Introduction
Tax considerations related to investing sure would be easier if we knew what future tax policy would be. Current low income tax rates and exploding government spending points to higher rates coming making contributions or conversions today to Roths attractive, maybe. I say that because age and income come into play. If you have the choice between pre-tax contributions versus after-tax ones, avoiding Medicare premium bumps comes into play for those over 63. Investors need to keep in mind the income used is from two years prior to when you or your spouse enrolls in Medicare. While tax rates primarily are going up, your retired income might drop enough, resulting in your marginal income rate not increasing much. Avoiding RMDs helps on that account and that is where Roth’s help compared to IRAs or pre-tax 401k accounts.
My wife and I both have a Roth IRA and I still have a 401k Roth with my former employer. Combined, they represent a decent percent of our Net Worth. We also have my work 401k, two regular IRAs and one inherited IRA that currently has us taking an RMD. A recent tax law change means the other IRAs won’t require distributions until we reach 72 and there is talk that Congress might move that to 75. That would benefit investors by giving them longer to do IRA-to-Roth conversions.
All data below is from March 31, 2021. Our current situation indicates we should not have to touch our Roth IRAs during our lifetime. That fact helps drive the investment strategy used by each account. Also, having many accounts, the total asset allocation comes into play and thus exposure to every asset class or segment isn't required in each account.
My wife’s Roth IRA investments and strategy
The current allocation is 70% Equity, 18% Fixed Income, and 12% Cash. The account earned $830 in dividends and $1380 in interest for the quarter, resulting in a 2.87% portfolio yield.
This account has our highest equity allocation with the plan of pushing that to 75% by the end of the year, if not sooner if we see a 5-8% market pullback. The equity choices here, or more importantly, the ones missing, reflect the fact each accounts' holdings should not be evaluated in isolation. There are no broad equity funds or even US exposure above Small-Cap stocks. International equity exposure is only in Emerging Markets. All of our EM exposure is in this account as is our Micro-Cap exposure. That, along with the high equity ratio, make this also our most aggressively invested account. Partially offsetting that, is the majority of the fixed income assets have maturity dates or highly likely to be called in the next few years. This minimizes the damage done as interest rates rise and represent a large part of our Fixed Income Ladder. It was just announced that the PRIF.PB is being called.
A new part of this account's strategy will be getting more funding via conversions from my wife's non-inherited IRA before she turns 72. After that, I will restart on 401k-to-Roth 401k conversions.
My Roth IRA investments and strategy
I did not provide the asset allocation percents for this account as they would not apply well based on the main strategy I use here. This is the main account I use for writing Cash-Secured Puts, thus the large amount of cash you see. The Put options currently require $111,000 in cash to be held. The annualize ROI generated by option premiums in the first quarter was 12.5%. I suspect that will be down going forward unless volatility comes back like it was in late 2020 when most of the first quarter options were written. My plan is to roll most of the term fixed income assets into equities as they mature or get called by writing ITM Puts using some of the ETFs that have active option markets.
I find option writing fun, but it has come at a cost. With cash making my account less aggressive, since I restarted writing option in July 2019, my Roth account has grown 24% versus my wife's 37%. About 2% of that change for both accounts was from contributions.
You might have noticed both accounts have a small position in DWSH. This is an ETF that shorts individual stocks and has a negative correlation to equities. This was added to smooth out down market effects and did very well when the panic crushed the market in March 2020. It has stunk since and only these small exposures remain.
My Roth 401k investments and strategy
This account is the bedrock of our retirement plan. While working, I was very aggressive in my 401k allocation and I "maxed out" my annual contributions, resulting in the total plan representing a large part of our net worth. The Roth segment is a small part of the overall 401k as the company delayed offering it.
Right now, the strategy for this account is driven by three factors:
- The Stable Value asset is only available in 401k plans. Its current yield is 2.2%. That will float up as interest rates increase.
- The allocation is tied to the regular 401k account and any allocation shift in one effects both types.
- Each conversion I make from the 401k to the Roth 401k slightly alters the allocation as they do not match because of account funding done after the Roth option became available.
I have about $40,000 in After-Tax contributions I want to move into the Roth option and then convert that part into a Roth IRA before RMDs commence in 2027. This conversion is on hold while I convert my wife's IRA over to her Roth, otherwise we could break the lowest IRMMA limit. At that time, without access to the Stable Value fund, most of those funds will be allocated to equity investments. I haven’t decided two things related to my 401k:
- Whether to convert some Pre-Tax funds to the Roth option. This will be based on marginal tax rate projections after 2024.
- Whether to roll some or all the remaining funds to a regular IRA. A complete move would mean no more Stable Value fund, my main SWAN asset that allows for taking greater risks elsewhere. There are other concerns and benefits to consider too.
Portfolio Strategy
As readers can tell from this article, investment strategies can vary by account, but investors need to have an overall comprehensive financial plan. Note I said financial, not investment plan; that is critical. Here are some items that could be in your financial plan:
- Live within your means so you can retire on your time schedule.
- If you do not have a pension, consider annuities for guaranteed income.
- If you have a pension, consider adding term insurance if your pension doesn’t come with adequate spousal payments.
- Consider funding a Donor Advised Fund while working so you can continue your charity giving in retirement at the same level as you did while employed.
- Know your acceptable risk level and invest accordingly. Keep in mind this could alter as you age and net worth changes.
- Along with your investment asset diversity, having different accounts based on their tax properties is wise as future tax policies are unpredictable.
Final Thought
No one has a crystal ball so we make investment decisions based on our best guesses. The more we know, the better we can plan for the unknown. As you approach retirement age, part of your plan should be estimating the size of your pending RMDs. For most of us, once we start Social Security, we should be able to closely estimate what our annual income will be; then the RMDs kick in. Knowing how much they will be helps you decide if actions today to reduce those RMDs are warranted. If you plan on avoiding the taxman via QCDs, which can replace RMDs, then doing actions today might not be required.
For those contemplating Roth conversions, a recent article covered the topic.
