Over at Bogleheads we came across the following discussion: Optimizing Tax Efficiency vs. Minimizing Expenses
by Ganacel » Tue Sep 02, 2014 4:32 pm
Like everyone, I want to pay less for my
investments, whether it is in the form of expense ratios or taxes. But
how do you balance the two when they're at odds?
In my case, I have a 403(b) with investment options that have relatively high expense ratios for nearly every category except one large cap fund, which has an ER of 0.18%. Any other option in any category is at least twice that expensive, if not three or four times as expensive. My employer mandates that I contribute to this account. So my original plan was to put all of my mandatory contributions into this low-ER large cap fund, and then use a taxable account with Vanguard to diversify with international, bonds, and maybe a small amt of REIT contributions. The problem, of course, is that this reverses the best way to structure my accounts for tax purposes. Does anyone have any suggestions for how to get around this issue?
If it helps, I also have an option for a guaranteed 3% annuity in my 403(b). Maybe I could use that in place of a bond fund?
Thanks in advance for any insight you can give me.
Editing to add what additional info I have for those who requested it:
Yearly Income/Tax Bracket not yet known. No state income tax. Monthly pay varies widely.
First time investor. No debt, no spouse, no kids, no other retirement accounts to take into consideration.
In my case, I have a 403(b) with investment options that have relatively high expense ratios for nearly every category except one large cap fund, which has an ER of 0.18%. Any other option in any category is at least twice that expensive, if not three or four times as expensive. My employer mandates that I contribute to this account. So my original plan was to put all of my mandatory contributions into this low-ER large cap fund, and then use a taxable account with Vanguard to diversify with international, bonds, and maybe a small amt of REIT contributions. The problem, of course, is that this reverses the best way to structure my accounts for tax purposes. Does anyone have any suggestions for how to get around this issue?
If it helps, I also have an option for a guaranteed 3% annuity in my 403(b). Maybe I could use that in place of a bond fund?
Thanks in advance for any insight you can give me.
Editing to add what additional info I have for those who requested it:
Yearly Income/Tax Bracket not yet known. No state income tax. Monthly pay varies widely.
First time investor. No debt, no spouse, no kids, no other retirement accounts to take into consideration.
Last edited by Ganacel on Tue Sep 02, 2014 10:57 pm, edited 2 times in total.
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Re: Optimizing Tax Efficiency vs. Minimizing Expenses
by Ganacel » Tue Sep 02, 2014 10:08 pm
After some more reading, I see that other people
have solved this type of problem by using the Vanguard intermediate
tax-exempt bond funds in their taxable accounts, along with either the
Total US Stock Market Index and Total International funds to make a
three fund portfolio, or else separating the US component into the 500
Index + completion fund in an 80:20 ratio (or slightly greater if they
want to over-value). The second option will definitely work better for
me so that I can use the 403(b) funds as part of my total US fund
contribution. I'm a little bummed there is no equivalent tax-managed or
tax-exempt option for REITs, but I guess you can't have everything.
In case this helps anyone else, or if anyone has any comments/suggestions, here's my plan.
Allocation is 25% bonds, 50% US, 25% international. I do not get paid a constant amount of money each pay period, so my initial contributions to both the mandated 403(b) and my taxable account will vary pretty widely until I build up a good amount of money in both where the monthly contribution swings won't affect the account allocations as much. My 403(b) contributions are made biweekly, but I was only going to contribute to the taxable account on a monthly basis, because I don't think it's worth rebalancing everything on a biweekly basis!
403(b):
- Large cap US fund (100% of my mandated contribution + match)
Taxable account (Vanguard):
- Large cap US fund or ETF like VFINX (whatever amt is needed to have 0.8 x 50% = ~40% overall portfolio allocation)
- Completion US fund or ETF like VEXMX (whatever amt is needed to have 0.2 x 50% = ~10% overall portfolio allocation)
- Total international fund or ETF like VTIAX (whatever amt is needed to have ~25% overall portfolio allocation)
- Intermediate tax-exempt bond fund like VWITX (whatever amt is needed to have ~25% overall portfolio allocation)
Still not decided on whether to go with ETFs vs. mutual funds for the taxable account, so if anyone has any input about that, I'd appreciate it.
