contributions? and put them into a vanguard traditional IRA. Then, convert that to ROTH. Yeah?
There are two separate choices.

1. You can withdraw your annual contribution to Roth and put the money somewhere else (savings, taxable brokerage account). It will be like you never made the contribution. Have the custodian do this, specifying exactly what contribution you want to undo. They will give you two things - the contribution and the earnings associated with the contribution. The earnings will be taxable income for 2020 so include that on your tax return.


2. You can call the custodian and have the contribution "re-characterized" from Roth IRA to tIRA. They will move both the contribution and the associated earnings into tIRA. At that point, you can convert that tIRA to Roth IRA. You will pay tax on the earnings because that money has not been taxed before. This is only a good option if you have no other money in traditional IRA (which includes rollover IRA, SEP IRA, and SIMPLE IRA).

There is paperwork that goes along with this second option - Form 8606. You need to understand the paperwork well before deciding to do it.
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Re: Improving tax efficiency in retirement accounts

Post by 2commaBH »

Most of the important points covered already - I would just add that I don't really understand using target date funds as a quick and dirty allocation. Would be better IMO to just hold the allocations outright.

I don't know but expect that there is some modest expense drag from holding the assets inside the target date wrapper, but more importantly I like knowing my exact allocations, and target date funds change allocations over time.
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Re: Improving tax efficiency in retirement accounts

Post by grabiner »

2commaBH wrote: Sat Aug 08, 2020 10:09 am Most of the important points covered already - I would just add that I don't really understand using target date funds as a quick and dirty allocation. Would be better IMO to just hold the allocations outright.

I don't know but expect that there is some modest expense drag from holding the assets inside the target date wrapper, but more importantly I like knowing my exact allocations, and target date funds change allocations over time.
There are two possible sources of expense drag. A fund-of-funds may hold more expensive share classes (as Vanguard does; you can get Admiral shares of the funds in the Target Retirement funds), or it may add its own fees. However, there are many target-date funds which don't add extra expenses.

If you can manage your own allocation, and will actually do this (giving your portfolio an annual checkup, and rebalancing at the right time), there is no advantage to target-date funds. But many investors won't actually do this, and others would prefer the simplicity.

And still others may not be capable of managing their own allocations appropriately. I often recommend target-date funds for investors getting started with IRAs, who may not be able to meet the minimums for the underlying funds but want to start with a diversified portfolio.
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2commaBH
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Re: Improving tax efficiency in retirement accounts

Post by 2commaBH »

grabiner wrote: Sat Aug 08, 2020 11:41 am
2commaBH wrote: Sat Aug 08, 2020 10:09 am Most of the important points covered already - I would just add that I don't really understand using target date funds as a quick and dirty allocation. Would be better IMO to just hold the allocations outright.

I don't know but expect that there is some modest expense drag from holding the assets inside the target date wrapper, but more importantly I like knowing my exact allocations, and target date funds change allocations over time.
There are two possible sources of expense drag. A fund-of-funds may hold more expensive share classes (as Vanguard does; you can get Admiral shares of the funds in the Target Retirement funds), or it may add its own fees. However, there are many target-date funds which don't add extra expenses.

If you can manage your own allocation, and will actually do this (giving your portfolio an annual checkup, and rebalancing at the right time), there is no advantage to target-date funds. But many investors won't actually do this, and others would prefer the simplicity.

And still others may not be capable of managing their own allocations appropriately. I often recommend target-date funds for investors getting started with IRAs, who may not be able to meet the minimums for the underlying funds but want to start with a diversified portfolio.
Thank you. Unless the fund company is eating the target date fund expenses, there must be some non-zero drag just from the registration and filing costs, right? Although perhaps immaterial. The other thing that occurred to me was that the wife's accounts may not have the underlying funds as an investment option, and the OP has tried to recreate an allocation with available options.
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