If you are not near or in retirement, you can skip this post. But whether or not you are near or in retirement you still might want to review what I wrote two months ago http://twocents.blogs.com/weblog/2009/03/a-modest-proposal-liquidate-iras-in-2009.html on the subject based on the fact that US taxes are going up in 2010.
Here's part of what I wrote about my IRAs two months ago: "...for someone in my position, the IRA is a looming tax obligation since every dollar coming out of an IRA account is taxable at ordinary income tax rates. So this modest proposal is a personal "diary entry" on my private blog which is totally non-commercial. This is only what I am thinking, and I am not recommending this to anyone else.......... The reasons for emptying [cashing in] a regular IRA in 2009 and/or in 2010 are 1. you're retired or may soon be; 2. taxes will be going up so you will pay more tax on IRA withdrawals later if you wait; 3. you will avoid tax bracket upwards creep due to the always increasing IRS-mandated Required Mandatory Distributions (RMD's) after age 70; 4. you want to avoid even the remote chance that private pensions could be nationalized; and 5. you want to take advantage of a one-time removal of limits on conversions to a Roth IRA and the two year tax payment option available in 2010."
Since I wrote this the Obama administration has vowed to repeal the one year Federal estate tax holiday for 2010, so I wouldn't be surprised if the 2010 one year Roth conversion tax advantages were also repealed since democrats hate Roth IRAs almost as much as they hate rich people and zero estate taxes. If so, the main remaining advantages to cashing out in 2009 are 1-4 above.
Further background is that I have 35% of my invested assets in tax-deferred accounts and 65% in fully taxable accounts. So the tax-deferred accounts are significant but not the whole banana. And I am not including Social Security payments received in this discussion, but one could conceivably capitalize them at 5% such that if you were to receive $25,000 per year from SS its estimated annuity value would be $500,000.
The disadvantages to cashing out your IRA in 2009 are paying a one time fairly high income tax rate and getting bumped into other various "tax the rich" traps affecting Social Security, Medicare parts B and D costs,etc. Fortunately we can wait until much later in the year to make the decision and see how the tax planning and gains and incomes are going, and wait to see what other plans Obama has for us.
In my recent post http://twocents.blogs.com/weblog/2009/04/an-all-cash-portfolio-in-retirement.html I hope I clearly laid out my thinking that in the intermediate to long run inflation is coming back with a big bang and that gold and cash and near cash will probably be the way to go for retirees.*
Putting this all together, what could I do with the 35% in self-directed tax-deferred funds and 65% in taxable funds to save the bacon and legally pay as little tax as possible IF I don't close out the tax-deferred fund entirely this year? Everything that comes out of an IRA or 401K is 100% taxable at US Income tax rates, whether it was a long term capital gain or ordinary income or gold profits, and after age 70 there is a mandated yearly increasing stream of required withdrawals. Therefore in my case it makes no sense to have gold or stocks in the tax-deferreds, and I don't. Up until mid year 2008 a good bit of the IRA was in US and Canadian oil and gas trusts paying 8-12% with a lot more in Loomis & Sayles Bond Fund (LSBDX/LSBRX)paying ~7% on average. As I grew frightened by what was starting in the markets I cut way back on the trusts and eliminated LSBDX and went to very short term Vanguard Agencies funds VSGDX and VFIJX. That preserved capital and avoided sleepless nights. As the trusts fell in the fall, I began buying them back on huge declines which were pretty easy to find and am break even to ahead on them now.
Even at these current very low gas and oil prices the trusts are paying about 7% average. VFIJX is paying about 4.7%, but LSBDX is now paying 8.5% and has rallied strongly from the lows along with stocks. My plan is to wait for a stock market drop, which I expect soon, in May, and which LSBDX will join in sympathy since its largely high yield corporate bonds trade more with equity expectations than with vanilla bonds. Then I will get rid of the VSGDX, VFIJX, and money market funds and buy LSBDX with about 75% of the funds apart from the oil and gas trusts. The latter will serve as an inflation hedge, but the whole portfolio could earn 8% annualized from day 1! All the withdrawals are taxable, but they would be 100% taxable even if not in the IRAs and at the very same tax rate. 8% payouts exceed the required withdrawal rates (RMD) for some number of years, so part of the current income would be sheltered and re-invested. If you are seriously interested in this subject or maybe just curious, take a look at Hugh Chou's excellent and very simple calculator for IRA and 401K required minimum withdrawals (RMD) after age 70. Vary the expected annualized returns and inflation assumptions for some surprises and ideas. http://www.hughchou.org/calc/irawith.cgi
Who cares if the capital value of the IRA or 401K fund goes down due to a bond bear market or stock decline during payout RMDs? We're only interested in the income stream from this source, not capital gains. But if inflation rises, as it will, the price of oil and gas will fly again and the trusts' prices and payouts will rise. So if I am starting the new plan with only 25% in the trusts, and with oil gas prices low, they could become 50% of the IRA at some future date. (To quell that ever-nagging question about the trusts, Mesa Royalty Trust had an estimated reserve life of about ten years when the trust was distributed by T Boone Pickens in 1979. Now Mesa has a 13 year estimated reserves life! Several others of the trusts have also increased their remaining reserves lives in the past year. Due to re-drilling, horizontal drilling, in-filling with new wells, better extraction, and other advances, reserves can and do grow for these "wasting assets".)
