I would like to understand better how dynamic reallocation works in Mode 2.
I understand how I can input my portfolio allocation and account prioritization, and I understand that "[a]s [my] account balances vary over time, the asset locations will be dynamically adjusted to maintain [my] portfolio asset allocation.
The main things I would like to understand next are:
- For rebalancing that occurs within the TAXABLE account, how about calculation/retention/distribution of any resulting capital gains/losses?
- Is there a way to INCLUDE the taxable account in the overall portfolio allocation, but EXCLUDE it from automatic reallocation? (perhaps by putting it last in order?)
PS I'm also curious,
- When does rebalancing take placein relation to contributions, withdrawals, and calculation/retention/distribution of annual returns?
Pralana currently does not account for taxes that may be due when you rebalance in taxable, whether that's due to Mode 2 or any other reason. I avoid this by telling Mode 2 to put bonds in taxable last. Charlie and Stuart are aware of the shortcoming, but it's a good idea if you would make a feature request to push it up the priority list of improvements.
@ricke I would much prefer having the option to exclude the taxable account from rebalancing: take its contribution to the total portfolio into account, but do all the rebalancing in the tax Aadvantages accounts
Pralana currently does not account for taxes that may be due when you rebalance in taxable, whether that's due to Mode 2 or any other reason. I avoid this by telling Mode 2 to put bonds in taxable last.
How do you do your hack? I'm confused.
On Build-Advanced Portfolio Modeling-Asset Allocation/Location, you will notice 3 tabs on that page - after selecting Mode 2 on the Active Asset Allocation Mode and setting the Portfolio Allocation, go to the rightmost tab called Account Prioritization. There you just drag and drop the accounts in the order in which they should have stocks. So I put taxable at the top, then Roth, then Tax Deferred. That means that once my t-IRA is full of bonds, it will put bonds in Roth.
Attaching a screenshot, hopefully that comes through
Pralana currently does not account for taxes that may be due when you rebalance in taxable, whether that's due to Mode 2 or any other reason.
This is a surprise. I was hoping it would at least account for the taxes in the next year. 😕
My portfolio is not all that unusual -- 60/40 allocation, taxable account heavy with a smallish Roth (59% taxable, 40% traditional, 1% Roth) -- and my traditional IRA is 100% bonds, so I anticipate a lot of taxable rebalancing when I start RMDs next year. Any suggestions on how to keep the missing taxes from skewing my results too much when I consider Roth conversions?
While this change is not on the More > Resources > Feature Voting page, I have started work on this and expect to have it implemented before the end of Aug, hopefully sooner. On initial implementation, for assets in the Taxable Investment account that are overallocated and need to be sold, I may realize LTCG on the asset sale amount proportionately assets % unrealized LTCG to the pre-sale balance.
For example, assume:
- an asset has a balance of $100K with $25K (25%) of unrealized LTCG.
- $10K of the asset needs to be sold to bring its allocation back in line.
- Pralana will realize 25% of the sale amount or $2.5K as realized LTCG.
Or, I may be able to use the specified LTCG Strategy for realizing LTCG first, last, or proportionately...which would take a little longer.I welcome your thoughts on this.
Or, I may be able to use the specified LTCG Strategy for realizing LTCG first, last, or proportionately...which would take a little longer.I welcome your thoughts on this.
I asked this in a separate thread, but it applies here as well: When exactly would one use "proportionate" LTCG withdrawal strategy setting? If I understand thing correctly, this taxes the LTCG according to the proportions one listed for taxable growth. But wouldn't those proportions only apply to internal growth of your taxable account, which wouldn't be the case for the majority of unscheduled taxable withdrawals?
Re: "...this taxes the LTCG according to the proportions one listed for taxable growth."
In the context of unrealized LTCG withdrawal strategy, proportional ('Distribute withdrawals evenly') means the % of the account balance, at the time of the withdrawal, that is unrealized LTCG....e.g. 10% or 30%.
Example: Investment account has an balance of $100K of which $30K or 30% is unrealized LTCG. (Some or all of the unrealized LTCG may have existed at plan start and entered on the Initial Balances page or accumulated from growth during the plan years.)
If a $10K scheduled or unscheduled withdrawal is made from that account and the withdrawal strategy for unrealized LTCG is:
- 'Evenly' aka Proportional: $10K will be withdrawn, 30% or $3K will be taxed as realized LTCG that year, the remaining balance will be $90K total / $27K unrealized LTCG.
- First: $10K will be withdrawn, all of which will be taxed as realized LTCG that year, the remaining balance will be $90K total / $20K unrealized LTCG.
- Last: $10K will be withdrawn, none of which will be taxed as realized LTCG that year, the remaining balance will be $90K total / $30K unrealized LTCG.
Pralana handles the edge cases where, for example, you specify 'First' for a $10K withdrawal, but don't have $10K of unrealized LTCG...it realizes whatever you do have and takes the rest from other unappreciated assets.
Re: "When exactly would one use "proportionate" LTCG withdrawal strategy setting?"
Others may provide better/different answers. I don't know of a good reason to use proportional. First would be useful to benefit from the $0 LTCG bracket in otherwise low income years. Last would be useful for deferring tax LTCG forever via step-up in basis on death of spouse or oneself to the benefit of heirs.
There are ways we can make the LTCG withdrawal strategy more useful (one of the Feature Voting choices) by:
- Giving options beyond first/last/evenly
- Allowing you to vary the option from year-to-year.
