masrepus wrote: ↑Sun Oct 17, 2021 10:07 am
It is going to take me a little to digest this info, but I have to say THANKS! My napkin math was nowhere near as detailed as this, so your comments are very helpful. These are the kinds of details that bring clarity to the decisions. I still admit, I need to understand the whole use taxable, exchange bonds for equities in 401k idea to make sure it isn't better. The mechanics of the idea are understandable, but I have never done it so just not comfortable with it. It seems like about a wash compared to keeping more fixed income in taxable. But keeping only 50k to 100k in taxable it isn't a huge number either way.
Also earlier you mentioned the taxable will overtake the 401k. I do Megabackdoor Roth, so that side still grows, but the taxable does get the bulk of the savings currently since the RSUs come in quarterly and are multiples of what I can contribute to the 401k. The taxable is not larger yet, but it will be in a couple years if the market holds. Either way, I full fund pre-tax, then post-tax (to Roth), backdoor Roth and HSA, and then the rest to taxable.
I will also add I have my first child entering college in a couple years, so I am sure the cash flow issue will again rear it's head. Having a greater fixed income position in the taxable will help. I have 529's for all the kids, but I started those late and the state does not have a a deduction. I have invested fairly aggressively, with the plan if things are not looking so good in years 2-6 then I will just roll those dollars to the next kid's 529. I only have about 125k total across four 529's, so I have a way to go to fully fund four, 4-year educations at 100k each. If the money is there great, if not take out some loans unless I can cash flow it.
Next point, my current plan is 10-15 years continuing work. If things are looking good the next 6 years, I could see early retirement at 55. At that point I can use the 401k, though I do have a good chunk in Roth so I can get by for a while. Having more fixed income in taxable will also help in this plan to avoid needing the 401k money. With the kids school, though, I might have to keep working. Unless the drop in income helps with need-based aid, though I think we would still be too high.
No worries. Take your time. Glad it was useful
Yeah it's trickier to model how selling in taxable will behave as it depends on the sequence of returns. We can estimate using long running averages, but the reality is we don't actually know what those returns look like (particularly in the short-term). Also there can be some optionality as to which tax lots one sells using
SpecID.
The average return of the S&P 500 has been
8% since 1957. The portion attributable to
capital appreciation over that time frame is ~2/3. IOW on average 5.33% has been due to capital appreciation. If one sells every year and we assume the average return (this latter part is a big if as it could be much higher or lower), then at 18.8% LTCG one is losing ~1%/year to taxes. Now this ~1% is just on the portion sold. So it really depends how much one is needing to sell per year. With munis, they are mostly about dividends and not capital appreciation. Though hopefully this gives you some context to wrap your mind around this use case.
Yep it seems like munis would be applicable to you for a variety of reasons.
Going aggressive in the 529s makes sense, one could approximate a more conservative allocation by holding munis in taxable to create a more balanced allocation. The main advantage of 529s is the tax free growth. So avoid bonds in 529s and holding them elsewhere seems sensible.
While the math above is focused on going all in on munis, the reality is probably more mixed. Munis can be a bumpier ride than treasuries or a total bond heavily weighted in treasuries. There are several people that recommend limiting the amount in munis. No more than 50% in munis is a common rule of thumb. For example, here's
a quote from Bill Bernstein on this:
But I think that less than half of your bond portfolio should be in munis, and less than half your munis should be obviously in a single state’s munis, as attractive as that may be if you’re in California or New York. You’re taking too much concentrated risk by, you know, owning all of your munis in, in one state.
So it is possible that some munis in taxable and some Total Bond in 401k will make a good mix. One can sell some munis to cover expenses with minimal tax drag. If the expense is larger, one can start selling stocks in taxable. In other accounts one can rebalance to keep the same asset allocation.
Something else to look into would be savings bonds. In particular would look at
I Bonds (maybe
EE Bonds as well). These can expand your tax-deferred space while also putting some bonds in taxable where they are easily accessible. Taxes are deferred on them until redeemed or they mature, whichever comes first. There are limits on how much can be purchased per year (for I Bonds $10k/person and $5k/tax return; so $25k/couple). Though these could be a secondary source of liquidity (due to the purchase limits and time to accumulate one wants to avoid tapping into these until necessary).
Anyways hopefully that provides some more food for thought
"Anyone who claims to understand quantum theory is either lying or crazy" -- Richard Feynman