In case this helps anyone else, or if anyone has any comments/suggestions, here's my plan.
Allocation is 25% bonds, 50% US, 25% international. I do not get paid a constant amount of money each pay period, so my initial contributions to both the mandated 403(b) and my taxable account will vary pretty widely until I build up a good amount of money in both where the monthly contribution swings won't affect the account allocations as much. My 403(b) contributions are made biweekly, but I was only going to contribute to the taxable account on a monthly basis, because I don't think it's worth rebalancing everything on a biweekly basis!
403(b):
- Large cap US fund (100% of my mandated contribution + match)
Taxable account (Vanguard):
- Large cap US fund or ETF like VFINX (whatever amt is needed to have 0.8 x 50% = ~40% overall portfolio allocation)
- Completion US fund or ETF like VEXMX (whatever amt is needed to have 0.2 x 50% = ~10% overall portfolio allocation)
- Total international fund or ETF like VTIAX (whatever amt is needed to have ~25% overall portfolio allocation)
- Intermediate tax-exempt bond fund like VWITX (whatever amt is needed to have ~25% overall portfolio allocation)
Still not decided on whether to go with ETFs vs. mutual funds for the taxable account, so if anyone has any input about that, I'd appreciate it.
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Re: Optimizing Tax Efficiency vs. Minimizing Expenses
by Beth* » Tue Sep 02, 2014 10:20 pm
Based upon your post, it sounds like you have a
lot of options in your 403(b) with ERs of significantly less than one
percent. In the world of 403(b)s and 401(k)s, that's not bad. Most
people don't have options to very inexpensive Vanguard funds in these
accounts.
You might want to post the various options available in your 403(b) and ask for advice on evaluating them. While ideally it would be less, paying an ER of .46 or .64 is not the end of the world when combined with the tax advantages of maximizing a 403(b).
You might want to post the various options available in your 403(b) and ask for advice on evaluating them. While ideally it would be less, paying an ER of .46 or .64 is not the end of the world when combined with the tax advantages of maximizing a 403(b).
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Re: Optimizing Tax Efficiency vs. Minimizing Expenses
by cherijoh » Tue Sep 02, 2014 10:23 pm Ganacel wrote:After some more reading, I see that other people have solved this type of problem by using the Vanguard intermediate tax-exempt bond funds in their taxable accounts, along with either the Total US Stock Market Index and Total International funds to make a three fund portfolio, or else separating the US component into the 500 Index + completion fund in an 80:20 ratio (or slightly greater if they want to over-value). The second option will definitely work better for me so that I can use the 403(b) funds as part of my total US fund contribution. I'm a little bummed there is no equivalent tax-managed or tax-exempt option for REITs, but I guess you can't have everything.
In case this helps anyone else, or if anyone has any comments/suggestions, here's my plan.
Allocation is 25% bonds, 50% US, 25% international. I do not get paid a constant amount of money each pay period, so my initial contributions to both the mandated 403(b) and my taxable account will vary pretty widely until I build up a good amount of money in both where the monthly contribution swings won't affect the account allocations as much. My 403(b) contributions are made biweekly, but I was only going to contribute to the taxable account on a monthly basis, because I don't think it's worth rebalancing everything on a biweekly basis!
403(b):
- Large cap US fund (100% of my mandated contribution + match)
Taxable account (Vanguard):
- Large cap US fund or ETF like VFINX (whatever amt is needed to have 0.8 x 50% = ~40% overall portfolio allocation)
- Completion US fund or ETF like VEXMX (whatever amt is needed to have 0.2 x 50% = ~10% overall portfolio allocation)
- Total international fund or ETF like VTIAX (whatever amt is needed to have ~25% overall portfolio allocation)
- Intermediate tax-exempt bond fund like VWITX (whatever amt is needed to have ~25% overall portfolio allocation)
Still not decided on whether to go with ETFs vs. mutual funds for the taxable account, so if anyone has any input about that, I'd appreciate it.
