Portfolio Review Update - Fund Placement & Retirement Planning

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Topic Author
finingo
Posts: 23
Joined: Sun Jul 09, 2017 9:00 am

Portfolio Review Update - Fund Placement & Retirement Planning

Post by finingo »

Emergency funds: 6 months
Debt: 596k, 30-year fixed, 2.375%, 60% LTV
Tax Filing Status: Married Filing Jointly
Tax Rate: 37% Federal, 0% State
State of Residence: WA
Age: 34m / 39f
Desired Asset allocation: 100% stocks / 0% bonds
Desired International allocation: FTSE Global All Cap (~42% currently)

Portfolio Size ~1M

Current retirement assets

Overall
4.15% HSA
31.00% Roth
36.90% Deferred
27.95% Taxable

Taxable
6.12% Vanguard Total Stock Market Index (VTSAX) (0.04%)
21.82% Vanguard Total International Stock Index  (VTIAX) (0.11%)

Her Solo 401k (Traditional)
2.68% Fidelity Total International Index (FTIHX) (0.06%)

Her Employer 401k
11.65% Fidelity 500 Index Fund (FXAIX) (0.015%) (Traditional)
10.17% Fidelity 500 Index Fund (FXAIX) (0.015%) (Mega Backdoor Roth)

His Solo 401k (Traditional)
10.63% Fidelity Total International Index (FTIHX) (0.06%)

His Employer 401k (Traditional)
3.52% Vanguard Institutional 500 Index Trust (no ticker) (0.012%)
3.20% Vanguard Institutional Extended Market Index Trust (no ticker) (0.031%)
3.97% Vanguard Developed Markets Index Fund (VDIPX) (0.04%)
1.25% Vanguard Emerging Markets Index (VEMRX) (0.08%)

His Employer 401k (Mega Backdoor Roth)
2.61% Vanguard Institutional 500 Index Trust (no ticker) (0.012%)
3.20% Vanguard Institutional Extended Market Index Trust (no ticker) (0.031%)
1.54% Vanguard Developed Markets Index Fund (VDIPX) (0.04%)
0.49% Vanguard Emerging Markets Index (VEMRX) (0.08%)

Her Roth IRA
5.67% Vanguard Total Stock Market Index (VTSAX) (0.04%)

His Roth IRA
7.33% Vanguard Total Stock Market Index (VTSAX) (0.04%)

HSA
4.15% Vanguard Institutional Index Fund  (VIIIX) (0.02%)

Contributions

New annual Contributions
$58,0000 his 401k Deferred + Mega Backdoor (including $9,750 match)
$58,0000 her 401k Deferred + Mega Backdoor (including $2,500 match)
$6,000 his Backdoor Roth IRA
$6,000 her Backdoor Roth IRA
$7,300 HSA ($2,000 from employer)
$300,000 taxable


