Author Topic: Tax efficiency  (Read 581 times)

Murse

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Tax efficiency
« on: March 29, 2019, 06:32:57 AM »
Hello,

I have a 457 at my current job, a Roth IRA and a brokerage account.

I am curious in which funds to place what due to taxes, also due to growth.

I guess my target AA is 70% total stock market/10% small cap tilt/20% international

My Roth IRA, I have vtsax- my thinking is I want this pot of money to grow as large/safely as possible over the next 40 years since it is tax free.

My traditional 457 I have a mix of international, total stock and small cap.

My brokerage I have total stock market

My question is this- where should each of these go to maximize tax efficiency over the long run?

About 50% of our NW is in our 457/401s, 30% in our Roth IRAs and 20% in our brokerage.

beltim

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Re: Tax efficiency
« Reply #1 on: March 29, 2019, 07:12:42 AM »
If you hold international in your taxable accounts, you can get a tax credit for any foreign taxes deducted from your dividends. 

tyler2016

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Re: Tax efficiency
« Reply #2 on: March 29, 2019, 07:47:06 AM »
457 rules are a little different than 401k. There is no early withdrawal penalty, but withdrawals are taxed as income. From my understanding, they are harder to withdraw from while employed, but you can withdraw from them after leaving employment. I'm not an expert, but 457 may be a good option for you.

Murse

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Re: Tax efficiency
« Reply #3 on: March 29, 2019, 08:22:04 AM »
457 rules are a little different than 401k. There is no early withdrawal penalty, but withdrawals are taxed as income. From my understanding, they are harder to withdraw from while employed, but you can withdraw from them after leaving employment. I'm not an expert, but 457 may be a good option for you.

I understand. I should have specified in the OP that I am maxing all of my tax advantaged buckets prior to putting money into our brokerage each year including my 457. This is a questions specifically of - how should I devide up my assets among my accounts for tax efficiency

Proud Foot

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Re: Tax efficiency
« Reply #4 on: March 29, 2019, 10:01:38 AM »
I agree with Beltim regarding the international funds and the foreign tax credit on the dividends. But you should also balance that with the strategy of the fund to make sure your credit on the dividends is not offset by any capital gains distributions.

Also keep the small cap in a tax advantaged account since they tend to have a higher turnover and capital gains than the large cap funds.

Here is how I would probably make my allocations:

Roth: Small Cap, VTSAX - I put the small cap here because there is no tax on the gains and the higher volatility of a small cap can result in larger gains than the total stock. The Vanguard Small Cap Index Fund (VSMAX) outperformed VTSAX over the past 10 years.
457: VTSAX
Taxable: International, VTSAX

MustacheAndaHalf

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Re: Tax efficiency
« Reply #5 on: March 29, 2019, 10:49:05 AM »
International in taxable is less straightforward that was mentioned above.  Here's the brief +/- involved:
(+) foreign tax credit, which tends to be a small percentage of dividends
(-) for many years now, international has had +1% higher dividends (right now 2.9% int'l vs 1.9% U.S. total market)
(-) a lower percentage of international dividends are qualified (compared to U.S.), so you pay more tax on this part, also.
(-) you must file form 1116, and both H&R Block and TaxSlayer dump you into this form to fill it out on your own.  No interview involved.

Back to OP's allocation question - take a look at tax-exempt bonds.  If your tax bracket makes them worthwhile, it's a good idea to put them in taxable.  That frees up more room in retirement accounts, and has minimal tax impact (when selling the bond / bond fund shares, you still pay capital gains, if any.  Most of the gains from bonds are from income).

appleshampooid

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Re: Tax efficiency
« Reply #6 on: March 29, 2019, 11:25:36 AM »
International in taxable is less straightforward that was mentioned above.  Here's the brief +/- involved:
(+) foreign tax credit, which tends to be a small percentage of dividends
(-) for many years now, international has had +1% higher dividends (right now 2.9% int'l vs 1.9% U.S. total market)
(-) a lower percentage of international dividends are qualified (compared to U.S.), so you pay more tax on this part, also.
(-) you must file form 1116, and both H&R Block and TaxSlayer dump you into this form to fill it out on your own.  No interview involved.