Can you do a ROTH IRA? That might be a good place for a REIT fund. I would skip it altogether if the only place for it was taxable.
If you are going to continue to invest monthly, I'd stick with the mutual funds for the taxable accounts. Vanguard index funds only require a $10K balance to get Admiral class shares.
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Re: Optimizing Tax Efficiency vs. Minimizing Expenses
by sdsailing » Tue Sep 02, 2014 10:31 pm
All of this strategy depends at least partially on your tax bracket. It would be helpful to reveal this.
Edit. If that annuity that you mention is TIAA at 3 percent, then yes I would use that, for at least part of your bond allocation.
Edit. If that annuity that you mention is TIAA at 3 percent, then yes I would use that, for at least part of your bond allocation.
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Re: Optimizing Tax Efficiency vs. Minimizing Expenses
by Ganacel » Tue Sep 02, 2014 10:44 pm
No, I do not qualify to contribute to a Roth.
TBH, I don't absolutely have my heart set on doing the REIT fund,
especially given the level of complexity I already have introduced
because of the unequal monthly contributions and the dual accounts. So
like you alluded, I'm not going to worry about REIT funds for now,
because I can always add one later. Thanks for your input.
Just as a general aside: Someone PMed me to suggest that I should post more details about my situation to get a better answer. I just wanted to say that there aren't any other details. This is my first time investing, and I'm starting both accounts from scratch. So these are going to be the only two accounts I have, at least for now. I'm also not married and have no spousal or children's accounts to consider. I don't have any competing debt like a school loan or mortgage to pay off either. Sorry if it seemed like I was being uninformative about my situation in the earlier posts to some of you, but I lead a pretty boring life!
Edit: I'm sorry, I also don't know what my tax bracket is going to be. I have only been working here for one month, and like I said, my monthly income varies widely. I can tell you that I have no state income tax, federal only.
Just as a general aside: Someone PMed me to suggest that I should post more details about my situation to get a better answer. I just wanted to say that there aren't any other details. This is my first time investing, and I'm starting both accounts from scratch. So these are going to be the only two accounts I have, at least for now. I'm also not married and have no spousal or children's accounts to consider. I don't have any competing debt like a school loan or mortgage to pay off either. Sorry if it seemed like I was being uninformative about my situation in the earlier posts to some of you, but I lead a pretty boring life!
Edit: I'm sorry, I also don't know what my tax bracket is going to be. I have only been working here for one month, and like I said, my monthly income varies widely. I can tell you that I have no state income tax, federal only.
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Re: Optimizing Tax Efficiency vs. Minimizing Expenses
by Beth* » Tue Sep 02, 2014 10:52 pm Ganacel wrote:No, I do not qualify to contribute to a Roth.
If this is your first time investing and you have no money in an IRA, you can almost certainly do a backdoor Roth IRA if your income is too high to contribute directly to a Roth IRA:
http://www.bogleheads.org/wiki/Backdoor_Roth_IRA
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Re: Optimizing Tax Efficiency vs. Minimizing Expenses
by sdsailing » Tue Sep 02, 2014 11:03 pm
In that case I would say don't worry about tax
consequences now. It will not matter until you have accumulated a fair
sum. At that point you will have learned the basics of investing and
will be ready to address more advanced topics such as tax efficiency.
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Re: Optimizing Tax Efficiency vs. Minimizing Expenses
by Ganacel » Tue Sep 02, 2014 11:09 pm Beth* wrote:Ganacel wrote:No, I do not qualify to contribute to a Roth.
If this is your first time investing and you have no money in an IRA, you can almost certainly do a backdoor Roth IRA if your income is too high to contribute directly to a Roth IRA:
http://www.bogleheads.org/wiki/Backdoor_Roth_IRA
Yes, I have read about the backdoor Roth. I will look into this again at the end of the year when I have a better idea what my income is going to be. Thank you.
sdsailing wrote:In that case I would say don't worry about tax consequences now. It will not matter until you have accumulated a fair sum. At that point you will have learned the basics of investing and will be ready to address more advanced topics such as tax efficiency.
