Put stocks in Traditional IRA first? Or put in Roth IRA first?

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teelainen
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Put stocks in Traditional IRA first? Or put in Roth IRA first?

Post by teelainen »

Let's say you have $100,000 in a Traditional IRA account and $100,000 in a Roth IRA account. So you have a total of $200,000.

If you want to achieve a portfolio of 70% stocks and 30% bonds, is better to put all the stocks in the Traditional IRA account first? Or put them in the Roth IRA account first? What are the reasons why?
Silk McCue
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Re: Put stocks in Traditional IRA first? Or put in Roth IRA first?

Post by Silk McCue »

Roth due to tax free growth and withdrawal.

Our Roth’s in retirement are 100% globally diverse equity. Tax deferred holds both equity and bond/bond like.

Cheers
Last edited by Silk McCue on Thu Jan 20, 2022 12:13 pm, edited 2 times in total.
ivgrivchuck
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Re: Put stocks in Traditional IRA first? Or put in Roth IRA first?

Post by ivgrivchuck »

teelainen wrote: Thu Jan 20, 2022 11:39 am If you want to achieve a portfolio of 70% stocks and 30% bonds, is better to put all the stocks in the Traditional IRA account first? Or put them in the Roth IRA account first? What are the reasons why?
Stocks into Roth IRA. Growth is tax free. While in traditional IRA growth is subject to progressive taxation.
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KlangFool
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Re: Put stocks in Traditional IRA first? Or put in Roth IRA first?

Post by KlangFool »

OP,

Put the bond in the Trad IRA first. You want to reduce your future tax burden first. Then, put the stock on the rest of the account (Roth IRA, Taxable, Trad IRA).

This advice works across almost all situations.

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Doc7
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Re: Put stocks in Traditional IRA first? Or put in Roth IRA first?

Post by Doc7 »

I would prefer stocks in Roth account for higher returns / untaxed future dollars.

I would also tax adjust the trad by 15% (this is a swag and i dont think matters either way).

so portfolio is $185,000 tax-adjusted. $129.5K tax adjusted dollars needed in stocks.

$100K in Roth
$34.7K in Trad

Rest Bonds ($65,300)


This is how i handle my 401k accounts vs Roth IRAs. There is 0% reason to believe it would be better than simply not tax adjusting, as who knows if i have the optimal AA within 5-10% accuracy. Savings rate will have an enormously bigger impact. But, I built the spreadsheet and I could choose to tax adjust, and once built, it is no more complicated than not tax adjusting (the calculation was written in the spreadsheet over 10 years ago and thus takes no additional time nor would removing it save time or reduce complexity).
livesoft
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Re: Put stocks in Traditional IRA first? Or put in Roth IRA first?

Post by livesoft »

If one is OK with big losses in their Roth IRA, then putting only equities in their Roth IRA is the way to go.

If one is less OK with big losses in their Roth IRA, then putting mostly equities in their Roth IRA is the way to go.

The trick is transitioning between the Yin and the Yang.
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vtsnowdin
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Re: Put stocks in Traditional IRA first? Or put in Roth IRA first?

Post by vtsnowdin »

I would change the thread title to" Put whole market zero cost index funds into....?"
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teelainen
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Re: Put stocks in Traditional IRA first? Or put in Roth IRA first?

Post by teelainen »

livesoft wrote: Thu Jan 20, 2022 11:57 am If one is OK with big losses in their Roth IRA, then putting only equities in their Roth IRA is the way to go.

If one is less OK with big losses in their Roth IRA, then putting mostly equities in their Roth IRA is the way to go.

The trick is transitioning between the Yin and the Yang.
Good point. Money in a Roth IRA is not easy to replace unfortunately.
tonyclifton
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Re: Put stocks in Traditional IRA first? Or put in Roth IRA first?

Post by tonyclifton »

teelainen wrote: Thu Jan 20, 2022 11:55 pm Good point. Money in a Roth IRA is not easy to replace unfortunately.
Yes, but please view your portfolio as a whole across your entire set of accounts….if your Roth goes “down”, unless the market never recovers or you cash out, then you really aren’t harmed so long as you can wait for a recovery and able to continue contributing. If the market never recovers then we will all have problems :)

Our Roth’s are 100% equities (low cost index funds) and our tax advantaged funds (401k and 457b) have equities and fixed income. I also recently made the move to have my HSA be 100% equities. The overall portfolio, across all accounts, is 70/30 in a Boglehead three asset class mix.
comeinvest
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Re: Put stocks in Traditional IRA first? Or put in Roth IRA first?

