All about asset location: How to make the most of your accounts

When Robert submitted this, he advised, “File this under the ‘long and tedious but important' category. It might need pictures of cats.” So, once again, J.D. has obliged with photos of one of his cats.

Want to have more money and pay less in taxes? It's easy! Just call this number and send in your three easy payments of — no, wait. Actually, all you have to do is learn a little about asset location. No, not asset allocation — asset location: deciding which assets should go in which accounts. A recent surge of Roth assets, thanks to the increasing availability of the Roth 401(k) and the wave of conversions that occurred last year, makes this a particularly timely topic.

Outside?!?
Wait! Don't leave! Though a little tedious, this is an important subject.

To understand asset location, you need to remember that most investors have accounts that receive different tax treatment, such as the following:

  • A traditional tax-deferred account, like a traditional IRA or traditional 401(k): Contributions may be tax-deductible, and the investment growth and income isn't taxed until money is withdrawn. Those withdrawals will be taxed as ordinary income — the highest tax rate most Americans pay. It ranges from 10% to 35%.
  • A Roth IRA or Roth 401(k): Contributions aren't tax-deductible, but withdrawals are tax-free (as long as you follow the rules).
  • A taxable, non-retirement account: The taxation of an account that isn't an IRA or employer-sponsored retirement account (e.g., a 401(k)) varies. Interest from bonds and CDs as well as short-term capital gains are taxed as ordinary income, but qualified stock dividends and long-term capital gains are taxed at lower rates, currently between 0% and 15%.

Studies have shown that making the right choices about which investments belong in which accounts can increase an investor's after-tax wealth by 15% to 20% over a lifetime. So what are those “right choices”? They can be summed up by five basic rules.

Rule #1: Keep Taxable Bonds and Certificates of Deposit in Tax-Deferred Accounts

If you hold these investments outside of a traditional IRA or 401(k), the interest is fully taxable at ordinary income rates. You essentially hand over a good portion of the return each year to Uncle Sam and Sister State, leaving less to grow through the years.

Tip: Confused about bonds? To refresh your memory, read about the basics of bonds and how bonds work.

Rule #2: Consider Keeping Bonds With Tax Advantages in Taxable Accounts

Some bonds have their own built-in tax advantages. Treasuries are exempt from state and local taxes, and municipal bonds can be exempt from all taxes — federal, state, and local. If you place muni bonds in a traditional IRA, however, you lose the tax advantages.

Unless you live in a state with high taxes, it likely still makes sense for you to hold your Treasuries in your tax-deferred account, especially if you're years away from retirement. However, it rarely makes sense to buy municipal bonds in your tax-advantaged retirement accounts. The only exception is if you're buying bonds that are trading below par value (the price at which they were originally issued) and you expect the price to rise, leading to a capital gain. While the interest from government-issued bonds might have tax benefits, a capital gain — for example, the $100 profit you made if you bought the bond at $850 and sold it later for $950 — is fully taxable if held outside of an IRA or 401(k).

Brothers
Hold off the tax man by putting the right investments in the right accounts.

Rule #3: In Taxable Accounts, Favor Stocks With Little to No Dividends and Those You'll Hold for Many Years

Let's say two investors put $50,000 in the exact same stock and hold it for a decade. The stock doesn't pay a dividend and earns an average of 8% annually. Investor A holds the stock in his traditional IRA, and Investor B holds it in her taxable brokerage account. A decade later, here's the value of each account and the taxes each investor has paid through the years (at this point, they haven't sold the stock yet):

  • Investor A holds the stock in a traditional IRA. The pre-tax value of the account is $107,946 and Investor A has paid no taxes on the gain — yet.
  • Investor B holds the stock in a taxable brokerage account. The pre-tax value of the account is $107,946, and Investor B has paid no taxes on the gain — yet.

Surprise! The values of the investments and the taxes paid (i.e., none) are exactly the same, even though Investor B held the stock in a “taxable” account. That's because when you buy and hold stocks, especially ones that pay little to no dividends, you have built-in tax deferral.

