Q. I recently retired at 55. My wife is 52. Our family has about $2 million in taxable accounts and another $1.5 million in non-taxable retirement accounts. I have no source of income other than the dividends and capital gains distribution from the mutual funds we hold, all of which are index funds.
As we accumulated assets, we followed the standard advice of putting our bond funds in our non-taxable account (currently about 80 percent bonds) and equity funds in our taxable accounts (currently about 90 percent equity). The overall allocation of our entire portfolio is 60/40 stock/bond.
Your book "Spend "Til the End" got me to thinking about my allocation within these accounts. I do not plan to draw Social Security until I am 70. I also don’t plan to touch the non-taxable accounts until then. I think we can live comfortably for the next 15 years off our taxable account assets.
At today's tax rates— and assuming that they are only going to go higher— do you think that it would be prudent for me to switch my non-taxable accounts to 60/40 or more stock/bond allocation today and slowly change over a period of the next several years the allocation in my taxable account to say 60/40 or more bond/stock? —Y.L., by email
A. You’ve got pretty wild over-weighting in both kinds of accounts. To be sure, overweighting equities in taxable accounts is beneficial, as is overweighting fixed income in qualified retirement accounts, but having such extreme allocations can create trouble for you as you switch from accumulating to distributing.
Here’s the problem. Unless you live very, very modestly, you’ll have a very high withdrawal rate from your taxable account. The consequence is that a bad year could put that portfolio into a death spiral, forcing you to change your plans.
Another issue is very long term. If you build your qualified account excessively, you could be putting yourself into a forced high tax rate position after you reach age 70 1/2 and take required minimum distributions.
A better route is to take distributions in a way that produces regular income, but also moderates your tax rate. You could, for instance, take about $95,000 a year from your qualified accounts and not pay taxes at a higher rate than 15 percent. That’s about as good as it gets. Income from the taxable accounts, if in stocks, would also be taxed at 15 percent (the rate on dividends and capital gains).
There is no final calculus for this because we don’t know the future. But if we look for taxes in moderation, the best path would appear to be a mix of distributions from both types of accounts.
To avoid having to sell equities in a bear market, it would be good to have more bonds in the taxable account. A 25 percent bond allocation, for instance, would cover about 5 years of withdrawals, if you were using a 5 percent rate. It would cover longer at a lower withdrawal rate.
Q. We are looking for a decent savings program to invest for our new grandson. We are aware of the 529 college funds and plan to max that out. But we would also like to add a bit more in some other way. I recently read about, and am aware of, the pitfalls of this program. My question is: Are EE Savings Bonds or I Bonds still a viable option? Or is there something better? —W.A., Cedar Rapids, Iowa
A. Currently, you’d be better off in I Bonds than EE bonds. I Bonds are yielding 0.10 percent plus adjustment for inflation. EE bonds are yielding just 0.10 percent— without adjustment for inflation. Big difference.
Still, neither has a chance of keeping up with education inflation. So you’ll need to look for an alternative with risk, such as an exchange-traded fund (ETF) that invests in the total U.S. Stock market. These funds are very tax-efficient and low-cost. Schwab (ticker: SCHB), iShares (ticker ITOT), and Vanguard (ticker: VTI) all offer such exchange traded funds.