Intern with custodial accounts looking for help with retirement investments

[scooty]

Good afternoon all, I am a total newbie when it comes to investing and have only been reading for a week now so I would greatly, greatly appreciate any advice you all have for me!

Emergency funds: I have this
Debt: No debt
Tax Filing Status: Single
Tax Rate: 25% Federal, 9.3% CA
Age: 26
Desired Asset allocation: 80% stocks / 20% bonds
Desired International allocation: 30% of stocks (?Not sure about this)

I am a new resident physician just starting out with an annual income 51k, emergency fund in the bank, and I just found out I have ~120k in taxable mutual funds with high ERs (0.56-0.99%) from custodial accounts outside Vanguard that I would like to liquidate completely to reinvest into low cost Vanguard funds. I figured I’d withdraw the entire amount immediately (rather than portions) because my capital gains tax rates will stay the same at 15% federal and 9.3% state with my income of 51k (at least that’s how I understand it).

I am trying to maximize on Roth contributions while in Residency for the next 6 years while I still can. I am planning to re-invest the cash from the custodial account into a Roth IRA as well as a Roth 403b (with low-cost index Vanguard funds) for the remainder of this year and the next coming year.

I am trying to max out the 403b contributions this academic year as much as possible because the next institution I attend in July 2018 only offers a 457 with a single investment option with returns of 1.1% and expense-ratio of 1.2%. I don’t believe I will contribute any more than the mandatory 4.5% with matching 3% to this 457 at my next institution. Therefore, I’d rather invest the cash from the custodial account into a taxable account than save it to invest in my future 457. This is because I think I can expect higher returns with a taxable account that will justify not investing in a tax-deferred account. Unless there is another option for me that I don’t know of?

Therefore, based on my preliminary calculations, leaving some cash from the custodial accounts aside to pay taxes and supplement my income while I try to max my 403b contributions, I should have:

 

My planned contributions 2017-2018

-Roth 403b at Vanguard (will not be able to contribute to after July 2018)

-13.2k for remainder of 2017

-18k to max out before July 2018

 

Roth IRA at Vanguard

- 5.5k yearly for 6 years

 

Taxable account at Vanguard (for retirement)

- 70k to invest right now

 

457 at future employer starting July 2018

- mandatory 4.5% with matching 3% (~4.3k) yearly for 5 years

 

Available funds

Low-cost index funds available in my Roth 403b at Vanguard:

Domestic stocks

- Vanguard Institutional Total Stock Market Index Fund Institutional Plus Shares (VITPX) (0.02%)

- Vanguard Value Index Fund Institutional Shares (VIVIX) (0.05%)

- Vanguard FTSE Social Index Fund Institutional Shares (VFTNX) (0.12%)

Bonds

- Vanguard Total Bond Market Index Fund Institutional Plus Shares (VBMPX) (0.03%)

 

My planned assets by the end of year 2017

Taxable at Vanguard (79%) ~70k

-55% Vanguard Total Stock Market Index Fund Admiral Shares (VTSAX) (0.04%)

-24% Vanguard Total International Stock Index Fund Admiral Shares (VTIAX) (0.11%)

 

Roth 403b (15%) – 13.2k

-1% Vanguard Institutional Total Stock Market Index Fund Institutional Plus Shares (VITPX) (0.02%)

-14% Vanguard Total Bond Market Index Fund Institutional Plus Shares (VBMPX) (0.03%)

 

Roth IRA (6%) – 5.5k

- 6% Vanguard Total Bond Market Index Fund Investor Shares (VBMFX) (0.15%)

 

Questions:
1. I am really lucky to be in this situation in that my parents have given me this custodial account, I don’t have any student loans, and I have a stable job prospect. I’d really like to start my retirement savings off on the right foot. Does my short-term plan for liquidating the custodial mutual funds to reinvest in my upcoming contributions, as detailed above, make sense?

2. Is my asset allocation of 80% stock/ 20% bond bordering on conservative for my situation or is this perfectly reasonable? I understand it’s hard to say since you’re not me. I am wondering if I can be more aggressive because my investments are purely for retirement for now and I plan to rebalance annually no matter what. On the other hand, while I could afford to take the risk in investing in more stocks, I’m not sure I have the need to take more risk if I have good job security. Also, is having 30% of my stocks being international reasonable?