But what happens when these investors sell their stocks to spend the proceeds in retirement? Assuming they're both in the 25% tax bracket, Investor A will have to pay a 25% tax rate on everything he withdraws from the IRA, whereas Investor B will pay just a 15% long-term capital gains rate — and only on the profit. If they each liquidated the investment and withdrew the cash from the accounts:

  • Investor A would pay $26,987 in taxes and have $80,960 remaining.
  • Investor B would pay $8,692 in taxes and have $99,254 remaining.

As if more after-tax wealth weren't enough, there are other benefits to holding equities in your taxable account:

  • If shares drop below what you paid for them, you can harvest the losses by selling the shares and using the capital loss to reduce taxes. Of course, you can do that with any type of investment, but stocks present more opportunities since they're more volatile.
  • If you hold dividend-paying foreign stocks in your taxable account, you can claim the foreign tax credit for any taxes assessed by the country in which your stock is headquartered. However, you can't claim the credit if you hold the stock in an IRA or 401(k).
  • Investments in a taxable account receive a stepped-up cost basis upon the owner's death. Say a person buys stock for $10,000, and its value grows to $50,000. When he dies, this person bequeaths the stock to his daughter. Her new cost basis will be $50,000; she will not owe taxes on the $40,000 of capital appreciation.
  • A less fatal way to escape paying capital gains taxes is by donating appreciated stock held in a taxable account to a qualified charity. Bonus: The donation can also be deducted on your tax return.

While all these benefits sound good, the tax efficiency of holding equities in a taxable account relies on your buying and holding for years and keeping dividends to a minimum. What do you do for high-yielding stocks or those you trade more frequently? Read on!

Nemo's Finch
Choosing the right accounts lets you keep more of your money.

Rule #4: For Your Roth, Choose High-Growth, Tax-Inefficient Investments

When it comes to deciding what to put in this tax-free account, keep two principles in mind:

  • Generally speaking, the assets in your Roth should be the last you withdraw in retirement. Studies indicate it's best to first tap your taxable accounts, then your traditional tax-deferred accounts, and your Roth last.
  • Which account do you hope will be the biggest when you retire? The one with the best tax advantages, of course. That's the Roth, since withdrawals are tax-free.

Given those two principles, the ideal investments for your Roth are those that have the greatest return potential, especially if they're tax-inefficient. Historically, small-cap value stocks have posted the highest returns, and because of their generally higher turnover and higher dividends, the mutual funds that invest in that sector are among the most tax-inefficient — so these would be good candidates for a Roth. You could also use the account for any other active-trading strategies or real estate investment trusts, which pay a high yield but have dividends that aren't eligible for the lower qualified-dividend tax rate.

Also note that Roth assets are the best kind for your heirs to inherit, since they'll also enjoy tax-free growth. If leaving a legacy is important to you, then the Roth has an investment time horizon that extends beyond your lifetime; thus, it can theoretically hold riskier assets.

Rule #5: Retirement Changes Asset Location a Bit

Once you retire, if you plan to invest in high-yield stocks for the income, it makes sense to hold them outside of a tax-deferred account to take advantage of the lower tax rate on qualified dividends. It's less important where you hold the bonds that produce interest you plan on spending, since that interest will be taxed as ordinary income no matter what (muni bonds excepted).

Nemo Rolling for the Camera
When you're ready to retire, you may want to mix things up a bit.

Remember: It's Not What You Make, It's What You Keep

Smart asset location also means you'll pay fewer taxes. The higher your taxable income, the less likely you are to qualify for certain tax breaks. Also, once you begin receiving Social Security, the more you earn, the more likely your benefits will be taxed, and the more likely you'll pay higher Medicare premiums.

So while paying attention to your asset location won't double your portfolio overnight, it will pay off for decades to come — perhaps even after you've headed off to the Antiques Roadshow beyond the pearly gates.

Asset Location at a Glance

Here's a quick summary of which investments to keep in which accounts:

  • Roth accounts: Small-cap stocks; REITs; active-trading stock strategies; high-turnover and/or high-yielding funds, especially if they have above-average growth potential.
  • Traditional tax-deferred accounts: Corporate bonds; Treasuries (especially TIPS); high-yielding and slower-growth stocks; diversified commodities funds; investments listed in the Roth category above if your Roth accounts aren't very big or you don't have a Roth.
  • Taxable, non-tax-advantaged accounts: Low- or non-yielding stocks you plan to hold for several years (decades, even); low-turnover stock funds (e.g., many index funds and ETFs as well as “tax-managed” funds); municipal bonds; U.S. government savings bonds or I-bonds; maybe Treasuries if escaping state income taxes is important to you.

