Tuesday, February 17, 2015

Tax-efficient placement - opening Roth IRA

 Over at Bogleheads we came across the following conversation:
           
Postby SNESChalmers » Mon Feb 16, 2015 9:34 am
                       
I've been lurking the forums and reading the wiki, and I was hoping for some confirmation on my understanding of tax-efficient fund placement in the context of opening and funding a taxable account and a Roth IRA.

The relevant info:
  • After setting aside enough for an emergency fund, I have $100,000 to invest.
  • Assume I have no other assets.
  • I want to allocate 80/20 stocks/bonds using a lazy 3-fund portfolio.
  • I want to open a Roth IRA in addition to a taxable account (because of course I can't put the full 50K into a Roth, and I can't think of any reason not to open a tax-advantaged account...)

With an 80/20 AA, that means $20,000 in bonds. I can put only $5,500 in the Roth. If I understand the tax-efficiency wiki article correctly, because generally bonds are relatively tax-inefficient, I want them in the tax-advantaged account.

So my question is: does that mean I should put $5,500 of a bond index into my (new) Roth, with the remaining $14,500 of bonds and the entirety of the stock allocation ($80K) into a taxable account? So it would look like on Day 1:
  • Taxable account: $80,000 stocks / $14,500 bonds
  • Roth: $5,500 bonds

Thank you for indulging what yall probably see as a dumb question.
                   
                   
                SNESChalmers            
Posts: 3
Joined: Sun Feb 15, 2015 12:37 pm
           
       
   
        -----------------------------------------------------------
       
       
                       

Re: Tax-efficient placement - opening Roth IRA

           
Postby ruralavalon » Mon Feb 16, 2015 11:13 am
                       
Welcome to the forum :) .

SNESChalmers wrote:So my question is: does that mean I should put $5,500 of a bond index into my (new) Roth, with the remaining $14,500 of bonds and the entirety of the stock allocation ($80K) into a taxable account? So it would look like on Day 1:
  • Taxable account: $80,000 stocks / $14,500 bonds
  • Roth: $5,500 bonds
.

That's correct.

But do you have a work-based plan available, like a 401k or 403b?
           
"Everything should be as simple as it is, but not simpler." - Albert Einstein | Wiki article link:Getting Started
       
                   
                User avatar
                ruralavalon            
Posts: 5608
Joined: Sat Feb 02, 2008 10:29 am
Location: Illinois
           
       
   
   
        -----------------------------------------------------------
       
       
       
       
                       

Re: Tax-efficient placement - opening Roth IRA

           
Postby grabiner » Mon Feb 16, 2015 11:23 am
                       
Did you work in 2014? If so, you can contribute $5500 (or your earnings, if less than that) to a Roth IRA for 2014 if you do it by April 15, and $5500 more for 2015. When you make your contribution, be sure to indicate that this is what you are doing.

Also, what is your tax bracket? If you are using a lazy 3-fund portfolio and do need to hold bonds in taxable, and are in a 25% or higher bracket, you probably want to use a municipal-bond fund such as Intermediate-Term Tax-Exempt for the bonds you hold in your taxable account.

Finally, if you are new to investing, I would not recommend putting 80% of a large amount of money (and to you, $100K is a large amount) into the stock market on day 1. See Dollar cost averaging on the wiki. You might put 20% into the stock market on day 1 (with the remainder in a bond fund), and an additional 10% every month until you reach 80%.
           
David Grabiner
       
                   
                User avatar
                grabiner            
Advisory Board
Posts: 14186
Joined: Tue Feb 20, 2007 11:58 pm
Location: Columbia, MD
           
       
   
   
        -----------------------------------------------------------
       
       
       
       
                       

Re: Tax-efficient placement - opening Roth IRA

           
Postby SNESChalmers » Mon Feb 16, 2015 1:52 pm
                       
ruralavalon wrote:Welcome to the forum :) .
...
But do you have a work-based plan available, like a 401k or 403b?

Thanks for the welcome and for the response. I do have a 401k, invested in a target fund. I omitted it from the assumptions in my original post because I was trying to simplify things to focus on my tax question. Do you ask because I need to incorporate the 401k allocation into my overall portfolio allocation?
                   
                   
                SNESChalmers            
Posts: 3
Joined: Sun Feb 15, 2015 12:37 pm
           
       
   
   
        -----------------------------------------------------------
       
                                               

Re: Tax-efficient placement - opening Roth IRA

           
Postby SNESChalmers » Mon Feb 16, 2015 1:56 pm
                       
grabiner wrote:Did you work in 2014? If so, you can contribute $5500 (or your earnings, if less than that) to a Roth IRA for 2014 if you do it by April 15, and $5500 more for 2015. When you make your contribution, be sure to indicate that this is what you are doing.

Thanks for this tip.

Also, what is your tax bracket? If you are using a lazy 3-fund portfolio and do need to hold bonds in taxable, and are in a 25% or higher bracket, you probably want to use a municipal-bond fund such as Intermediate-Term Tax-Exempt for the bonds you hold in your taxable account.

I'm in the 25% bracket. Thanks for pointing this out. I will look into a tax-exempt bond index.

Finally, if you are new to investing, I would not recommend putting 80% of a large amount of money (and to you, $100K is a large amount) into the stock market on day 1. See Dollar cost averaging on the wiki. You might put 20% into the stock market on day 1 (with the remainder in a bond fund), and an additional 10% every month until you reach 80%.


That is certainly a large amount of money to me. When I had looked into dollar cost averaging, I found a Vanguard paper indicating that lump-sum wins about 2/3 of the time, so that's why I was leaning towards the one-time investment... But perhaps with the market where it is, DCA would be a good choice

3 comments: