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By Christine Benz and Jason Stipp | 09-09-2015 02:00 PM

Top Funds for Tax-Efficient Bucket Retirement Portfolios

Tax-managed, index, and municipal-bond funds from Fidelity and Vanguard are among the best options for investors looking to minimize the tax drag on their portfolios, says Morningstar's Christine Benz.

Jason Stipp: I'm Jason Stipp for Morningstar. It's Model Portfolio Week on, and today we're talking with our model portfolio maven, Christine Benz, about some of her favorite picks for tax-efficient bucket portfolios in retirement.

Christine, thanks for joining me.

Christine Benz: Jason, it's great to be here.

Stipp: A lot of retirees will have taxable accounts, and today you brought some tax-efficient picks for those accounts for bucket portfolios. Before we get to the picks, though, what is this bucket approach? Can you sum it up for us?

Benz: This approach is not original to me. Harold Evensky, the financial planner in Coral Gables, Florida--it's really his brainchild. The idea is how can we get retirees comfortable with holding equities as a portion of the portfolio? His idea was if we set up enough conservative assets in the portfolio--so if we set aside near-term living expenses in what he calls bucket one, which is kind of a cash bucket, and maybe set aside some bond investments in bucket two--then that will allow the retiree to ride through the volatility that will inevitably accompany the equity investments in the portfolio.

Stipp: Folks who are in retirement often have different types of accounts from a taxable perspective--some IRAs, they have some taxable accounts. Obviously, tax efficiency is important for the taxable accounts. So, if I do have a mix, should I mirror my asset allocation in my taxable accounts as I do in, for example, an IRA account?

Benz: Here again, you want to let your spending time horizon drive the way you position each of these portfolios. Say I'm someone who is subject to required minimum distributions and those RMDs are fulfilling most of the income needs that I have from my retirement portfolio, I want to position that portfolio more conservatively. I want to tee up the money to supply my spending needs. So, I'd want to have more cash and bonds in that portion of the portfolio. If that IRA were supplying all of my income needs, I'd want to position my taxable portfolio more aggressively because I'm not actively drawing upon that portfolio. So, I'd hold more stocks in that portion of the portfolio, maybe very little in bucket one--the cash piece--and maybe relatively less in bucket two as well. So, let your spending horizon drive what you do.

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