Pre-tax assets messing up my asset allocation percentages.. pls help!

Submitted by ToothPicker2 t3_12707zn in personalfinance

My dad’s current asset allocations are as follows:

VT (tIRA, brokerage) - $119546

401k (VTSAX+VTMGX)- $41794

(Total $161340) 57%

BNDW (tIRA, brokerage) - $53520

ibonds - $40000

Savings Ac - $27510

(Total $121030) 43%

It seems, however, that my calculated allocation percentages are wrong because the assets in the 401k and IRA are pre-tax.

How do I correct this? I understand that I need to consider the post-tax figures for the retirement accounts but how do I know what his tax rate will be in retirement?

FWIW, he’s currently 66, earns 95k pa, files jointly, and his federal tax rate is 12% and a Michigan flat tax rate of 4.25%.

Once he retires (probably at 70?), his only income will be SS (estimated around $3400 for himself and 50% for his wife (she’s never worked) - $1700.

Based on all of this, can someone help to estimate his retirement tax rate so I can accordingly correct the asset allocation percentages?

TIA!

P.S. I know some people are saying not to bother with this but I remember one of the redditors on this sub saying “something to keep in mind is that after-tax and before-tax dollars are not equal. If it is a traditional 401k then there are still income taxes to be paid. That might change what the actual split is when compare on an after tax basis.”

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nkyguy1988 t1_jebvnq5 wrote

Tax rate is irrelevant. Just look at the dollars in the account and allocate accordingly. Don't overthink it.

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ToothPicker2 OP t1_jebzn4v wrote

But how can we compare apples to oranges? The non-retirement account assets are POST-TAX, and the retirement account assets are PRE-TAX.

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Werewolfdad t1_jec08js wrote

You don’t. He doesn’t have anywhere close to enough money to bother with this much granularity

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nkyguy1988 t1_jec1bef wrote

There's literally zero need. You are looking for a solution to a problem that doesn't exist.

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ToothPicker2 OP t1_jec2oie wrote

Someone yesterday said: something to keep in mind is that after-tax and before-tax dollars are not equal. If it is a traditional 401k then there are still income taxes to be paid. That might change what the actual split is when compare on an after tax basis.

Which is why I asked.

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nkyguy1988 t1_jec38q1 wrote

That's true, but not when it comes to asset allocation. You get around it by doing the same split in each type.

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ToothPicker2 OP t1_jed5m2q wrote

I’m not sure what you’re saying. Split and asset allocation mean the same thing right?

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nkyguy1988 t1_jed6b61 wrote

Yes. If you use 2 funds, buy the same funds in identical proportions in each tax status.

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ToothPicker2 OP t1_jed716t wrote

Yeah and that’s very difficult to do, because my funds are spread out all over in different quantities and proportions, so I can’t just consider the pre-tax assets and post-tax assets equal to reach my asset allocation, ratio right?

Ok let me explain in the most basic way:

Assume I have $100 to invest and I split it between VTI and BND in a 60:40 ratio ($60 in VTI and $40 in BND), so my asset allocation is 60:40.

Now, assume the VTI sits in a tax-advantaged account like a 401k or IRA, and the $40 of BND is in a taxable brokerage, so that $60 is actually pre-tax dollars, while the $40 is post-tax dollars.

If I assume my tax rate in retirement would be 10%, the $60 of VT is effectively $54 of assets I own.

So my actual asset allocation is $54:$40 or 57:43.

That’s what I’m trying to say.

Ok let me explain in the most basic way:

Assume I have $100 to invest and I split it between VTI and BND in a 60:40 ratio ($60 in VTI and $40 in BND), so my asset allocation is 60:40.

Now, assume the VTI sits in a tax-advantaged account like a 401k or IRA, and the $40 of BND is in a taxable brokerage, so that $60 is actually pre-tax dollars, while the $40 is post-tax dollars.

If I assume my tax rate in retirement would be 10%, the $60 of VT is effectively $54 of assets I own.

So my actual asset allocation is $54:$40 or 57:43.

That’s what I’m trying to say.

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nkyguy1988 t1_jed8bmx wrote

You run 60/40 in taxable and 60/40 in IRA/401k. Problem solved

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ToothPicker2 OP t1_jed8hp6 wrote

That would require a lot of buying and selling, for example - I’m 100% stocks in 401k.. which is why I’m wondering is it important?

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nkyguy1988 t1_jed99ej wrote

It costs nothing and is tax blind in a 401k. Literally can change allocations in about 3 minutes.

It's not important because the differences are minimal in the grand scheme of things.

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ToothPicker2 OP t1_jedak3n wrote

It’s tax blind in the 401k and IRA but would trigger taxable events in the brokerage right?

