Author Topic: Tax implications of reallocating  (Read 878 times)

BuzzFire

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Tax implications of reallocating
« on: December 20, 2017, 11:58:28 AM »
Last year I received a sizable inheritance split into a taxable account and an IRA account. I set up a lazy portfolio with Fidelity that consists of a total market index, a total bond index, and a REIT index. I put the REIT in the IRA, which I think is correct? However, I put the bond fund in the taxable account, and it is about 10% of my portfolio. Does it make sense to somehow move it to the IRA, or would you just leave it alone?

terran

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Re: Tax implications of reallocating
« Reply #1 on: December 20, 2017, 12:00:36 PM »

daverobev

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Re: Tax implications of reallocating
« Reply #2 on: December 20, 2017, 12:01:56 PM »
You want 'high return' stuff in tax shelters, and 'low return' stuff outside - you want to shelter growth. Over the longer period, stocks grow more than bonds (which may or may not beat inflation). The last few years have been great for bonds as interest rates have gone down.

I would not put bonds into a tax shelter.

BuzzFire

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Re: Tax implications of reallocating
« Reply #3 on: December 20, 2017, 12:37:20 PM »
You want 'high return' stuff in tax shelters, and 'low return' stuff outside - you want to shelter growth. Over the longer period, stocks grow more than bonds (which may or may not beat inflation). The last few years have been great for bonds as interest rates have gone down.

I would not put bonds into a tax shelter.
So I should just stay the course?

terran

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Re: Tax implications of reallocating
« Reply #4 on: December 20, 2017, 12:48:24 PM »
You want 'high return' stuff in tax shelters, and 'low return' stuff outside - you want to shelter growth. Over the longer period, stocks grow more than bonds (which may or may not beat inflation). The last few years have been great for bonds as interest rates have gone down.

I would not put bonds into a tax shelter.

That's actually the opposite of the common recommendation. Capital gains have favorable tax rates below regular income tax rates in all brackets. You could make an argument that stocks are best in Roth because that will never be taxed on gains in roth while gains will be taxed if held in taxable, but if you're comparing taxable and tax deferred then the gains will actually be taxed at a lower rate in taxable.

Also, bond interest is paid regularly and at ordinary income tax rates, so you actually DO want it to be tax advantaged for the same reason that you want to defer income while working: you're likely to be in a lower tax bracket when you withdraw than you are while working, so you'd rather pay tax on the bond interest in the future than you would now.

Basically, roth is good for things you expect to grow a lot, tax deferred is good if you think your future tax rate will be less than your current tax rate regardless of growth, any tax advantaged is good for things that force you to take income now, taxable is good for things that grow but don't force you to take income now. Roth is still always better than taxable for all things, but to get roth space you (may) have to give up tax deferred space, and deferring taxes is always better than not if you think our future tax rate will be lower than your current tax rate.

BuzzFire

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Re: Tax implications of reallocating
« Reply #5 on: December 20, 2017, 01:17:53 PM »
To better clarify my question..My wife is going to work five more years and then we will start withdrawing from the retirement accounts. We will start from the taxable accounts and also probably start a Roth ladder from our IRAs. I just want everything to be optimized for the withdrawal phase. So should I take a tax hit now by selling the bonds in the taxable account and buying them in the IRA, or just leave it alone? We plan to withdraw in the same range as her current salary which is $110k-$130k.

terran

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Re: Tax implications of reallocating
« Reply #6 on: December 20, 2017, 01:32:36 PM »
Read the bogleheads link.

Since your tax rate won't change (although it might with the new tax bill, so look into that before you do anything this year) then it probably makes sense to sell the bonds in taxable now and rebuy in tax deferred and instead invest in equities in taxable. Make sure you don't bump yourself into a higher bracket when selling the bonds (you probably don't have much in gains on them since bonds don't grow that much).

Remember that the investments you inherited received a stepped up basis on the date of death, so you'll only owe tax on the gains from then to now. Also remember that you may need to take RMDs on inherited IRAs and there shouldn't be early withdrawal penalties (check on both of those if the person you inherited from was under 59.5, as I'm not sure if that changes things), so I'm not sure the roth ladder is necessary (I think you could withdraw straight from the inherited IRAs).