Note: This article uses current federal tax rates, which will continue through 2012. Tax law will certainly be different a few years from now, but I think it's a good bet that some current principles — such as long-term capital gains rates will be lower than ordinary income rates, and that municipal bonds will have tax advantages — will continue.

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Imelda
Imelda
9 years ago

This is a terrific post. Yes it’s a little dry, but I learned a LOT, which after years of following PF blogs is something of a rarity!

billie
billie
9 years ago

EXCELLENT article! I’m so glad I took the time to read it, I learned so much and our retirement accounts are really in need of this type of help.

Bogey@BackNineFinance
9 years ago

All good info. I’ve been going through some moderate changes to my savings account, both taxable and tax sheltered. Just this month, I finally qualify for my 401k plan at work, so as a way to simplify things, I am going to just contribute as much as I can to that plan, and then doing some saving in a Roth as I am able.

Marilyn
Marilyn
9 years ago

Definately missed the word change from allocation to location in the title. When I started reading the article I had a facepalm moment. The kitty pictures made the article more readable.

I had never heard of the double whammy trick of donating stock to get out of capital gains and get an additional break. Brilliant.

Barbara Friedberg
Barbara Friedberg
9 years ago

Love the cats! I hate it when I incur a loss in a tax advantaged account! (Fortunately, doesn’t happen very often because I follow Robert’s strategy). In my opinion, Roth’s and Traditional IRAs can hold the same types of assets (those creating potentially high and reoccurring tax exposure).

Nicole
Nicole
9 years ago

Me too! The Roth that my dad invested in for me with my first college earnings took a forced loss this year. It was so sad! Index funds all the way.

Nicole
Nicole
9 years ago

I don’t understand why you would keep a CD in a tax deferred account. Aren’t CDs only for short term savings? Is this something you would do when you’re older?

The Siamese certainly is an alpha kitty.

J.D. Roth
J.D. Roth
9 years ago
Reply to  Nicole

I think some people use CDs for the “cash” portion of their portfolio. I suspect they buy longer-term CDs (five to seven years?) and hold them just like they would stocks. If you have a ton of money, this is just part of diversification. But again, this is just a guess. And Nemo is actually a beta kitty, but he thinks he’s an alpha kitty. His brother Simon, who is in two photos here, is actually the alpha kitty. But when Simon isn’t exerting his position (which he does from time to time), he lets Nemo think he’s boss. And… Read more »

Mike Piper
Mike Piper
9 years ago
Reply to  J.D. Roth

CDs can often be used as a replacement for comparable-maturity Treasury bonds in a portfolio.

Provided you keep them under FDIC limits, they have just as little credit risk (zero, basically). And if you shop around you can often find CDs offering higher rates than comparable T-bonds.

It’s more work, but if your bond allocation is sizable, it can be worth it.

Mike Piper
Mike Piper
9 years ago

Excellent article! 🙂

One additional point: When choosing whether to tax-shelter a domestic stock fund or an international stock fund, all else being equal, it’s best to shelter the domestic one so that you can receive the Foreign Tax Credit on the international fund.

El
El
9 years ago

I had never heard this discussed – or ever thought about it either. The cats are helpful. I’ll be bookmarking this. Now, to get some coffee and read it again . . .

Lou Lamoureux
Lou Lamoureux
9 years ago
Does this allow you to write off your cats as a business expense?
Kellen
Kellen
9 years ago
Reply to  Lou Lamoureux

That’s a good point, especially since several readers admitted that the cats added to the readability of the article. You’d have to figure out what % of the cats was business use for the year though…

brokeprofessionals
brokeprofessionals
9 years ago

All great advice and something my wife and I need to focus more on. That said, is it paranoid that sometimes I fear investing in roth IRA’s becasue I worry the US is in such debt that I worry about the future viability of the investment vehicle?

Carey
Carey
9 years ago

What does government debt structure have to do with the safety of funds in a Roth IRA? To answer your question, yes, I think this puts you dangerously close to tinfoil hat territory.