What qualifies as "a fair sum?" Just curious to know at what point tax issues should be considered as significant. Thank you.
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Re: Optimizing Tax Efficiency vs. Minimizing Expenses
by Beth* » Tue Sep 02, 2014 11:13 pm sdsailing wrote:In that case I would say don't worry about tax consequences now. It will not matter until you have accumulated a fair sum. At that point you will have learned the basics of investing and will be ready to address more advanced topics such as tax efficiency.
I disagree with this. You have a certain amount of tax advantage space each year. Either you use it or you lose it. You can't save up $25,000 in a taxable account and then decide to go back and convert it to a Roth IRA. It doesn't work that way.
If you have specific goals other than retirement for which you need to save money, save in a taxable account. Otherwise, take advantage of your tax advantaged space. In particular, if you start saving in a Roth IRA at a young age and don't touch it, I guarantee that you will ultimately be very happy you made that decision.
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Re: Optimizing Tax Efficiency vs. Minimizing Expenses
by Beth* » Tue Sep 02, 2014 11:16 pm
And even if you are saving for pre-retirement
goals in a taxable account, put something into a retirement account.
Start with a smallish percentage of your salary if that is all you can
afford. Then every time you get a raise, increase the amount you are
saving by some portion of that raise. Keep doing this until you hit the
maximum amount you can put in retirement accounts. Don't touch the money
in your retirement accounts. That's what I did and that is what I have
advised my children to do.
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Re: Optimizing Tax Efficiency vs. Minimizing Expenses
by grabiner » Tue Sep 02, 2014 11:19 pm
Get as much into the 403(b) (and Roth IRA) as
possible. As long as you have a few decent options, investing inside
the 403(b) is better than investing outside it.
If you still have money for taxable investing, it is worth using slightly less tax-efficient options in your taxable account to get the lowest costs. REITs should not be in your taxable account; you should probably limit your REIT holding to the amount in the Roth IRA. But you can use the large-cap fund, and the stable value fund in place of a bond fund, and then hold Tax-Managed Small-Cap, Total International, and a muncipal-bond fund if necessary in your taxable account.
My guess is that the stable value fund is a better investment than anything else in the 403(b). Therefore, you may actually want to treat this as your main "bond" holding. (TIAA-CREF investors often do this.)
If you still have money for taxable investing, it is worth using slightly less tax-efficient options in your taxable account to get the lowest costs. REITs should not be in your taxable account; you should probably limit your REIT holding to the amount in the Roth IRA. But you can use the large-cap fund, and the stable value fund in place of a bond fund, and then hold Tax-Managed Small-Cap, Total International, and a muncipal-bond fund if necessary in your taxable account.
My guess is that the stable value fund is a better investment than anything else in the 403(b). Therefore, you may actually want to treat this as your main "bond" holding. (TIAA-CREF investors often do this.)
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Re: Optimizing Tax Efficiency vs. Minimizing Expenses
by alife » Tue Sep 02, 2014 11:36 pm
A dissenting view on the conventional wisdom regarding asset location can be found at:
http://whitecoatinvestor.com/asset-loca ... n-taxable/
The argument for putting bonds in taxable looks pretty straightforward and compelling to me!
http://whitecoatinvestor.com/asset-loca ... n-taxable/
The argument for putting bonds in taxable looks pretty straightforward and compelling to me!
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Re: Optimizing Tax Efficiency vs. Minimizing Expenses
by Ganacel » Tue Sep 02, 2014 11:38 pm
Yes, the 3% annuity is through TIAA-CREF. If I
do this, my understanding is that I have to withdraw the money over 10
years in order to avoid a penalty. Does that lack of flexibility make
it a less enticing option?
I do understand about maximizing the retirement account contributions, and I am making the maximum voluntary contribution along with my mandatory contribution and match. They determine the contribution amounts based on percentage of income, not dollar amount, so I do not know yet whether I will be able to contribute the entire $17,500 for this year. The mandatory contributions apparently do not count toward the $17,500 yearly limit. If I were to go over on the voluntary contributions, they would stop taking it out of my paycheck once I reach $17,500 for the year.