3. I’d like to make a three-fund portfolio that is distributed tax-efficiently across my Roth and taxable accounts that also takes into account the fact that I won’t be able to contribute to my 403b after I change institutions. I’ve planned it out based on what I’ve read from the asset allocation guide across multiple accounts. Does my planned asset allocation for this year make sense in terms of tax efficiency and easy rebalancing? Is there anything I could do better? Perhaps add another fund for another type of bond for a 4-fund portfolio?

[ajm184]

Thorough post.  Others will probably answer in better detail.  Here are my thoughts:

a. The taxable custodial account from your parents.  I would be absolutely sure (i.e. check with a CPA type) before liquidating and moving.  Not saying its a bad idea, but you will want to make absolutely sure there are no additional tax implications beyond the LT tax rate before executing.

b. Asset allocation seems reasonable in terms of stock vs. bond split.  Though I would be more aggressive, at the end of the day, you need to be comfortable. As you have no debt, contain lifestyle creep and save aggressively you are well ahead of most and can therefore have the option to be more or less conservative than stated.  30% being international is reasonable, though be aware that equity capitalization is split roughly 52% US and 48% Rest of World.  Also, international has not performed as well as the US over the last several years, and there is opportunity for better performance vs US.

c.  Only thing that stands out to me is the Bond fund in your Roth IRA.  My approach is to be as aggressive as possible with non-taxable (already taxed) retirement accounts, therefore I would either have a Total Stock or Total International Stock in this type of account.  Also guessing at some point your 403B will become a such a small portion of your overall retirement assets, that it would be consolidated to a single fund.  You could purchase an international bond fund, though something to consider later as you build retirement assets.

 

[scooty]

ajm184 wrote:

Thorough post.  Others will probably answer in better detail.  Here are my thoughts:

a. The taxable custodial account from your parents.  I would be absolutely sure (i.e. check with a CPA type) before liquidating and moving.  Not saying its a bad idea, but you will want to make absolutely sure there are no additional tax implications beyond the LT tax rate before executing.

b. Asset allocation seems reasonable in terms of stock vs. bond split.  Though I would be more aggressive, at the end of the day, you need to be comfortable. As you have no debt, contain lifestyle creep and save aggressively you are well ahead of most and can therefore have the option to be more or less conservative than stated.  30% being international is reasonable, though be aware that equity capitalization is split roughly 52% US and 48% Rest of World.  Also, international has not performed as well as the US over the last several years, and there is opportunity for better performance vs US.

c.  Only thing that stands out to me is the Bond fund in your Roth IRA.  My approach is to be as aggressive as possible with non-taxable (already taxed) retirement accounts, therefore I would either have a Total Stock or Total International Stock in this type of account.  Also guessing at some point your 403B will become a such a small portion of your overall retirement assets, that it would be consolidated to a single fund.  You could purchase an international bond fund, though something to consider later as you build retirement assets.

 

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Thank you very much for your response!

a. Will do my research before executing!

b. I was also thinking along the same line that international could do better eventually, but didn't want to put too much into international just yet, so 30% seemed reasonable to me.

c. I'm a little confused about how to calculate the advantage of placing total bond market shares into a taxable account over a Roth. I know WCI had an article on playing bonds into taxable accounts, but in his example he used muni bonds, not total bonds. The math says that at my 25% fed+ 9.3% CA tax bracket Vanguard's muni bond index fund would be more tax-efficient in a taxable account. But I am still a bit hesitant to use Vanguards muni bond index fund because of the risk of defaulting. Do you have any thoughts about using muni bonds only or maybe 50/50 total bond/muni bond?

[ajm184]

Other folks may have different views regarding a bond fund in a Roth IRA versus either tax-deferred or taxable retirement savings; mine is that you embrace as much risk as you are comfortable having in a Roth IRA within the overall asset allocation constraints.  VBTLX would be the bond fund to consider for the taxable/tax deferred area of retirement savings.