@cstone: I have difficulty understanding why Pralana offers the "First" and "Last" forms of LTCG withdrawal strategy. My understanding is that in actuality, when withdrawing $10,000 from a $100,000 brokerage account, the investor would have the choice of using the "average cost" method (so far so good), or sell specific lots - either "last in first out" or LIFO (typically with low gain) or "first in first out" or FIFO (typicallly with low gain). But as I understand it, there is no way to perform withdrawals that have either 100% or 0% gain (corresponding to Pralana Online's "First" and "Last" LTCG withdrawal strategies; nor does Pralana Online offer a way to model either a LIFO or FIFO strategy - which would require keeping track of the cost basis by lot, not just a single total cost basis for the account.
In my personal case, my taxable account contains three asset classes, which I plan to sell in the following order:
- Triple tax free municipal bonds (with no unrealized capital gain)
- Recently acquired stock (with 10-20% unrealized capital gain)
- Stock acquired long ago (with 60-80% unrealized capital gain)
I wish there was a way for me to model this.
P.S. Is Pralana Online's order of operations documented somewhere (for end-of-year processing? In particular, I would like to know when rebalancing take place relative to other year-end tasks such as adding contributions, subtracting withdrawals, and calculation/retention/distribution of annual returns
Thanks as always for your amazing work!
@jason-blattyprotonmail-com: Your post duplicates one I was just working on! "Proportional" with Mode 2 seems closer to reality than "First" or "Last", but even it is skewed pretty significantly when you have highly-appreciated shares purchased decades ago (not an uncommon situation -- think about a buy-and-hold Boglehead portfolio).
@cstone: Could I better model this if I defined one User Asset class to hold my big gainers (purchased decades ago) and another class for more recent ones (including new stock purchases)? I'd specify Proportional treatment of unrealized LTCG in both (to use average unrealized LTCG -- hopefully not too far off since I've separated the funds) and then set up Pralana to sell stocks in the new Recent-Purchases asset class before the Big-Old-Gainers asset class. And if that will work, could I define more than two user asset classes and change which one gets new purchases and sales over time (say every 10 years or so)?
And yes, thanks for this wonderful planning tool!
@jason-blattyprotonmail-com I've been considering the same issue. BTW, Vanguard also offers a "Min Tax" method.
Other than picking the average method at the brokerage and modeling that in Pralana, there seems to be no way to model any method that would depend on identification of specific lots. On one hand, I understand that this would add both implementation complexity and user complexity, but on the other hand, the withdrawal method can obviously have major implications on taxes, Roth conversions, ACA subsidies, etc. Given this, I'm a bit stuck on how to most effectively use Pralana. Any suggestions, or even insights into possible enhancements from the dev team, would be welcome.
-J
@jason-blattyprotonmail-com You articulated a head-scratcher I have wrestled with for years now. Thanks for validating my bewilderment.
In real life "First" and "Last" are virtually impossible since no brokerage of which I am aware will allow a sale of stock/fund/ETF to be comprised of an arbitrary mix of cost basis and gain (loss). The only way either of these options is viable is if the lot being sold contains either all gains or all basis, with all gains being literally impossible and all basis being extremely rare. The "Proportional"/"Even" option seems like the only one that could even remotely approximate reality (although Mr. Stone makes me question whether I have any neurons firing at all when he says "I don't know of a good reason to use proportional"). I don't know of a realistic reason to use anything except "Proportional"! The ultimate answer, I'm afraid, is that Pralana can never come close to projecting actual gains/losses realized over the years short of our entering every lot in our portfolio, with cost basis + gain/loss, and then updating it every Jan 1 - something way beyond the scope of any planning tool. It's a conundrum. Perhaps the only halfway useful capability would be to specify percent basis/percent gain for each year in the plan (also pretty cumbersome and a wild swag at best).
But thanks again for expressing my same questions. Maybe it will lead to some kind of workable solution.
The gains first vs. gains last would be a way to bracket the sensitivity of the answer. If changing from one extreme to the other doesn't change your plan, then you don't need to worry about that parameter. For "Can I Retire Yet?" kind of questions, it probably wouldn't matter. Unfortunately, many of us have gains large enough that it would swing answers to questions like Roth Conversions.
I don't think there is a great answer. I've wondered if there was a way to input a few data points, but way less than the hundreds of entries that exist in the portfolio. However, my guess is there would be a messy problem in the programming at each bend point.
In our case, I don't think we'll exhaust taxable, so I look at the average gains only in the portion that we are likely to use and use the proportional option. That's not very precise, but keeps the program from showing large capital gains taxes on the oldest investments that we are not likely to ever sell.
...entering every lot in our portfolio, with cost basis + gain/loss, and then updating it every Jan 1 - something way beyond the scope of any planning tool.
Maybe not. I already keep a spreadsheet of all my taxable lots with their basis (a necessity for those really old shares that Vanguard won't track for me and handy when I'm what-if-ing). Pasting a simplified CSV of that spreadsheet annually into Pralana wouldn't be all that bad (especially for the exacting types who opt for Pralana over its competition anyway).
But this is a larger software change than @cstone was considering for August. Using Proportional to estimate the tax on rebalancing stocks (assuming it is applied separately per asset class within the taxable account) would increase the model's accuracy considerably.
