Author Topic: Factoring Taxable Investments into Tax Planning  (Read 973 times)

geo_kale

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Factoring Taxable Investments into Tax Planning
« on: August 02, 2017, 09:12:33 AM »
Hi there!

This is my first year trying to do tax optimization/tax planning and I'm aiming for the saver's tax credit. Below is the breakdown of my tax situation (with # corresponding to the 1040). I'm trying not to exceed an AGI of $18,500 as that's the number I need to earn the total $1,000 saver's credit.

Gross Income: $48,176.00
401k: -$18,000.00
HSA:   -$2,700.00
457:   -$3,600.00
MAGI (7): $23,876.00
IRA Deduction: -$5,500.00
AGI (38): $18,376.00
Standard Deduction (40): -$6,350.00
Exemptions (42): -$4,050.00
Taxable Income (43): $7,976.00
Tax (44): $798.00
Saver's Credit (Form 8880): -$1,000.00
Total Tax (63): $0.00


My question: This is the first year I've saved money in a taxable investment account with Vanguard (VTSMX). I realize I haven't factored in this money anywhere(!) and I want to do so while I still have time to move more money into my tax deferred 457 account. Can someone describe to me how earnings in a taxable account are taxed? Dividends/interest/capital gains. Will all the earnings I've made need to be added into my gross income number above? It's all still very fuzzy to me.

Note: I reinvest dividends and haven't sold any shares/am not planning to anytime soon.

Thanks in advance for any tips! And please feel free to tell me what else I might be missing.
« Last Edit: August 02, 2017, 10:36:58 AM by geo_kale »

kenaces

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Re: Factoring Taxable Investments into Tax Planning
« Reply #1 on: August 02, 2017, 11:30:25 AM »
http://www.schwab.com/public/schwab/nn/articles/Taxes-Whats-New

As you can see if you are in lowest 2 brackets you pay no taxes on dividends and LT cap gains.

Depending on your total assets and estimate of future earnings there may be a case to Roth IRA instead of IRA.  No one knows the future tax rates/law it is nice to have assets in Roth/taxable accounts as you will have more options to have tax smart withdrawal strategies(as long as the upfront cost of this is small or even zero)
« Last Edit: August 03, 2017, 10:16:09 AM by kenaces »

Proud Foot

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Re: Factoring Taxable Investments into Tax Planning
« Reply #2 on: August 02, 2017, 12:04:03 PM »
The earnings from your taxable account are taxed as the link by kenaces states.  Your rate per your numbers would be the 0% LTCG/Qualified Dividends rate. You will most likely not have any capital gains from VTSMX as long as you don't sell and the dividends you receive are typically qualified dividends. Also whether you automatically reinvest them or not has no bearing on whether they are taxed or not.

As far as the Roth suggestion, using your numbers but removing the IRA deduction gets you a total tax of $1,155. Whether it makes more sense to do Roth or Traditional would all depend on what you think your tax rate will be in retirement and what you would do right now with the tax savings of using a Traditional.

terran

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Re: Factoring Taxable Investments into Tax Planning
« Reply #3 on: August 02, 2017, 12:58:35 PM »
Also remember that while you may not pay taxes on capital gains and qualified dividends, they are still income (really they are taxed, it's just at a rate of 0%), which means they will effect your eligibility for things like the saver's tax credit.

Are the investment options in your 457 good? Is it a governmental plan? If so, then for early retirement purposes I would prioritize it over all other investment options. If it's governmental and at least doesn't have terrible options you might consider putting in a bit more so you leave some headroom in your t.IRA to make up for any overages due to dividends since you can contribute to the IRA after all your other numbers are solidified. You can also always contribute to a Roth once your income is low enough for the savers tax credit since that will wipe out any tax liability you have. 

geo_kale

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Re: Factoring Taxable Investments into Tax Planning
« Reply #4 on: August 02, 2017, 01:50:41 PM »
Also remember that while you may not pay taxes on capital gains and qualified dividends, they are still income (really they are taxed, it's just at a rate of 0%), which means they will effect your eligibility for things like the saver's tax credit.

This part's a little confusing to me. I'll try to articulate my questions as best I can:
1). Upon reviewing the 1040, I see that dividends are meant to be included on line 9. I also see that taxable interest comes into play on line 8 - is this interest earned on taxable investments?
2). Since this money goes into the calculation for Adjusted Gross Income and thus taxable income, I'm having trouble understanding how it would be taxed differently from the rest of my money (at a 0% rate as stated above).
3). Can any Vanguard customers tell me where on their site I would find these numbers for estimation/planning purposes? I see the "Dividends and Capital Gains" tab which shows me year-to-date dividends, but I also checked the "Cost Basis" tab which shows me short-term capital gains (a totally different figure).

Are the investment options in your 457 good? Is it a governmental plan? If so, then for early retirement purposes I would prioritize it over all other investment options. If it's governmental and at least doesn't have terrible options you might consider putting in a bit more so you leave some headroom in your t.IRA to make up for any overages due to dividends since you can contribute to the IRA after all your other numbers are solidified. You can also always contribute to a Roth once your income is low enough for the savers tax credit since that will wipe out any tax liability you have. 

My 457 is governmental, but the best expense ratio I have is 1%. I'm working with Human Resources to see if we can get better options but I don't have any definite news on that front. This is why I haven't prioritized it before my 401k. Still, I love your idea about leaving room in the IRA since there's more flexibility in terms of contributing after my other numbers are solid. To your other point, I've also thought about how to strategize and fund a Roth if everything else is in order to earn the Saver's credit.

Proud Foot

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Re: Factoring Taxable Investments into Tax Planning
« Reply #5 on: August 02, 2017, 04:04:31 PM »
Also remember that while you may not pay taxes on capital gains and qualified dividends, they are still income (really they are taxed, it's just at a rate of 0%), which means they will effect your eligibility for things like the saver's tax credit.

This part's a little confusing to me. I'll try to articulate my questions as best I can:
1). Upon reviewing the 1040, I see that dividends are meant to be included on line 9. I also see that taxable interest comes into play on line 8 - is this interest earned on taxable investments?  Yes, the interest would be from Bonds, CD's, Savings Accounts, Interest Checking Accounts. You will receive a 1099-INT from whoever paid you the interest. If you don't have nay bonds this will be easy to calculate throughout the year from your bank statements.
2). Since this money goes into the calculation for Adjusted Gross Income and thus taxable income, I'm having trouble understanding how it would be taxed differently from the rest of my money (at a 0% rate as stated above). If the dividends are qualified (Line 9b) then you will use the Qualified Dividends and Capital Gain Tax Worksheet in the Form 1040 instructions for Line 44.
3). Can any Vanguard customers tell me where on their site I would find these numbers for estimation/planning purposes? I see the "Dividends and Capital Gains" tab which shows me year-to-date dividends, but I also checked the "Cost Basis" tab which shows me short-term capital gains (a totally different figure). Look at the Dividends and Capital Gains tab. The Cost Basis tab only shows any short-term/long-term capital gains if you were to sell your investments. Dividends and Capital Gains tab will show what was paid per share as a dividend or capital gains distribution. Use the number of shares you own and the per share dividend to estimate your annual dividends.


Bolded answers above.

geo_kale

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Re: Factoring Taxable Investments into Tax Planning
« Reply #6 on: August 02, 2017, 08:44:18 PM »
3). Can any Vanguard customers tell me where on their site I would find these numbers for estimation/planning purposes? I see the "Dividends and Capital Gains" tab which shows me year-to-date dividends, but I also checked the "Cost Basis" tab which shows me short-term capital gains (a totally different figure). Look at the Dividends and Capital Gains tab. The Cost Basis tab only shows any short-term/long-term capital gains if you were to sell your investments. Dividends and Capital Gains tab will show what was paid per share as a dividend or capital gains distribution. Use the number of shares you own and the per share dividend to estimate your annual dividends.

Bolded answers above.

Ok, so if I'm understanding correctly: Dividend earnings are included in my adjusted gross income. Short-term/long-term capital gains (i.e. how much my investments have made) only come into play if I sell shares...is that correct? Ultimately I'm looking at how to estimate my AGI accurately since I'm aiming for a certain $ amount.

Thanks all for the wisdom!