Thank you for your help.
I do understand about maximizing the retirement account contributions, and I am making the maximum voluntary contribution along with my mandatory contribution and match. They determine the contribution amounts based on percentage of income, not dollar amount, so I do not know yet whether I will be able to contribute the entire $17,500 for this year. The mandatory contributions apparently do not count toward the $17,500 yearly limit. If I were to go over on the voluntary contributions, they would stop taking it out of my paycheck once I reach $17,500 for the year.
Thank you for your help.
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Re: Optimizing Tax Efficiency vs. Minimizing Expenses
by grabiner » Wed Sep 03, 2014 12:06 am Ganacel wrote:Yes, the 3% annuity is through TIAA-CREF. If I do this, my understanding is that I have to withdraw the money over 10 years in order to avoid a penalty. Does that lack of flexibility make it a less enticing option?
It's a bit less attractive because of this feature, because the fund effectively has a 4.5-year duration. If you want to withdraw the money, you get 10% now and 10% per year for the next nine years, as if you had ten bonds maturing over the 0-9 year period.
Still, 3% is better than the market rate on funds with a 5-year duration, and the fund is backed by TIAA-CREF, a very high quality institution. (In contrast, if you bought a corporate bond fund, it would have some BBB-rated corporates, which have somewhat more risk of default.) And TIAA-CREF has a good record of low expenses and maintaining good rates on its traditional annuity.
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Re: Optimizing Tax Efficiency vs. Minimizing Expenses
by sdsailing » Wed Sep 03, 2014 12:13 am Beth* wrote:sdsailing wrote:In that case I would say don't worry about tax consequences now. It will not matter until you have accumulated a fair sum. At that point you will have learned the basics of investing and will be ready to address more advanced topics such as tax efficiency.
I disagree with this. You have a certain amount of tax advantage space each year. Either you use it or you lose it. You can't save up $25,000 in a taxable account and then decide to go back and convert it to a Roth IRA. It doesn't work that way.
If you have specific goals other than retirement for which you need to save money, save in a taxable account. Otherwise, take advantage of your tax advantaged space. In particular, if you start saving in a Roth IRA at a young age and don't touch it, I guarantee that you will ultimately be very happy you made that decision.
The question at hand is not whether to max out pre tax, that is a given. The issue is the distribution of investments...tax efficient vs less tax efficient...between pre tax and taxable.
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Re: Optimizing Tax Efficiency vs. Minimizing Expenses
by Ganacel » Wed Sep 03, 2014 12:15 am alife wrote:A dissenting view on the conventional wisdom regarding asset location can be found at:
http://whitecoatinvestor.com/asset-loca ... n-taxable/
The argument for putting bonds in taxable looks pretty straightforward and compelling to me!
Thank you for the link. That seems to support what I was proposing--using the tax-exempt bond fund in the taxable account and investing 100% in the large cap stock fund in the 403(b)--especially since the ERs will also be much lower if I do it this way.
I have to confess that I also like the relative simplicity of doing it that way versus trying to allocate different percentages of each account to fixed income versus bonds versus mutual funds. I still have to spend some time rebalancing the taxable account, but this would make it easy to put the 403(b) on total autopilot.
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Re: Optimizing Tax Efficiency vs. Minimizing Expenses
by chrysogonus » Wed Sep 03, 2014 12:45 am
If you have access to the TIAA traditional
annuity, you probably have access to the TIAA Real Estate estate account
as well. Since you mention REITs, that's worth a look for commercial
real estate exposure that's less volatile. The expense ratio is a
little high, but there's nothing else to compare it to, and the general
consensus seems to be not to worry about it.. You'll find lots of
discussions about it if you search for TREA.
Also, index funds with an ER of less than 0.50% in a 401(k)/403(b) are reasonably good. Sure, it's not as low as Vanguard, but it's still decent.
Also, index funds with an ER of less than 0.50% in a 401(k)/403(b) are reasonably good. Sure, it's not as low as Vanguard, but it's still decent.
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