Post by comeinvest »

Almost all the posts in this thread recommend to fill up the Roth with stocks first.

But there is zero rational justification for this, is there?

First, after tax-adjusting the tax-deferred account, i.e. multiplying its NAV by (1 - your expected tax rate), your tax-deferred "behaves" (in terms of before-tax and after-tax risk-return characteristics) almost exactly the same as your Roth, correct?

Second, the arguments in the posts for filling of the Roth with stocks first, are based on the assumption that stocks are sure to outperform bonds during your investment horizon.
But if this was 100% sure, we would not invest in bonds in the first place. We would fill up all accounts with 100% stocks.
So the reason for filling up Roth with 100% stocks would equally apply to all accounts.
If, on the other hand, there is a chance, however small, that bonds outperform stocks during your investment horizon, (which is the reason why we invest in bonds in the first place), then in that scenario the Roth would get crushed, and more so than the tax-deferred accounts (which also have bonds). So we would have achieved the opposite of what we wanted. In summary, we have to look at the probabilistic assumptions with all possible outcomes, and they apply equally to all accounts regardless of account type.

If you can find a rational argument for filling up the Roth with stocks first while putting bonds in tax-deferred, please make a rational case and describe the scenarios with your assumptions.
Last edited by comeinvest on Mon Jan 24, 2022 4:05 am, edited 1 time in total.
TropikThunder
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Re: Put stocks in Traditional IRA first? Or put in Roth IRA first?

Post by TropikThunder »

comeinvest wrote: Sun Jan 23, 2022 4:03 pm But if this was 100% sure, we would not invest in bonds in the first place. We would fill up all accounts with 100% stocks.
So the reason for filling up Roth with 100% stocks would equally apply to all accounts.
If we didn’t expect stocks to outperform bonds given a long time frame, no one would invest in stocks. I don’t know anyone who insists on 100% surety before deciding on a plan.

Many do choose to put 100% stocks in all their accounts and hold no bonds or fixed income. That may be riskier than some would choose, but given a long time frame it’s not an irrational choice.

But IMO your thinking is backwards. One doesn’t decide to own bonds so that they have something to put in their tax-deferred accounts. One decides to own bonds as a sequence of returns hedge and a volatility hedge. After deciding on an asset allocation, one then decides which account type to put each asset in. And it would be irrational to put the asset with the higher growth expectation in tax-deferred rather than tax-free.
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retiredjg
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Re: Put stocks in Traditional IRA first? Or put in Roth IRA first?

Post by retiredjg »

teelainen wrote: Thu Jan 20, 2022 11:39 am Let's say you have $100,000 in a Traditional IRA account and $100,000 in a Roth IRA account. So you have a total of $200,000.

If you want to achieve a portfolio of 70% stocks and 30% bonds, is better to put all the stocks in the Traditional IRA account first? Or put them in the Roth IRA account first? What are the reasons why?
If these are my only two accounts, I would do something like this so that it is easy to rebalance or easy to make withdrawals of what I want from the account I want to take it out of.

Well, in fact, that is what I have actually done for exactly that reason (different numbers though).

Traditional IRA 50%
25% stocks
25% bonds


Roth IRA 50%
45% stocks
5% bonds

It would not bother me for my Roth IRA to shrink more during a downturn. I'm interested in the portfolio as a whole, not which account is shrinking more.

The reason I want more stocks in Roth is to benefit most from the tax-free growth.
ivgrivchuck
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Re: Put stocks in Traditional IRA first? Or put in Roth IRA first?

Post by ivgrivchuck »

comeinvest wrote: Sun Jan 23, 2022 4:03 pm Almost all the posts in this thread recommend to to fill up the Roth with stocks first.

But there is zero rational justification for this, is there?

First, after tax-adjusting the tax-deferred account, i.e. multiplying its NAV by (1 - your expected tax rate), your tax-deferred "behaves" (in terms of before-tax and after-tax risk-return characteristics) almost exactly the same as your Roth, correct?
Tax-deferred is subject to progressive taxation. The more it grows, the higher your marginal and effective tax rate will be.

This impact can be very substantial.
Second, the arguments in the posts for filling of the Roth with stocks first, are based on the assumption that stocks are sure to outperform bonds during your investment horizon.
But if this was 100% sure, we would not invest in bonds in the first place. We would fill up all accounts with 100% stocks.
So the reason for filling up .
What if you need the money before your retirement? If I could be 100% sure that I'm not going to need the money in 30 years, I'd be 100% in stocks. But how can I know that?