MDM

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Re: Factoring Taxable Investments into Tax Planning
« Reply #7 on: August 02, 2017, 09:55:16 PM »
This is my first year trying to do tax optimization/tax planning and I'm aiming for the saver's tax credit.
Ultimately I'm looking at how to estimate my AGI accurately since I'm aiming for a certain $ amount.
The first post implies this won't be the first year doing taxes at all.  If you have commercial tax software from 2016, using it to do a dummy 2017 return could be illuminating.  Just don't assume it will be accurate to the nearest $1, as there may be slight tax law differences from one year to the next.

You could also use the tax calculations in the case study spreadsheet, which does have 2017 numbers but is not commercial tax software. 

MDM

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Re: Factoring Taxable Investments into Tax Planning
« Reply #8 on: August 02, 2017, 09:55:57 PM »
Ok, so if I'm understanding correctly: Dividend earnings are included in my adjusted gross income. Short-term/long-term capital gains (i.e. how much my investments have made) only come into play if I sell shares...is that correct?
Yes.

geo_kale

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Re: Factoring Taxable Investments into Tax Planning
« Reply #9 on: August 03, 2017, 12:54:17 PM »
The first post implies this won't be the first year doing taxes at all.  If you have commercial tax software from 2016, using it to do a dummy 2017 return could be illuminating.  Just don't assume it will be accurate to the nearest $1, as there may be slight tax law differences from one year to the next.

You could also use the tax calculations in the case study spreadsheet, which does have 2017 numbers but is not commercial tax software. 

Ok, so if I'm understanding correctly: Dividend earnings are included in my adjusted gross income. Short-term/long-term capital gains (i.e. how much my investments have made) only come into play if I sell shares...is that correct?
Yes.

Thanks for clarifying MDM. I will take another look at the case study spreadsheet and do plan to complete a few dummy 2017 returns while I still have time to make changes to my various contributions.

Ramparts

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Re: Factoring Taxable Investments into Tax Planning
« Reply #10 on: August 04, 2017, 10:08:12 AM »
Ok, so if I'm understanding correctly: Dividend earnings are included in my adjusted gross income. Short-term/long-term capital gains (i.e. how much my investments have made) only come into play if I sell shares...is that correct?
Yes.

This isn't true in general. The fund can distribute capital gains, and taxes must be paid in that tax year for them, even if you don't sell any shares. Vanguard has some special structure that it uses to avoid these distributions in its funds, but I've no idea if that just lessens the blow or is guaranteed to remove them entirely. It hasn't had any for a while (or ever?) in any case, so you're probably fine.

For example, Fidelity's equivalent to VTSAX, FSTVX, has both short and long-term capital gains in some tax years (in addition to dividend income): http://www.morningstar.com/funds/XNAS/FSTVX/quote.html

(Scroll down to "Dividend and Capital Gains Distributions", and compare it to other funds you have or are interested in).

MDM

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Re: Factoring Taxable Investments into Tax Planning
« Reply #11 on: August 04, 2017, 11:22:11 AM »
Ok, so if I'm understanding correctly: Dividend earnings are included in my adjusted gross income. Short-term/long-term capital gains (i.e. how much my investments have made) only come into play if I sell shares...is that correct?
Yes.

This isn't true in general. The fund can distribute capital gains, and taxes must be paid in that tax year for them, even if you don't sell any shares. Vanguard has some special structure that it uses to avoid these distributions in its funds, but I've no idea if that just lessens the blow or is guaranteed to remove them entirely. It hasn't had any for a while (or ever?) in any case, so you're probably fine.

For example, Fidelity's equivalent to VTSAX, FSTVX, has both short and long-term capital gains in some tax years (in addition to dividend income): http://www.morningstar.com/funds/XNAS/FSTVX/quote.html

(Scroll down to "Dividend and Capital Gains Distributions", and compare it to other funds you have or are interested in).

Note that the OP's question was "3). Can any Vanguard customers tell me where on their site I would find these numbers for estimation/planning purposes? I see the "Dividends and Capital Gains" tab which shows me year-to-date dividends, but I also checked the "Cost Basis" tab which shows me short-term capital gains (a totally different figure)."

The difference here is between the dividends and capital gains that occur "within" the funds and are reported on a 1099-DIV (and are included in AGI every year), vs. the capital gains one incurs only if selling a fund one bought.  The latter are reported on a 1099-B.