Besides, it would go against the ideology of putting maxing out bonds in tax advantage accounts right?

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Werewolfdad t1_jebv977 wrote

What does his tax rate have to do with his asset allocation?

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ToothPicker2 OP t1_jebzgym wrote

If he has say $100k of equity in his traditional IRA, and his tax rate in retirement is 10%, the above equity amount is effectively $90k needed for calculating his current asset allocation, no?

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Werewolfdad t1_jec0282 wrote

No because you can manage your tax rate and tax rates change

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ToothPicker2 OP t1_jec04a2 wrote

What does that mean?

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Werewolfdad t1_jec09gd wrote

It means you’re wasting your time

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ToothPicker2 OP t1_jec2pdf wrote

Someone yesterday said: something to keep in mind is that after-tax and before-tax dollars are not equal. If it is a traditional 401k then there are still income taxes to be paid. That might change what the actual split is when compare on an after tax basis.

Which is why I asked.

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Werewolfdad t1_jec37zn wrote

Sure but I don’t see how that relates to asset allocation

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ToothPicker2 OP t1_jed5nqs wrote

Isn’t split and asset allocation the same thing? Or am I missing something?

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Werewolfdad t1_jed5xiu wrote

No

Asset allocation is what sort of assets you own.

I don’t actually understand what you’re asking for at this point

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ToothPicker2 OP t1_jed6pvj wrote

Ok let me explain in the most basic way:

Assume I have $100 to invest and I split it between VTI and BND in a 60:40 ratio ($60 in VTI and $40 in BND), so my asset allocation is 60:40.

Now, assume the VTI sits in a tax-advantaged account like a 401k or IRA, and the $40 of BND is in a taxable brokerage, so that $60 is actually pre-tax dollars, while the $40 is post-tax dollars.

If I assume my tax rate in retirement would be 10%, the $60 of VT is effectively $54 of assets I own.

So my actual asset allocation is $54:$40 or 57:43.

That’s what I’m trying to say.

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Werewolfdad t1_jed82oe wrote

Read the tax efficient asset allocation at the bottom of the following link

Start here: https://www.reddit.com/r/personalfinance/wiki/commontopics

> So my actual asset allocation is $54:$40 or 57:43.

And this is wrong. It’s not. A traditional account doesn’t get a discount.

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ToothPicker2 OP t1_jed8oc7 wrote

I’m aware about tax efficient asset allocation, where bonds must go into tax advantaged accounts rather than a brokerage, etc etc.. that’s not what I’m asking.

A traditional IRA is pre tax dollars, right? So when we calculate the total ratio, all the assets must be considered post-tax right? So how’s it wrong?

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Werewolfdad t1_jedaen4 wrote

> A traditional IRA is pre tax dollars, right? So when we calculate the total ratio, all the assets must be considered post-tax right? So how’s it wrong?

Because it’s not a consideration because he can withdraw it all and have a large tax liability or withdraw none of it and have no tax liability.

Plus he doesn’t have enough money to put this much effort into a few percentage points of assets or way or the other

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smugbug23 t1_jecurl0 wrote

His total financial assets are 282,000, and since he is already so close to 70 I would assume he isn't going to save a lot more before then, and the pile won't grow very much more in the market by then either. At a 4% safe withdrawal rate, he can only take out about $11,000 a year to augment his SS (he doesn't have to follow the 4% SWR of course, but we need to make some starting assumption if we want to get an answer). Even if all of that were taxable income (it wouldn't be, as some would presumably come from savings or from principal of I-bonds) it would be below the standard deduction, so the tax rate on it would be zero.

So even if you wanted to take the tax rate into account, being zero you still wouldn't need to take it into account. The advice to worry about this would mostly only apply to wealthier people.

By my calculation, he would need to be taking about $20,000 in taxable income out a year before he would start to pay federal income taxes. At that point, the marginal rate would be 18.5%. (The taxable dollars themselves would be taxed at 10%, plus each one would cause 85 cents of SS benefits to move from untaxed to taxed.)

That is for federal taxes. My understanding for MI, $11000 in taxable withdrawals would put him just past the point where it exceeds the MI standard deduction for married, and so would start being taxed at 4.25%. But the legislature is still in session, so...

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ToothPicker2 OP t1_jed47p4 wrote

Oh wow, wait… so you’re saying he wouldn’t pay any tax in retirement if his only income is SS + 4% or less withdrawals from the retirement accounts?

Just making sure.. SS for him would be ~$3400/mo, wife would be $1700, and 4% withdrawal is another $1kish a month. Is it really under the standard deduction amount making the whole thing tax free essentially?

So if that’s true, even the traditional IRA or 401k withdrawals will forever be withdrawn tax free if the above withdrawal pattern is followed?

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