Also there is a correlation between a stock market crash and risk of losing one's job...
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dboeger1
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Re: Put stocks in Traditional IRA first? Or put in Roth IRA first?

Post by dboeger1 »

comeinvest wrote: Sun Jan 23, 2022 4:03 pm First, after tax-adjusting the tax-deferred account, i.e. multiplying its NAV by (1 - your expected tax rate), your tax-deferred "behaves" (in terms of before-tax and after-tax risk-return characteristics) almost exactly the same as your Roth, correct?
Correct, but you're mixing up concepts. When it comes to choosing traditional vs. Roth, then yes, it comes down to comparing marginal tax rates at the time of contribution and in retirement. However, once money has been placed in either traditional or Roth, the decision on when to pay taxes is more or less locked in (ignoring Roth conversions, since they are more of an income-spreading strategy than having anything to do with how growth itself is taxed).

At that point, when to pay taxes is no longer a consideration, only how to locate assets so as to minimize taxes. By placing higher-expected-growth assets in Roth and lower-expected-growth assets in traditional, you would be minimizing the amount of growth which is ultimately taxable, while maintaining the desired overall asset allocation.
comeinvest wrote: Sun Jan 23, 2022 4:03 pm Second, the arguments in the posts for filling of the Roth with stocks first, are based on the assumption that stocks are sure to outperform bonds during your investment horizon.
But if this was 100% sure, we would not invest in bonds in the first place. We would fill up all accounts with 100% stocks.
So the reason for filling up Roth with 100% stocks would equally apply to all accounts.
Since when do entire retirement portfolios have a single investment time horizon? Retirees generally plan to draw down their portfolio gradually over many years. They have the power to decide which accounts to draw from at various points in time. Roth accounts are a natural fit for the longest time horizon because they have no RMDs and the growth is tax-free. So yes, you're right, there is an implicit assumption that stocks will outperform over the long run, but that has always been a valid assumption thus far. Since Roth accounts are generally drawn down last, they are the obvious place for stocks. There is nothing about such a plan which is incompatible with the philosophy of risk diversification and holding bonds in case stocks do poorly.

Putting bonds in Roth is effectively a bet that from now to the very end of your retirement, bonds will outperform stocks. For people many decades from a then multi-decade retirement, that bet would have lost 100% of the time historically, very often by a lot.
comeinvest wrote: Sun Jan 23, 2022 4:03 pm If, on the other hand, there is a chance, however small, that bonds outperform stocks during your investment horizon, (which is the reason why we invest in bonds in the first place), then in that scenario the Roth would get crushed, and more so than the tax-deferred accounts (which also have bonds). So we would have achieved the opposite of what we wanted. In summary, we have to look at the probabilistic assumptions with all possible outcomes, and they apply equally to all accounts regardless of account type.
Your stated reason of why people invest in bonds is not universally true. For many people, it comes down to emotions and being able to stay the course. Bonds reduce volatility, which is a desired characteristic for many people, even beyond the point where it would be optimal for their long-term returns.

But okay, I'm in a similar boat to you, I care more about total returns than anything else, and I have the emotional fortitude to stay the course during downturns. So let's say the reason I'm investing in bonds is in fact because stocks may underperform bonds over my time horizon. However, you have misinterpreted your own statement to suggest that this means bonds are likely to outperform over say 50 years. Again, going to the point up above, historically, that has never happened on a global scale (it has within certain emerging markets, but presumably we're not talking about going all-in on some super high-risk country).

I would counter that the reason to hold bonds is not because they are likely to outperform over 50 years, but because I am more likely to need money much sooner than that. I am much more concerned about the unknowns of my career, health, etc. than I am over the potential long-term underperformance of stocks, which is again something that has never happened in the modern world. In other words, the main reason your statement is true is not because of bonds or stocks, but because of my unknown time horizon. I might get laid off, injured, sick, divorced, quit, etc., stalling my career much sooner than expected. THAT is why I would hold bonds, because I don't want stocks to crater at the same time that I'm no longer earning enough income to support myself. It is NOT because I believe bonds will outperform stocks in the long run.

