Should Roth IRA & Traditional IRA Asset Allocations Be the Same?
After recently changing jobs, I rolled over my 401(k) into my existing IRAs. I learned an interesting tax quirk along the way, too. Now I’m to the point where I need to rebuild the asset allocation I had in the 401(k)…or not. My question about this is really simple.
Should my Roth IRA asset allocation be the same as my Traditional IRA asset allocation?
I can think of a couple of reasons why and why not.
Yes, the asset allocations should be the same.
- Since both IRAs are for the same goal (retirement) and the same time frame, asset allocation theory seems to say they should be identical.
- They should be the same just for simplicity. Since you’re possibly going to change the asset mix as time passes (to reduce risk, say), keeping both IRA types the same makes it considerably easier. However, the use of a lifecycle fund might mitigate this factor.
No, the Roth IRA asset allocation should be different than the Traditional IRA.
- Using both a Roth and Traditional IRA allows you to do tax diversification. As such, your goals and objectives for the two types of IRAs may be different. [Thanks to Lily who pointed this post from Dough Roller out to me on this subject.]
- Since conventional wisdom says there’s a certain order in which you draw down retirement assets, the allocations of those assets should differ.
- There are some peculiarities about Roth IRAs that may dictate a different asset mix. Specifically, you can withdraw contributions to your Roth IRA penalty free at any time. That’s generally not so with a Traditional IRA. This may mean the two types should hold different assets, especially if you anticipate you might need to take a withdrawal.
Anyone have any thoughts on this?
I want to take action and set up my asset allocations, but I’m not sure which way to go. Right now, I’m leaning toward having them a slightly different mix simply because of how I’ll (hopefully) be drawing down the retirement assets.
March 12th, 2008 at 12:40 pm
I just read a great article about this from The Dough Roller (http://www.doughroller.net/2008/02/27/after-tax-asset-allocation-is-there-a-gremlin-lurking-in-your-401k/). It took me a couple of read-throughs to get what DR was really saying, but he points out that your overall asset allocation may be different than what you think it is if you allocate different types of assets between Roth and non-Roth accounts.
March 12th, 2008 at 2:43 pm
Thanks Lily. That Dough Roller article is just what I’ve been looking for. I’ve added it to my post. I’ll have to read through all the articles he links to, too.
March 12th, 2008 at 9:22 pm
[…] Personal Finance discussed whether Traditional IRA and Roth IRA should have same asset allocation. I never thought about that, though I treat my taxable accounts and retirement accounts differently […]
March 13th, 2008 at 3:45 am
There was also a topic talking about this on Diehards forum, but I can’t remember the specific arguments. I do remember walking away from it saying that I was just going to treat them all the same. I would just rebalance as needed.
When you withdraw money later in retirement, you can always rebalance then as well.
March 13th, 2008 at 5:01 am
Unlike a traditional IRA or 401k plan the Roth IRA does not require MRD’s at age 70 1/2..so it can be invested more aggressively if you’d like. The Roth may be the last pool of money you use for retirement.
March 13th, 2008 at 6:35 pm
I appreciate the link to my article. I found the concept of after-tax asset allocation a bit mind-numbing at first, but it really is an important concept if you have a lot invested in both Roth and traditional retirement accounts. And allocating your investments on an after-tax basis isn’t as difficult as it may first appear.
March 13th, 2008 at 11:44 pm
I’m confused….. It seems like there are two fundamentally different concepts that are getting intertwined here… Asset Allocation (how your investment dollar is distributed among types of investments, i.e. stocks vs bonds) and what I’ll call Asset Distribution (which type of accounts those investments are held in, i.e. Roth vs Traditional).
The example in Dough Roller has $100k invested in bonds in a Roth accounts and $100k invested in stocks in traditional accounts, and basically shows that it should be “Allocated” differently.. $87,500 in bonds and $112,500 in stocks. If one were to reverse the roles of the accounts…
100k in stocks in the Roth and 100k in Bonds in the traditional, then wouldn’t it result in an allocation of $112,500 in bonds and $87,500 in stocks? An entirely different result! Also, consider what happens if the tax rate is different… and take it to an extreme… say 75%. Now it says that you should have your investments split $37,500 and $162,500 between stocks and bonds in order to have a “50/50″ asset allocation. The whole process does not maintain consistency over variations, and in the extreme becomes totally nonsensical.
The after tax asset allocation strategy is essentially re-allocating the assets based on the future net value of the invested (contributed) dollar which is determined by the distribution of those dollars, after you have had it invested for many years and then withdraw it (i.e. after it has done all the work it is ever going to do for you). If the value of the dollar when you withdraw it were important in “Asset Allocation”, then shouldn’t we be allocated our assets based on not only the tax status at withdrawal, but also on the expected net returns over the life of the investments themselves? I don’t think anyone would buy into that.
Isn’t the whole “Asset Allocation” thing designed to balance risk/growth versus capital preservation in one’s investment portfolio? If that’s the case, then shouldn’t the allocation be based on the current dollars invested rather than any “future value” or tax treatment at withdrawal time?
March 14th, 2008 at 6:40 am
@ EJD - You make a good point. I can’t speak to DR’s example numbers, since it’s not my place to do so. I will say, however, that fundamentally, asset allocation seeks to balance risk and return (as you say). It’s predicated on the investor’s goals and time horizon. I’m coming around to think that a Roth will likely have a slightly different time horizon than a traditional, assuming you take the convention wisdom advice on drawing down assets.