Mike
Mike
9 years ago
Reply to  Carey

She probably feels that Congress will re-neg on its promise on not taxing the earnings of a Roth. There isn’t anything to stop them from doing this.

Elizabeth
Elizabeth
9 years ago

Interesting read! It takes a little converting for us Canadians, but I think we can work with the information. TFSAs versus RRSPs are a hot topic every winter here. I think this article offers some useful advice as to what could be included in a TFSA.

fantasma
fantasma
9 years ago

This post is truly informative, and I didn’t have a lalala off to space moment when I was reading it. Perhaps later on down the line you could talk about the best places to hold Roth IRA’s if you want to hold single stocks.

johno
johno
9 years ago

In example three (or rather, the second example two) I believe you’ve neglected the taxes that investor B will have to pay before investing his money. Investor A has the advantage of not paying taxes on the money invested in his IRA the year it is invested, while investor B will be taxed on the full amount then, in addition to the gains at the end. So, assuming they both start with 50,000 and are in the 25% tax bracket the entire time, investor A will drop the full 50,000 into his stock while investor B will shell out 12,500… Read more »

Gia
Gia
9 years ago
Reply to  johno

Good points!

Raghu Bilhana
Raghu Bilhana
9 years ago

\
Robert

Your articles are good. anytime I read your article, I learn something new.

You are good. Keep them coming.

Kevin @ Thousandaire.com
Kevin @ Thousandaire.com
9 years ago

This is a great article. I used to just invest in whatever I wanted, but recently I started using the tax benefits of my Roth and 401k to their full benefits. It makes a big difference.

Another thing to remember is that you don’t want to invest in highly risky companies in tax deferred accounts. You can’t write off losses in tax deferred accounts, so I try to make sure I don’t have big losses there.

Laura in ATL
Laura in ATL
9 years ago

Excellent article, thanks so much!

(Photos of kitties are always a plus btw, to make a ‘dull’ topic less tedious. ;-))

I love this blog and all the contributing authors. Thanks so much!

Steve S
Steve S
9 years ago

Ok maybe I’m missing something but isn’t the initial $50k in your examples of investor A and B really a different amount? Investor A’s $50k is pre-tax money and investor B’s is after tax money. Shouldn’t the two cancel out (or doesn’t that at least change the math a bit)?

Seems like a pretty important distinction to make, whether or not you’re starting with funds that have been taxed or not. The $50k doesn’t just show up on your front doorstep in cash one morning…

Robert Brokamp
Robert Brokamp
9 years ago
Reply to  Steve S

@Steve S: This article just addresses money that is already in these accounts, not whether you should add new money to a traditional IRA, Roth IRA, or taxable account. Your point is certainly an important consideration when you’re answering the “where do I put new money?” question.

This article just addresses the question of “OK, I already have money in a traditional account, a Roth account, and a taxable account — in which of these accounts should I choose which investments?”

Steve
Steve
9 years ago
Reply to  Robert Brokamp

@Robert: if you want the example to be of investors who already have money in the accounts, expand it. Give each $100k split between tax-deferred and taxable. Then A can invest right (according to your guidelines) and B can invest wrong (doing the opposite) and you can show how much better off A is. Or vice-versa.

Dan
Dan
9 years ago
Reply to  Robert Brokamp

Rob, that might be true, but you open #2 with: “Let’s say two investors put $50,000 in the exact same stock and hold it for a decade.” But they didn’t put the *same* $50k in the exact same stock and hold it for a decade. One invested pre-tax dollars, and the other invested post-tax dollars, which makes this two very different comparisons. Even if you want to say that you’re talking about existing money and not new money, you *cannot* overlook the taxes already paid on the investments in the traditional account. You do that in your conclusion, which at… Read more »

Steve
Steve
9 years ago
Reply to  Dan

Unfortunately I find this to be common in Robert’s articles. Don’t get me wrong, they are always entertaining and informative. But I am the kind of guy who likes to run the numbers myself, and often with his articles, I find something in the numbers doesn’t quite add up.

