Many of you are adopting the "retirement ready" IRA strategy I suggested in my brief August 31st LinkedIn article: Can I Deduct My IRA Management Fees?
The article described the approach I have been using since my RMD (Required Minimum Distribution) started, and there is no doubt that it has allowed me to grow my tax deferred income better in my retirement accounts.
- I've been paying my IRA fees from my taxable account and depositing my RMD there as well.
Additionally, by producing significantly more income than the RMD demands, I am also able to grow the retirement account Working Capital in the process.
- My fee paying taxable account operates as the "bank" from which all of my spending money (and investment management fees) are withdrawn.
There's no doubt that your long term spendable income numbers will benefit from paying all IRA fees from a separate portfolio large enough to produce income in excess of the fees being withdrawn.
BUT, I've made an additional strategic change in the composition of the income producers in my managed taxable accounts.
As most of you know by now, I think of tax free income as the road to the holy grail of income investing... what greater thrill is there in an investment manager's trading experience than realizing a "year's interest in advance" on a tax free income purpose security?
There comes a time, though, when not all "tax free" CEFs are better than all "taxable" CEFs. The combination of a nominal rise in share prices and widespread dividend reductions has created an "after tax" income growth opportunity.
- More than half of the our 82 tax free income CEFs have reduced their dividends in 2017 alone... only three have raised payouts. The average yield has fallen to less than 5.5%.
- In contrast, more than 50% of our 95 taxable income CEFs have maintained their payout levels, and ten others have raised their dividends. The average yield is well over 7.5%.
- Taxable CEFs yielding 7.5% or more (in a 25% federal tax bracket) have after tax yields above 5.6%
So, the strategic change in the "Income Bucket" of taxable accounts is to shift excess income and trading profits into taxable CEFs... the very same ones we've enjoyed such great income experience with in our retirement accounts for decades.
Depending on your age and asset allocation, your "taxable" portfolio could benefit from this strategy. Although taxable income CEFs are more price volatile than the tax free variety, using them to fund investment management fees makes good investment sense and your accountant may deem the payments tax deductible.
- Taxable income Closed End Funds are professionally managed portfolios containing diversified positions in hundreds of income purpose securities... and with payment track records that are easy to put your cursor on... less risky and more income productive than funds containing equities.
A combination of tax free CEFs, equity CEFs, and Investment Grade Value Stocks will continue to be used for the rest of the portfolio. In my personal (and managed) portfolios, I do not plan to go more than 30% into taxable CEFs, and I rarely touch anything with less than a five year payment history.
Non Client Questions? Click here for answers.
The first strategy question is: are you in a 25% tax bracket, or lower.
If yes, you'll probably (please check with an accountant) be better off in all categories (working capital growth, net spendable income, and growth of income) if:
- You start adding taxable CEFs yielding above 7.5%... there are dozens of them yielding between 7.5% and 9.5%, and
- start replacing tax free CEFs yielding less than 5.5% (also, dozens yielding barely 5%) with taxable CEFs yielding above 7.5%
Be patient with the transition process.
Clients only, please contact me if your tax bracket is higher than 25%, we can focus on replacing some of the lowest yielding tax free CEFs with some of the highest "taxables" for a net/net positive income effect... a rather slow process.
If your accountant thinks you need tax losses... talk to me. In income investing, this could be the one time I make an exception.
Questions? Clients only, call 800-245-0494