So if I have rationally secured a fabulous stream of earnings which will be taxed no higher from the IRA or 401K than if held in a taxable fund, and add in the also taxable Social Security payouts, I can then address the taxable 65% of funds. This comes back to the "all cash portfolio in retirement" but also to what in 2007 and 2008 I was calling the Hillary portfolio. At that time I assumed a democrat victory in 2008 and that Hillary Clinton would be president. It was a slam dunk idea then, as it is now, that taxes would rise in 2009 or 2010 and probably rise significantly. The Hillary portfolio was short term municipal bonds and gold, preferably as gold bars or coins. This is what I think should be the primary function and goal of the 65% of assets held in taxable accounts or privately vaulted. Right now I have only about 20% of those assets in gold related items and nearly all the remainder in Vanguard's municipal money market fund VMSXX and short term muni fund VWSUX. (I recently sold all of the large holding of my home state long term municipal bond fund which had been paying nearly 6%, for a taxable equivalent of 8.5%. It served me well, and I was able to sell it for a gain equal to over three years of interest from it. I worry about long term rates and also about municipal finance, and wanted to stay very short term. I also have sold off some other assets which do not fit the current plan, all at break even or with fine profits. So the cash and near cash is there for re-deployment.)
With municipal short term rates so low at this time, VMSXX and VWSUX are places really only for "lazy money". Therefore I see this as yet another reason to add more gold to the "taxable side", along the lines of the "all cash portfolio in retirement". Forget gold in the IRA or 401K under my current conditions, and load up on gold, on pullbacks, on the taxable side where it won't be taxed unless and until sold. At some time in the future when inflation begins to bite hard, whether next year or in five years, take out of the bank as many gold coins as you need for that month's budget which is not covered at that inflationary stage by other income (above), and toddle off to your local coin shop to convert them to cash. This is a practical solution to financial needs, and is it is very simple but sensitive to taxes and reality.
So in the end I am funding most of my income needs from IRAs yielding, hopefully, 8% and partially inflation-hedged with at least 25% of the fund in oil and gas trusts also paying 8%. Add to that Social Security monthly payouts, partly inflation-hedged, and an unhedged monthly annuity payment of which only 39% is taxable. Additional non-taxable municipal income comes from the taxable account, but at only about a 2% rate. Then there is the gold and a long/short physicals, bond, and currency futures fund, RYMFX. The gold is "insurance", a "just in case" holding, which can be cashed in if and when needed for the monthly budget.
Let me quote something smashingly fresh about gold that I've just read:
"Gold is more than just an inflation hedge. If it were just an inflation hedge, it would be a very poor one; people would have given up on it long ago. Remember, gold is not a financial asset; it cannot go poof. TIPs, inflation swaps, and even stocks can go poof. They depend upon the existence of a financial system and the liquidity to trade out of the position.
"Gold makes no such assumption. Gold will be here today, tomorrow, and if a nuclear warhead lands on our soil. It has been a medium of exchange much longer than any single currency has been, and it may be once again [a medium of exchange]....
"Gold not only hedges inflation risk, it hedges political risk. You see, the benign, demand-driven inflation that occasionally reaches five or seven percent is not the kind of risk that gold hedges. Gold couldn't care a darn about that kind of inflation. Gold hedges the kind of inflation that comes from quantitative easing. When a country turns its currency into walking, talking joke, gold is there as an alternative.... And what a big joke the dollar has become......"
That's from Jason Dillian of http://www.dailydirtnap.com
Last, here's a chart of old friend and probable future friend LSBDX from its inception in May 1991 to date. Along with it are representative bond funds plus balanced fund VWINX and S&P500 fund VFINX.
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