Matthew Amster-Burton
Matthew Amster-Burton
9 years ago

Robert, your comparison between the IRA and the taxable account is incorrect, because one contains pre-tax money and one contains after-tax money. It takes a much smaller initial investment to put $50,000 into an IRA than to put $50,000 into a taxable account, because you’re going to get $12,500 back (over a period of years, obviously, since the IRA limit is $5000) when you contribute to the IRA. In other words, the investor who put $50,000 into the IRA also has an additional $12,500 (also growing at 8%) that isn’t being shown in the example. It’s the IRA investor who… Read more »

Laura in Cancun
Laura in Cancun
9 years ago

Can’t relate bc I don’t live in the US, but the cat pictures were awesome, as always!

Caprini
Caprini
9 years ago

Thank you so much for this useful, accessible fact-filled article. This is one of the best entries in any financial blog that I’ve read in months. And I don’t find it dry at all — on the contrary, reading this kind of eye-opener gives me a rush of excitement. “Ah ha! Now I understand that” … and an immediate to-do list for reshuffling my asset locations. This is the kind of information that magazine articles usually omit (probably because they think it is too dry and detailed) but it’s so necessary.

Ken Faulkenberry
Ken Faulkenberry
9 years ago

Thanks for the great article on an important subject. Most people don’t want to tackle asset location because it is complicated. It is also dynamic with changes in law and investors individual needs. You gave great details and a convenient summary. I think your point on how great a difference in how much money you KEEP is not recongized by most investors.

Mary H
Mary H
9 years ago

Thanks to the commentors who addressed the IRA pre-tax money referred to in the example.I was wondering about the difference.

Justin
Justin
9 years ago

This really is a great post. It brings details to what I normally just kind of brush off…

I’ve been putting most of my money into the target date retirement funds, with about half of my money going into a 401K (this isn’t matched- sad Christmas), and the other half going into my ROTH.

If/when I do expand my portfolio, I’ll definitely keep these tips in mind!

Tyler Karaszewski
Tyler Karaszewski
9 years ago

Poor little finch, spent all that time saving up in his Roth IRA and will never get to retire on it.

Ely
Ely
9 years ago

Hopefully he had a will so his kids or favorite charities will benefit.

chacha1
chacha1
9 years ago

This is one of the best articles on asset strategies that I’ve ever read.

Could we have it as a PDF?

Julie @ The Family CEO
Julie @ The Family CEO
9 years ago

I’m with Imelda – I’ve been reading PF blogs a long time and have never seen this issue addressed. Hopefully the cats are taking this advice to heart for their retirement funds as well.

Ryan
Ryan
9 years ago

Robert, question about your claim for traditional IRA/401k’s: I was under the impression that the money you take out of an IRA will be taxed as ordinary income, that is, if I take out $30,000 from my IRA after I retire, I can take the standard deduction and personal exemptions to get it down to $12,000, then pay 10% taxes on 12,000. Is this accurate? Also, suppose I took out $30000 from a Roth, and $30000 from a traditional account. My understanding is the Roth is tax-free, and I’d pay about $1200 on the $30000 from the traditional (see first… Read more »

margot
margot
9 years ago

LOVE the cat photos!!! They make any topic more interesting!

Her Every Cent Counts
Her Every Cent Counts
9 years ago

One thing that wasn’t mentioned here is commodities that are taxed as collectables like Gold and Silver. I found out that the GLD and SLV ETFs are taxed at rates that may be even higher than your income tax, because they’re considered collectables (even though you’ve never touched the metal, you just own the ETF.) So I hear it’s best to put those in your Roth. Do you agree? Also, overall — what if you are still fairly new in your Roth investing and thus can only have a small amount in there (say $10k after 3 years) and the… Read more »

retirebyforty
retirebyforty
9 years ago

I have been trying to figure this out myself for a while now and it’s very confusing. This is a GREAT article on how to minimize tax! I have been trying to put high growth stocks like small cap/emerging market in the ROTH account, but it’s difficult to arrange everything. I’ll keep working on it.
I learn a new word as well – asset location. 😉

Hunter
Hunter
9 years ago

Great information. I would add that if your investments are structured tax efficiently like this, it takes some pressure off the order in which you liquidate these accounts in retirement.

Matt G
Matt G
9 years ago

I agree with johno and Steve S, it is misleading to assume that the 50,000 is equivalent between investor A and investor B.

Next time please be explicit about your assumptions because a person’s decisions could be wholly changed when based on all the facts.

