No. of Recommendations: 0
Author: c130king Date: 2/16/01 7:12 PM Number: 27947

Is there such a thing as too much tax free/deferred investing? Are you ever concerned about having all of your funds tied up in somewhat untouchable investments? I would think some percentage of investments in taxable instruments so that you can get to it if necessary.

I have mentioned this previously, but thought it might be worthwhile to repeat it.

I did some research a while back, and found that the Vanguard Tax Managed Growth and Income fund, VTGIX, appears to be just about as good as an IRA for sheltering longterm growth from taxes. This fund tracks the S&P 500 Index and, because it is managed, it distributes very little dividends and capital gains each year. The expense ratio is only 0.19%, and the distributions and dividends are only 1.0%.

Of course, the really big advantage to this fund, like any other longterm investment, occurs when you sell it. Then, assuming you have held it long enough, you only pay a maximum of 18% tax on the gains. In an IRA, you have to pay taxes on all gains at your marginal income tax rates when you take the money out.

I have run spreadsheets that show that the longterm results of investing in an Index Fund inside an IRA vs. VTGIX in a taxable account are nearly identical.

However, there are catches:
* there is a $10,000 minimum initial investment.
* there is a 2% redemption fee if you take your money out the first year, and a 1% redemption fee if you take your money out before 5 years. After that there are no more fees. This redemption fee money is then plowed back into the fund to offset the distribution of capital gains costs that are incurred when people sell out. There are no loads or 12b-1 fees on this fund.

So, if you have enough for the initial investment, and your horizon is at least five years out, before selling any shares, this fund will give you total returns nearly equal to an IRA, without tieing the money up (subject to a 10% penalty).

The other advantage of this fund over an IRA is that there are obviously no RMD's (Required Minimum Distributions) at age 70.5. In large IRA's, these RMD's can cause much higher income taxes, because they push you up into higher marginal brackets than you need to be.

(Disclosure: I don't have any affiliation with Vanguard other than being a loyal customer.)

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