Other Information
  • We plan to "retire," in ~5-10 years. I don't think either of us will just stop being productive all together. We want to take a few years to travel, explore hobbies, etc while we are young. We want to retain the option to not return to work.
  • After the pandemic, we gradually adjusted out of prior 20% bond allocation. Neither of us were worried with the 6 figure drop in our portfolio in a month. We decided to take on the extra risk to help boost our progress towards retiring early, and start adding some bond allocation back as we get closer.
  • Our house can cash flow break-even as a rental. We were careful to buy like this to allow renting during long-term travel or to build a small RE portfolio.
  • No kids or desire for any.
Questions:
  1. I am interested in hearing thoughts on our fund placement.
    1. When I designed our portfolio to have as much international in taxable as possible, we were in a lower tax bracket. I did this for the tax credit. Out of inertia, I’ve continued. However, we now pay 23.8% tax on qualified dividends and 41.8% on non-qualified. We’re adding ~25k per month. I shift 401k assets / contributions to keep the FTSE weighting. I am second guessing this since international pays higher dividends, and wondering If I should start buying VTSAX (or something else) instead. It would be more of a no-brainer for me, if weren't for "retiring" in ~5 years. We can just pay a bit extra tax until we drop into 0% dividend bracket. However, it's possible we still do something that earns an income in "retirement." Additionally, net investment income tax will likely hit us in 10-20 years anyways, since the $250k income limit isn't inflation adjusted.
    2. I have been thinking about diversifying our Roth exposure to include international. Thus far, our gamble that US equity will grow more has paid off. We are now less comfortable with this gamble due to the amount of Roth assets.
  2. Our retirement plan is to live on $80k income initially @ 2% withdrawal rate (flexible in downturn) with maybe a 70 global stock : 30 us bond allocation. If I understand the tax code correctly, based on the current tax code we will be able to:
    • Aim for taxable income of $105,900 - $25,100 deduction = $80,800 => 0% qualified dividend / LTCG. Take up to $80,800 dividends and/or LTCG from taxable for living expenses at 0% tax.
    • Start Roth conversions from traditional 401k in the 10 & 12% brackets, while being careful to not drive our dividend bracket up over the $105,900 income. Our portfolio should continue to compound (2% withdrawal rate initially). We may actually arbitrage cost of living for a few years (outside current VHCOL) to let it grow and jump start larger Roth conversions.
    • As our portfolio grows, we can gradually increase standard of living and/or charity. We can start accessing Roth principal (Roth ladder basically), if we want to live a higher standard of living as our portfolio grows.
    Does anyone have any feedback on this strategy or my understanding of the tax code? If we still earn some income in retirement, this plan will have to be adjusted. I'm a bit more focused on a few years of time off and getting as much of these deferred assets shifted to Roth as possible in low brackets.
  3. Is there anything else you all think I should consider as we continue to scale this portfolio or plan retirement?
Chip
Posts: 3994
Joined: Wed Feb 21, 2007 3:57 am

Re: Portfolio Review Update - Fund Placement & Retirement Planning

Post by Chip »

finingo wrote: Tue Sep 28, 2021 11:30 am Questions:
  1. I am interested in hearing thoughts on our fund placement.
    1. When I designed our portfolio to have as much international in taxable as possible, we were in a lower tax bracket. I did this for the tax credit. Out of inertia, I’ve continued. However, we now pay 23.8% tax on qualified dividends and 41.8% on non-qualified. We’re adding ~25k per month. I shift 401k assets / contributions to keep the FTSE weighting. I am second guessing this since international pays higher dividends, and wondering If I should start buying VTSAX (or something else) instead. It would be more of a no-brainer for me, if weren't for "retiring" in ~5 years.
      [...]
      Does anyone have any feedback on this strategy or my understanding of the tax code? If we still earn some income in retirement, this plan will have to be adjusted. I'm a bit more focused on a few years of time off and getting as much of these deferred assets shifted to Roth as possible in low brackets.
First, it's an extremely well-thought out plan with great fund choices. Your savings rate is amazing.

If it were me, I would immediately shift to putting all foreign equities in tax-deferred or Roth. The reason is that you will also face some "gotchas" on actually being able to claim the foreign tax credit (FTC) if you are early-retired in the 0% QDI bracket.

One reason is that you can't claim FTC that exceeds the average tax rate that you pay. e.g. if you pay 7% on VTIAX dividends, but your average tax rate overall is 5%, the "extra" 2% of the FTC can't be claimed and must be carried forward (this isn't precise, but it's roughly correct). See this thread for more details. Given your tax rate now you probably think a 5% tax rate is an impossibility, but try running some of your numbers through a tax calculator with significant amounts of LTCG or QDI taxed at 0%.

Another gotcha is that once you exceed 20k in foreign qualified dividends there is an adjustment that must be made on Form 1116 that will almost certainly substantially reduce the FTC that you can claim in retirement. You also face this if you are in the 32% bracket or above, but it likely won't affect you now given the high taxes you're paying on your other income.