Tara C
Tara C
9 years ago

I need to print the article out and read it several times because my brain seized up while reading it, but thanks for the info. The cat pictures are awesome!

Steve
Steve
9 years ago

Rule #3 (which has a typo, showing up as the second #2) is so misleading that I would almost call it wrong. How did investors A and B get the $50,000 into their respective accounts? Investor B would have paid income taxes on it already, reducing his investable capital to only $37,500. If the intention is that both A and B have money in tax deferred, Roth, and taxable accounts, and are just choosing which investments to hold in which accounts, that needs to be made clearer in the example. The fact of the matter is that a tax advantaged… Read more »

Ace
Ace
9 years ago

JD – Why not hold a bond fund in a Roth? Doesn’t that also get you out of interest being potentially taxed at regular income rates?

Dan
Dan
9 years ago

Rob, Thanks for a good “nuts and bolts” article. They aren’t common on PF websites. As a math geek, I appreciate them 🙂 But one thing that should be discussed more in retirement articles (and never is) are the assumptions underlying one’s tax bracket in retirement. Everyone always talks about “assume a bracket of X” or “assume your bracket in retirement is lower/higher…” But what we’re missing is the talk about how you get into the bracket. You get into a bracket by having taxable income in lower brackets. No taxable income = no bracket. (I know you know this.)… Read more »

ProfessorB
ProfessorB
9 years ago
Reply to  Dan

I like this line of thinking. Taking it further, you could invest in Tax-deferred and Tax-free accounts now such that, in retirement, you withdraw tax-deferred dollars up to the amount of the standard deduction (+ etc.), and withdraw tax-free dollars above that amount.

Wouldn’t that minimize both the tax paid in retirement (to zero) as well as the tax paid on money saved now for retirement ?

Of course you’d have to know what the standard deduction(s) will be in retirement, but I imagine one could reasonably estimate it.

Jaime B
Jaime B
9 years ago

Wow, my mind was just stretched a little.

Thanks so much for this article, something I have literally never thought about and is really quite interesting. I’ll keep this in mind as my retirment investing grows. Also a great reason for using a qualified financial professional, LOL.

J.D. Roth
J.D. Roth
9 years ago

Fixed the stupid numbering error, which was my fault, not Robert’s.

Pat S.
Pat S.
9 years ago

Excellent post. Sometimes you have to wade through the laborious information to get to some nuggets that will help you make more, save more, or spend less. It’s only dry if you don’t care enough to apply it to your own life. I, for one enjoyed it!

mitigateddisaster
mitigateddisaster
9 years ago

Super super helpful post! For those of us who can’t deduct contributions to IRA anyway, example 3 was great.

Chris
Chris
9 years ago

I’m only a few years from retirement and only recently heard this discussed. I’m going to do some rearranging but wish I had heard it explained before. If got my money in exactly the wrong places. Though I may not be in the higher tax bracket which will help.

The couple of people that pointed out that you have to consider the pre-tax vs. post-tax consequences in the investor A vs. investor B example are right but it doesn’t negate the basics of the article.

Bruce
Bruce
9 years ago

I can’t believe anyone is advising holding REITs in any form, in any investment vehicle. The whole idea of having money in my Roth is to have emergency access to cash via staggered CDs, and to keep it out of the hands of thieves in the stock market and fund managers. IMHO,commercial real estate is the next bomb to go off out there. My Roth will never be exposed to the whims of the markets. It is my ‘safe’ portion of my portfolio. Plus, if something happens to me, the Roth can transfer to a survivor of my choice immediately…and… Read more »

MC
MC
9 years ago
Reply to  Bruce

This is how I was thinking about the Roth as well. The real emergency monies because it’s still semi-liquid. Note, I’ve neglected this investment vehicle but hope to jump in in 2012. I’m in debt reduction mode (paying of the 20% loan on my home which should be done in 2012). Then when building up a more substantial emergency, it’s going to the Roth in low risk investments for the first few years.

Steve
Steve
9 years ago
Reply to  MC

If you’re using your Roth to hold your emergency fund (a good strategy until you really get going, by which I mean max out all retirement contributions and have a non-encumbered savings account for your e-fund) then what you say may be true. But for the majority of people who are using a Roth for retirement savings, the average person should be investing in something with growth potential.

kristin
kristin
9 years ago

Can you please give more examples of what types of investments should go where? I’m not sure what low or non-yielding stock means?