I see zero reason to have muni bond within a Roth IRA, you are taking the entire tax advantage off the table using a muni bond fund in a Roth IRA.  I can see using a CA muni bond fund as part of an emergency fund/portfolio (to avoid Fed/State taxes), say VCIAX or VCITC when you are more established/in a higher tax bracket.  In the 25% marginal tax bracket, I would be skeptical of having a muni bond fund at all.  Muni bonds yields target folks in higher marginal tax brackets (33% +). Default risk is not unheard of, but is fairly rare in the Muni space (despite the best efforts of lawmakers in California and Illinois to the contrary).  Perhaps the default risk story will again be more prominent when governmental units have to report to the same standards as publicly held companies, but don't hold your breath.

[scooty]

ajm184 wrote:

Other folks may have different views regarding a bond fund in a Roth IRA versus either tax-deferred or taxable retirement savings; mine is that you embrace as much risk as you are comfortable having in a Roth IRA within the overall asset allocation constraints.  VBTLX would be the bond fund to consider for the taxable/tax deferred area of retirement savings.

I see zero reason to have muni bond within a Roth IRA, you are taking the entire tax advantage off the table using a muni bond fund in a Roth IRA.  I can see using a CA muni bond fund as part of an emergency fund/portfolio (to avoid Fed/State taxes), say VCIAX or VCITC when you are more established/in a higher tax bracket.  In the 25% marginal tax bracket, I would be skeptical of having a muni bond fund at all.  Muni bonds yields target folks in higher marginal tax brackets (33% +). Default risk is not unheard of, but is fairly rare in the Muni space (despite the best efforts of lawmakers in California and Illinois to the contrary).  Perhaps the default risk story will again be more prominent when governmental units have to report to the same standards as publicly held companies, but don’t hold your breath.

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Oh yea I get why I wouldn't put a muni bond in a Roth IRA, but I was wondering why one wouldn't use a muni bond instead of total bond index in a taxable account at even the 25% tax bracket. VBMFX and VCAIX seem to have similar returns over the last 10 years and VCAIX even better more recently. It seems like the taxable equivalent yield of a california muni bond is already higher than the returns of total bond index funds. Is it a matter of keeping bonds more diversified for the long-run?

[ajm184]

For a taxable account, at a 25% tax rate, a muni is usually less compelling, all thing being equal.  As an issuer of a muni bond, they want to have the right mix of amount (not all muni have fed/state tax exclusion to buyers), rate to attract buyers, low rate to make it feasible to the muni bond purpose, plus other factors.  One of the ways the two rate objectives can be balanced (if you have fed/state tax exclusion) is to price the bonds in a way that targets certain people based upon the buyer's tax rate.  Based on the current interest rate environment, bond size, term, and rating, insurance, collateral or specific revenue streams and other factors, both muni and taxable bonds are priced (yield set).

A very simple example, two bonds issued on the same day, in the same amount ($100 million) with the same maturity date, credit rated the the same, with similar collateralization.  One is a large US manufacturer of widgets, the other is the State of California building a high speed train .  The US company's bond has a yield of 6%, and the State of California has a yield of 3.5%.  The question for a potential investor becomes, which is best return given my tax rate?  At a 25% tax rate in California, the rate I as an investor needs to be at or above 3.942% (6% - (6% * (25% Fed Tax + 9.3% State Tax)) otherwise the 6% widget bond makes more sense, at 28%; 3.762%, at 31%; 3.582%, at 33%; 3.462%, at 35%; 3.342%, at 39.6%; 3.066%. The question for the issuer is, what is a least price (yield) I can offer to sell this entire bond?  With feedback from the issuer underwriting (BoA, JPM, WFC) at 3.5% it is appealing to different degrees for folks in 33%, 35, and 39.6% federal tax bracket, and will likely attract some customers in the 31% tax bracket.

[scooty]

Ok so clearly I am a novice because I was looking at the average annual returns, not the SEC yields, when I was comparing total bond market index funds and municipal bonds. The returns for municipal bonds seemed higher so it was confusing to understand why I wouldn't choose them even at my relatively lower tax bracket. Now that I am looking at yields it makes a lot more sense why you're saying that I should choose taxable total bonds for my taxable account for the time being.

Is my understanding more complete now or am I still missing something? Thanks for running through this with me!

[ajm184]

Not sure of the difference between average return versus SEC yield.  Perhaps it is related to a bond fund purchasing certain bonds for a premium or discount, thereby changing the overall return characteristics.  Also understand that a bond fund is made up to a large number of individual bonds.  When your income/marginal tax rate is higher, then look again at a muni bond fund.