So given the above, it STILL makes sense to put bonds in traditional and stocks in Roth. I want bonds to preserve capital for spending, but I also expect stocks to outperform in the long run and benefit more from tax-free growth. There is nothing logically incompatible between these actions and your statement of why people hold bonds. The only conceptual reason I can think of (excluding tax code edge cases and various cliffs and whatnot, which are beyond the scope of this discussion) to prioritize bonds in Roth is, like I said earlier, if you wanted to hedge against the possibility of bonds outperforming in the long run, which again, has never happened.
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Re: Put stocks in Traditional IRA first? Or put in Roth IRA first?

Post by grabiner »

Stocks in the Roth have a minor advantage even after tax adjustment.

Suppose that you expect to lose 25% of your traditional IRA to tax. In that case, you can view the Traditional IRA as an account of which you own 75% tax-free and the IRS owns 25%, so that your portfolio is actually $175K tax-free. If you put stock in the Roth first, the Roth is $100K stock and the Traditional is $70K bonds and $30K stock. If you put stock in the Traditional first, the Roth is $47.5K stock and $52.5K bonds, and the Traditional is $100K stock.

These are equivalent in both return and risk; if the stock market gains or loses 50%, then your after-tax spending will rise or decline by $61,250 (with the IRS taking 25% of the Traditional gains or losses). This $61,250 is 35% of the $175K total, which is what you would expect from a portfolio that is 70% stock.

So why should you prefer one over the other? Because the assumption of a 25% tax rate is not guaranteed, and the risk is asymmetrical in a Traditional account. If you put stock in a Traditional account and the stock market crashes, you may withdraw in a lower tax bracket, and thus the IRS will give back less than 25% of your loss. If the stock market booms, you may withdraw in a higher tax bracket, and thus the IRS will take more than 25% of your gain. In contrast, if the stock is in a Roth IRA, the IRS takes the same percentage (zero) whether the market crashes or booms.

Another issue is that a booming stock market may force you to take RMDs from a Traditional account which are more than you need to spend; this will force you to make some investments in a taxable account, which are worse than either Traditional or Roth. Roth IRAs have no RMDs during your lifetime. (This effect can be mitigated if the excess RMDs would go to charity as Qualified Charitable Distributions.)
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Re: Put stocks in Traditional IRA first? Or put in Roth IRA first?

Post by comeinvest »

grabiner wrote: Sun Jan 23, 2022 7:57 pm Stocks in the Roth have a minor advantage even after tax adjustment.

Suppose that you expect to lose 25% of your traditional IRA to tax. In that case, you can view the Traditional IRA as an account of which you own 75% tax-free and the IRS owns 25%, so that your portfolio is actually $175K tax-free. If you put stock in the Roth first, the Roth is $100K stock and the Traditional is $70K bonds and $30K stock. If you put stock in the Traditional first, the Roth is $47.5K stock and $52.5K bonds, and the Traditional is $100K stock.

These are equivalent in both return and risk; if the stock market gains or loses 50%, then your after-tax spending will rise or decline by $61,250 (with the IRS taking 25% of the Traditional gains or losses). This $61,250 is 35% of the $175K total, which is what you would expect from a portfolio that is 70% stock.

So why should you prefer one over the other? Because the assumption of a 25% tax rate is not guaranteed, and the risk is asymmetrical in a Traditional account. If you put stock in a Traditional account and the stock market crashes, you may withdraw in a lower tax bracket, and thus the IRS will give back less than 25% of your loss. If the stock market booms, you may withdraw in a higher tax bracket, and thus the IRS will take more than 25% of your gain. In contrast, if the stock is in a Roth IRA, the IRS takes the same percentage (zero) whether the market crashes or booms.

Another issue is that a booming stock market may force you to take RMDs from a Traditional account which are more than you need to spend; this will force you to make some investments in a taxable account, which are worse than either Traditional or Roth. Roth IRAs have no RMDs during your lifetime. (This effect can be mitigated if the excess RMDs would go to charity as Qualified Charitable Distributions.)
Thanks. I didn't think of those subtleties. In my case, both my Roth and my tax-deferred accounts have a time horizon where stocks outperformed 100% historically; however, my tax-deferred account is a self-directed and self-funded defined benefit pension of my business, which means the total distributable dollar amount is fixed and limited, i.e. if assets grow faster, then I can contribute less. I have to re-think my optimization problem.
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Re: Put stocks in Traditional IRA first? Or put in Roth IRA first?

Post by Tom_T »

Another consideration is if you plan to bequeath your Roth some day. Your heirs won't have to pay taxes on withdrawals, so it won't matter how large the account becomes.
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