GS
GS
9 years ago

That all makes sense in a solid economy that is not threatened by too much debt. But the reality is that ALL sectors of our economy are drowning in debt, households, the business sector, the banks and the state. In this economy I would advice everyone to move out of bonds. We’re headed for haircuts for bondholders everywhere in the Western world. It may start in the European periphery but it won’t end there. Note that central bank programs like QE keep yields on bond very low. They barely offer more return that what is taken away via inflation. But… Read more »

jackowick
jackowick
9 years ago

I’m a fan of “Tax deFURRED” investing. Your use of cat pictures was cute, deceptive, and brilliant to keep me reading. Dang it.

alcie
alcie
9 years ago

This article is great, and the nuts and bolts of planning for money in retirement is helpful. I always learn something new from Robert’s articles. However, I would be curious for more information on investing outside of tax-advantaged accounts, especially in light of potentially providing income for the 45-67 age group. I know lots of people, family and family friends, who were laid off as older workers. These folks had no intention of retiring at that age, but were unable to find jobs at all or at greatly reduced salaries over the longer term (10+ yrs). Ageism is alive and… Read more »

Bob from Option Strategies
Bob from Option Strategies
9 years ago

I’m still fuzzy about how to decide between an IRA and a Roth IRA, at least for new money. Say you’re rolling over a large 401K when leaving an employer after many years. Go with the Roth, and you take an immediate tax hit. The hope is that you’ll eventually make it up by paying no tax on withdrawal. The IRA is the opposite case. Immediate savings, followed by (one hopes) large compounded gains, eventually taxed at normal rates. I’m still perplexed about which way to go.

Thanks for an extraordinary article.

Carey
Carey
9 years ago

There are actually two questions here: 1. Do I choose a tax deferred (such as 401k or traditional IRA) or after tax (roth 401k or roth IRA) retirement account? The crux of the decision is whether you expect to be in a higher tax bracket now, or later. If now, you should defer the taxes until later. If later, you should tax the tax hit now. Of course in real life we can’t always predict what our taxes are going to be in the future. I take a middle of the road approach and try to put half in tax… Read more »

Bob from Option Strategies
Bob from Option Strategies
9 years ago

Thanks, Carey. As you say, it’s hard to know in advance what your tax bracket will be, or what the tax laws will be. I envy anyone who’s income will be higher after he stops work. For me, and I expect for most others, instinct says to hold on to as much now as you can, so go with IRA. The biggest assumptions may be what the rate of return on your investments will be, and the frequency and size of your distributions. My bottom line is that it’s a coin toss.

Carey
Carey
9 years ago

I should mention there are some other considerations in regard to a Roth IRA. For example, you can withdraw all your Roth contributions at any time without penalty. With a rollover, I believe the entire balance is considered contributions at first, so only growth after the rollover would be off limits. Personally, I plan to keep my grubby hands off my Roth until retirement anyway, but, again, it’s hard to predict what will happen in the future. I like the idea of having additional flexibility.

Bob from Option Strategies
Bob from Option Strategies
9 years ago

I like the Roth flexibility as well. But having worked decades to amass a 401K, I hate to see so much of it lost to taxes immediately. With an IRA, there’s the hope that your compounded returns on the money you keep at first will be enough to compensate for the extra taxes later. Of course, that’s a big if. I just did a little spreadsheet exercise: start with a lump sum, compound at 6.7% annually (the average 20th century stock return) for 10 years, then take 1/3 for tax at the end; start with a lump sum less 1/3… Read more »

Steve
Steve
9 years ago

If the result was 1% higher with a Roth, you made a mistake in your calculation somewhere.

BrentABQ
BrentABQ
8 years ago

This is likely a bad way of calculating your end results. 1/3 for tax is your incorrect assumption. This should be the marginal tax rate at retirement and the marginal tax rate today. If you only have roth deductions in retirement your marginal rate is 0%! If you only have 401K income it is likely 15% to 28% (unless you are retiring in style). The best option is to get a little bit of both so you’re retirement income stays in a tax bracket that is still less than now. (even with tax code changes)

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