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Asset location considerations when rebalancing

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  • Asset location considerations when rebalancing

    I've searched the forums and web to see if people take asset location into account when rebalancing and haven't found much. It seems to me that tax free accounts should be weighted more heavily since 100% of the account and earnings will yours. For someone in the highest marginal tax bracket currently, would it be reasonable to only include a certain percentage of tax deferred accounts (401k) or even taxable accounts when calculating total assets for rebalancing purposes...and if so what percentage? Or is this just making things overly complex, particularly since the majority of my portfolio will be in 401k and taxable? Thanks!

  • #2
    IMO, you're overcomplicating it. Choose your desired asset allocation and rebalancing frequency and stick to it.

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    • #3
      This is called tax adjusting. It's been extensively covered at BH, wiki page, etc.
      Basically no one does it as not worth the hassle.

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    • #4
      I actually did start tax adjusting this year. Not terribly hard but you probably want to set up a spreadsheet for it.
      “Work” is a four letter word for good reason.

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      • #5
        Learning how to master Excel spreadsheets has been one of the best things for my personal finance management game I actually look forward to rebalancing in a nerdy kind of way.

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        • #6
          Appears you are asking two questions:
          a. Do you take consider asset location (taxable, tax-deferred, tax-free) into consideration when rebalancing a portfolio? Yes, I do as I consider my overall retirement portfolio in aggregate. Other folks may have a different AA per retirement account.
          b. Do you consider taxes when it comes to AA and/or re-balancing decisions understanding OP is in highest tax-bracket? No. I do consider the impact of taxes upon my projected withdraw rate relative to current retirement assets with differing tax implication(s). I also 'project' retirement asset returns/ additional contributions, including taxes (federal/state/LTCG [for taxable]).

          Given OP is currently in highest tax bracket and depending upon retirement assets, and potential RMD requirements, IMO understanding potential withdrawal strategies relative to taxes would be something to work upon.

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          • #7
            Originally posted by Lithium View Post
            I actually did start tax adjusting this year. Not terribly hard but you probably want to set up a spreadsheet for it.
            I have a spreadsheet and it wouldn't be too hard to do. What percent do you assign tax deferred or taxable holdings, assuming tax free is 100%? Thanks.

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            • #8
              Originally posted by NinjaDoc View Post

              I have a spreadsheet and it wouldn't be too hard to do. What percent do you assign tax deferred or taxable holdings, assuming tax free is 100%? Thanks.
              For tax deferred I estimate effective tax rate at retirement, federal and state. So if it is 15%, a mutual fund with $100k in it gets reduced to $85k.

              For taxable I am for now assuming 15% LTCG. But then I add my state tax on top of this (your state may be different). However this is a little more difficult to set up correctly in the spreadsheet because you have to plug in the cost basis and make sure it is only the gains that are taxed.
              “Work” is a four letter word for good reason.

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              • #9
                Originally posted by Lithium View Post

                For tax deferred I estimate effective tax rate at retirement, federal and state. So if it is 15%, a mutual fund with $100k in it gets reduced to $85k.

                For taxable I am for now assuming 15% LTCG. But then I add my state tax on top of this (your state may be different). However this is a little more difficult to set up correctly in the spreadsheet because you have to plug in the cost basis and make sure it is only the gains that are taxed.

                That's very helpful, thanks. It confused me a little because I read WCI saying your 401k is only 2/3 "yours" and 1/3 the government's (based on 33% tax when contributing?) but I feel like it should 85% yours (based on your mentioned anticipated withdrawal rate).

                My Roth IRA is probably not worth tax adjusting for since it'll be a small portion of my overall retirement and won't make a big difference. Just throw some total market index in there and realize that my portfolio will be slightly weighted towards that. I'll have to decide if want to try to tax adjust the gains on my taxable account....but leaning towards no based on complexity and hopefully not having too much gains to deal with if I manage things correctly.

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                • #10
                  It all depends on your spending. If you are going to FIRE and live on 50K a year then you will be paying so little tax that it will not matter much.
                  If you are Fat FIRE and spending 300K a year then yes taxes will cut deep.

                  You also have to make a lot of assumptions to what the tax rates will be when you retire. Kind of hard to predict 20-30 years down the road.

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                  • #11
                    I know 15% sounds really low but if you run a scenario with tax software using MFJ and 24k standard deduction, you might be surprised how much ordinary income it takes to get to that effective (not marginal) tax rate.

                    for now I calculate the effective tax rate on 3% of my portfolio size as a worst case scenario, should I begin drawing down my savings without accumulating anything more.
                    “Work” is a four letter word for good reason.

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