Back to OP's allocation question - take a look at tax-exempt bonds.  If your tax bracket makes them worthwhile, it's a good idea to put them in taxable.  That frees up more room in retirement accounts, and has minimal tax impact (when selling the bond / bond fund shares, you still pay capital gains, if any.  Most of the gains from bonds are from income).
I've received the foreign tax credit for several years (a pretty small amount as noted), and have never had to fill out form 1116. From the instructions for that form:
Quote
Election To Claim the Foreign Tax Credit Without Filing Form 1116
You may be able to claim the foreign tax credit without filing Form 1116. By making this election, the foreign tax credit limitation (lines 15 through 21 of the form) won't apply to you. This election is available only if you meet all of the following conditions.

All of your foreign source gross income was "passive category income" (which includes most interest and dividends). See c. Passive Category Income, later. However, for this purpose, passive income also includes (a) income subject to the special rule for High-taxed income described later, and (b) certain export financing interest.

All the income and any foreign taxes paid on it were reported to you on a qualified payee statement. Qualified payee statements include Form 1099-DIV, Form 1099-INT, Schedule K-1 (Form 1041), Schedule K-1 (Form 1065), Schedule K-1 (Form 1120S), or similar substitute statements.

Your total creditable foreign taxes aren't more than $300 ($600 if married filing a joint return).
I meet all those conditions so it makes sense. With how small this credit is, m'wife and I may never go over the $600 limit there.

YMMV.

Murse

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Re: Tax efficiency
« Reply #7 on: March 29, 2019, 04:40:47 PM »
International in taxable is less straightforward that was mentioned above.  Here's the brief +/- involved:
(+) foreign tax credit, which tends to be a small percentage of dividends
(-) for many years now, international has had +1% higher dividends (right now 2.9% int'l vs 1.9% U.S. total market)
(-) a lower percentage of international dividends are qualified (compared to U.S.), so you pay more tax on this part, also.
(-) you must file form 1116, and both H&R Block and TaxSlayer dump you into this form to fill it out on your own.  No interview involved.

Back to OP's allocation question - take a look at tax-exempt bonds.  If your tax bracket makes them worthwhile, it's a good idea to put them in taxable.  That frees up more room in retirement accounts, and has minimal tax impact (when selling the bond / bond fund shares, you still pay capital gains, if any.  Most of the gains from bonds are from income).
I've received the foreign tax credit for several years (a pretty small amount as noted), and have never had to fill out form 1116. From the instructions for that form:
Quote
Election To Claim the Foreign Tax Credit Without Filing Form 1116
You may be able to claim the foreign tax credit without filing Form 1116. By making this election, the foreign tax credit limitation (lines 15 through 21 of the form) won't apply to you. This election is available only if you meet all of the following conditions.

All of your foreign source gross income was "passive category income" (which includes most interest and dividends). See c. Passive Category Income, later. However, for this purpose, passive income also includes (a) income subject to the special rule for High-taxed income described later, and (b) certain export financing interest.

All the income and any foreign taxes paid on it were reported to you on a qualified payee statement. Qualified payee statements include Form 1099-DIV, Form 1099-INT, Schedule K-1 (Form 1041), Schedule K-1 (Form 1065), Schedule K-1 (Form 1120S), or similar substitute statements.

Your total creditable foreign taxes aren't more than $300 ($600 if married filing a joint return).
I meet all those conditions so it makes sense. With how small this credit is, m'wife and I may never go over the $600 limit there.

YMMV.

What does all of this mean?? How much international would trigger this?? 100k, 200k any kind of way to figure this out?

kingxiaodi

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Re: Tax efficiency
« Reply #8 on: March 29, 2019, 05:27:59 PM »
International in taxable is less straightforward that was mentioned above.  Here's the brief +/- involved:
(+) foreign tax credit, which tends to be a small percentage of dividends
(-) for many years now, international has had +1% higher dividends (right now 2.9% int'l vs 1.9% U.S. total market)
(-) a lower percentage of international dividends are qualified (compared to U.S.), so you pay more tax on this part, also.
(-) you must file form 1116, and both H&R Block and TaxSlayer dump you into this form to fill it out on your own.  No interview involved.

