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Structuring Assets in a Portfolio



March 22, 2013 – Comments (0)

Board: Macro Economics

Author: WendyBG

The METAR Board is dedicated to ensuring that each member has the maximum money available when needed. This is complex, since non-retirement accounts, retirement accounts, and other cash streams (such as annuities, insurance, pensions and Social Security) are all taxed differently.

Other assets, such as real estate, are even more complex because a primary residence has different costs if rented vs. owned, as well as different treatment in various situations (e.g. bankruptcy, evaluating assets for Medicaid, etc.) that differ by state. Non-primary-resident real estate is even more complex.

I would like to stick to financial assets in this post because that is simpler. Let's talk about real estate in a different post.

What is the best way to structure assets in a portfolio to maximize money over a lifetime?

Let's assume that tax law will stay the same regarding retirement accounts and dividend/ capital gain treatment.

There is an important benefit to holding a stock in a non-retirement account: capital loss in the non-retirement account can be carried over to subsequent years and subtracted from capital gains, reducing taxes.

Also, qualified dividends in a non-retirement account receive a lower tax rate. When the money is withdrawn from an IRA, it is taxed at the higher, ordinary income rate.

That is why I usually buy stocks in a non-retirement account. I buy bonds that I expect to hold to maturity in my IRAs, since the interest would be taxed as ordinary income in a non-retirement account.

I assume that taxes overall will rise because of the rise in government spending, especially entitlements. Because of this, I am gradually shifting assets from my Traditional IRA to my Roth IRA. I am paying current taxes in the expectation that future taxes would be higher. If the government reneges on the Roth promise and taxes the increase, I will be no worse off because I will have already paid taxes on the principal (of course I keep careful records).

I hope that many METARs will chime in with new ideas. So far, this is my thinking.

Non-retirement accounts -- stocks

I-Bonds are not in retirement accounts, but they act sort of like a retirement account because the interest is not taxed until the bond is cashed in. My I-Bonds pay 3% + inflation and mature in 2031 (when I would be age 78 if I live that long). I intend to hold them for their entire term because there is no way to replace them.

Retirement Accounts
Traditional IRA (this would include a 401(k) if I was still working). The money in the Traditional IRA has never been taxed. It will be taxed at the ordinary income rate when withdrawn. The law requires taxable Minimum Required Distributions beginning at age 70.5.

Roth IRA. The money contributed to the Roth IRA has been taxed. It will not be taxed when withdrawn and can be left indefinitely, which makes it a resource for old old age.

I have bonds in both the Traditional and Roth IRA. This is where I bought the TIPS in 2008. The considerable interest paid by these TIPS is thus tax-sheltered.

My husband has a whole-life insurance policy that he bought before we met (over 25 years ago). I'm not sure what use this is.

We do not have an annuity. I avoid variable annuities due to their high expenses. I could see a low-cost fixed annuity if real interest rates were high (as they were in 2007) since locking in a good fixed rate at low cost makes sense...if I thought my life expectancy would be significantly higher than 85 years...unlikely, since both my parents died slightly over age 70 and even my beloved Grandma only lived to age 89.

DH and I will need to carefully discuss when to begin Social Security. We can delay the age we begin. Like any annuity, the person who lives longest wins. It doesn't help to delay to get higher payments if you die before the payments expected longevity is an important factor. Our Social Security will easily cover our cost of living, especially once we are on Medicare in about 5 years. Currently, our highest household expense is health insurance.

DH and I don't have any children, so our intention would be to enjoy life as much as possible but not leave an inheritance. (Realistically, I would never spend down to zero because it would drive me crazy to be broke, let alone in debt.)

I won't talk about inheritance taxes because the situation is bound to change in the future.

If I was younger, I would maximize contributions to a 401(k) up to the employer's match, but probably not above because many 401(k)s have high hidden expenses. I would maximize contributions to a Roth IRA. I would save at least 20% of my gross income by automatic deduction from my paycheck. (This is what I did during my working life.) Needless to say, I would not carry consumer debt, but would pay all bills every month. (Mortgage debt is OK as long as PITI does not exceed 25% of gross income.)

I would live a top-down LBYM lifestyle, keeping the big expenses (house, car, education, etc.) low. I would also live a bottom-up LBYM lifestyle (keeping the small expenses low), but I would be flexible with this because a new set of watercolors, a new lipstick or a new jacket (especially when on sale) is a nice treat that won't break the bank.

I would keep an e-fund of at least 1 year's expenses in cash.

Please chime in, METARs, with your suggestions.

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