Again, well done on the plan and execution.
Topic Author
finingo
Posts: 23
Joined: Sun Jul 09, 2017 9:00 am

Re: Portfolio Review Update - Fund Placement & Retirement Planning

Post by finingo »

Chip wrote: Wed Sep 29, 2021 5:03 am First, it's an extremely well-thought out plan with great fund choices. Your savings rate is amazing.

If it were me, I would immediately shift to putting all foreign equities in tax-deferred or Roth. The reason is that you will also face some "gotchas" on actually being able to claim the foreign tax credit (FTC) if you are early-retired in the 0% QDI bracket.

One reason is that you can't claim FTC that exceeds the average tax rate that you pay. e.g. if you pay 7% on VTIAX dividends, but your average tax rate overall is 5%, the "extra" 2% of the FTC can't be claimed and must be carried forward (this isn't precise, but it's roughly correct). See this thread for more details. Given your tax rate now you probably think a 5% tax rate is an impossibility, but try running some of your numbers through a tax calculator with significant amounts of LTCG or QDI taxed at 0%.

Another gotcha is that once you exceed 20k in foreign qualified dividends there is an adjustment that must be made on Form 1116 that will almost certainly substantially reduce the FTC that you can claim in retirement. You also face this if you are in the 32% bracket or above, but it likely won't affect you now given the high taxes you're paying on your other income.

Again, well done on the plan and execution.
Thanks Chip, I really appreciate the response! This information helps a lot. We've been focused on increasing income and not increasing expenses commensurately. This has helped drive the savings rate higher.

I just ran a simplified scenario through a tax calculator and see the adjustments on form 1116 you are speaking about. 60k dividends (50k qualified) + 20k LTCG + 25k Roth conversion lands at total tax owed of ~$1k, and line 19 multiplier around 0.47-0.5. This would mean a ~$500 FTC on 3k foreign taxes paid. Even if we arbitrage COL to drive Roth conversions up to 50k, it caps around $2k of FTC.

I am inclined to agree based on my initial analysis. We are getting taxed higher now for the higher dividends + more non-qualified, and don't get as great of a FTC benefit in the early retirement scenario. It appears all VTIAX purchases since 5/11 are down, so I can even TLH a significant amount into VTSAX and replace with VDIPX/VEMRX or VTIAX in tax-advantaged. I'll have to think & calculate more to determine the balance of foreign equities in taxable, as there is some advantage just mitigated by these limits.

Thanks again, I'm thankful you highlighted this oversight!
Chip
Posts: 3994
Joined: Wed Feb 21, 2007 3:57 am

Re: Portfolio Review Update - Fund Placement & Retirement Planning

Post by Chip »

finingo wrote: Wed Sep 29, 2021 10:47 am I'll have to think & calculate more to determine the balance of foreign equities in taxable, as there is some advantage just mitigated by these limits.
Yes, I've described it as a titration of sorts -- getting the maximum advantage from the FTC without getting on the hamster wheel (credit to another poster for that label) of ongoing carryforwards.

We are approaching RMDs after a long period of early retirement that was similar to what you are planning. While we have been Roth converting all this time I've decided that from now on we'll be using our lower bracket "tax capacity" to reduce foreign holdings in taxable. The goal is to get to the point where our higher tax rates when RMDs hit will draw down the carryforwards plus make it unlikely that we'll ever hit the 20k QDI adjustment zone. By the way, note that the 20k QDI limit is not inflation-adjusted.

I don't know if it will be helpful, but I did a little "what-if" modeling in this thread, though no one jumped in to confirm/reject the results.

Here's another thread that might be useful: viewtopic.php?f=1&t=312312

Another thought is to put the "right" amount of developed markets in taxable as I believe that those funds typically have a higher QDI percentage. Especially since you have access to the institutional EM fund to balance out that holding.

Good luck!
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