Back to OP's allocation question - take a look at tax-exempt bonds.  If your tax bracket makes them worthwhile, it's a good idea to put them in taxable.  That frees up more room in retirement accounts, and has minimal tax impact (when selling the bond / bond fund shares, you still pay capital gains, if any.  Most of the gains from bonds are from income).
I've received the foreign tax credit for several years (a pretty small amount as noted), and have never had to fill out form 1116. From the instructions for that form:
Quote
Election To Claim the Foreign Tax Credit Without Filing Form 1116
You may be able to claim the foreign tax credit without filing Form 1116. By making this election, the foreign tax credit limitation (lines 15 through 21 of the form) won't apply to you. This election is available only if you meet all of the following conditions.

All of your foreign source gross income was "passive category income" (which includes most interest and dividends). See c. Passive Category Income, later. However, for this purpose, passive income also includes (a) income subject to the special rule for High-taxed income described later, and (b) certain export financing interest.

All the income and any foreign taxes paid on it were reported to you on a qualified payee statement. Qualified payee statements include Form 1099-DIV, Form 1099-INT, Schedule K-1 (Form 1041), Schedule K-1 (Form 1065), Schedule K-1 (Form 1120S), or similar substitute statements.

Your total creditable foreign taxes aren't more than $300 ($600 if married filing a joint return).
I meet all those conditions so it makes sense. With how small this credit is, m'wife and I may never go over the $600 limit there.

YMMV.

What does all of this mean?? How much international would trigger this?? 100k, 200k any kind of way to figure this out?

Using VXUS as an example (I believe that fund meets all of the criteria listed above, but if not, I'd appreciate someone letting me know so I can start amending my taxes :D), I paid ~$8.50 in foreign tax on ~70 shares or roughly $0.12 per share. Assuming that scales up, I would need to own 70*300/8  = 2625 shares before I paid $300 in foreign tax. VXUS has been hovering slightly above $50 for a while now, so that would be ~$131k in shares (or twice that if MFJ).

Now, it's possible that the fund could spit out more dividends, or foreign governments could tax more, both of which would decrease how many shares you could own before needing to fill out 1116, so it's probably safer to say $100k. Still, I doubt filling out an 1116 is an onerous burden.

[Insert caveat that I'm no tax expert here. Would appreciate corrections for my own sake if I'm wrong.]

secondcor521

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Re: Tax efficiency
« Reply #9 on: March 29, 2019, 07:46:57 PM »
My question is this- where should each of these go to maximize tax efficiency over the long run?

This source may be useful:

https://www.bogleheads.org/wiki/Tax-efficient_fund_placement

MustacheAndaHalf

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Re: Tax efficiency
« Reply #10 on: March 30, 2019, 03:04:26 AM »
That's right - thanks for the correction on who needs to file form 1116 (not required to file with under $300 in tax/spouse).

Here's as example of  IXUS (iShares Total International ETF):
$64.40 / share
dividend 1.87%
my tax data shows 9.1% of dividend is a tax credit...
If in 2018 you owned 100 shares of ITOT (worth $6440 now), you had $120 in dividends (85% LTCG tax), and a $10 tax credit.
So $18 LTCG + $4 ord tax - $10 tax credit = $12 tax owed on $120 dividends (10%)

Wait... what?  Here's VEU (FTSE All-World ex-US ETF):
$50.16 / share
dividend 3.02% (!)
my tax data shows 7.8% of dividend is a tax credit...
If in 2018 you owned 128 shares of VEU (worth $6420 now), you had $194 in dividends (80% LTCG tax), and a $15 tax credit.
So $23 LTCG + $9 ord tax - $15 tax credit = $17 tax owed on $194 in dividends

Yikes... holding VEU in taxable is +40% more expensive than holding IXUS in taxable!  Let me change my advice: find the "total international" fund with the lowest distributions, and hold that in taxable.  There was greater variability between international funds than I expected.