You should probably withdraw from the IRA's at least up to the standard deduction as soon as your wife stops working. That will not be taxed at all. You may want to withdraw up to the top of the 10% bracket. Then the gains from taxable up to the top of the 15% bracket will also not be taxed. Since not all the taxable withdrawals will be taxed (only the gains) that might give you enough income without even going into the 25% bracket where you likely are now.

BuzzFire

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Re: Tax implications of reallocating
« Reply #7 on: December 20, 2017, 04:23:04 PM »
Read the bogleheads link.

Since your tax rate won't change (although it might with the new tax bill, so look into that before you do anything this year) then it probably makes sense to sell the bonds in taxable now and rebuy in tax deferred and instead invest in equities in taxable. Make sure you don't bump yourself into a higher bracket when selling the bonds (you probably don't have much in gains on them since bonds don't grow that much).

Remember that the investments you inherited received a stepped up basis on the date of death, so you'll only owe tax on the gains from then to now. Also remember that you may need to take RMDs on inherited IRAs and there shouldn't be early withdrawal penalties (check on both of those if the person you inherited from was under 59.5, as I'm not sure if that changes things), so I'm not sure the roth ladder is necessary (I think you could withdraw straight from the inherited IRAs).

You should probably withdraw from the IRA's at least up to the standard deduction as soon as your wife stops working. That will not be taxed at all. You may want to withdraw up to the top of the 10% bracket. Then the gains from taxable up to the top of the 15% bracket will also not be taxed. Since not all the taxable withdrawals will be taxed (only the gains) that might give you enough income without even going into the 25% bracket where you likely are now.
That is terrific advice. Thank you very much. I have read so much from these forums, JLCollins, MadFientist etc, but could not quite translate it all to my specific situation. Where do I send the bottle of wine?

terran

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Re: Tax implications of reallocating
« Reply #8 on: December 20, 2017, 07:26:11 PM »
That is terrific advice. Thank you very much. I have read so much from these forums, JLCollins, MadFientist etc, but could not quite translate it all to my specific situation. Where do I send the bottle of wine?

No Worries, glad I could help!

Another thought that has occurred to me: If you're not currently maxing out IRAs for both you and your wife, and whatever tax advantaged accounts she has through work, do that even if it means you use some of your taxable account for living expenses now.

BuzzFire

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Re: Tax implications of reallocating
« Reply #9 on: January 03, 2018, 01:39:50 PM »
I have one more withdrawal question. My wife and I will also have our own rollover 401(k)s, hers being a Roth 401 that will each be in the $700k range. How would I effectively add these to the withdrawal strategy laid down by Terran? We have the nice problem of being able to let them grow and just use my inheritance. However, part of me thinks it would only be fair to use some of her Roth 401(k). Also, the inherited IRA has MRDs, so I would have to withdraw from that.

terran

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Re: Tax implications of reallocating
« Reply #10 on: January 03, 2018, 02:28:18 PM »
Since you're married you're treated as a unified entity for tax purposes, so I wouldn't worry about fairness, and just do what's best for taxes.

Since you have such a large amount available in Roth, something you might consider is withdrawing from the IRA's both for spending and converting to roth such that you at least fill the standard deduction, and don't go over the 10-12% bracket. Then fill the rest of the 0% capital gains bracket (near the top of the new 12% bracket, but it's actually the same as the old 15% bracket) -- remember this is based on gains, not the amount you withdraw. Then withdraw from Roth to make up the rest of your spending. This would keep your taxes below what they are currently despite living on the same amount.

BuzzFire

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Re: Tax implications of reallocating
« Reply #11 on: January 03, 2018, 02:55:51 PM »
Since you're married you're treated as a unified entity for tax purposes, so I wouldn't worry about fairness, and just do what's best for taxes.

Since you have such a large amount available in Roth, something you might consider is withdrawing from the IRA's both for spending and converting to roth such that you at least fill the standard deduction, and don't go over the 10-12% bracket. Then fill the rest of the 0% capital gains bracket (near the top of the new 12% bracket, but it's actually the same as the old 15% bracket) -- remember this is based on gains, not the amount you withdraw. Then withdraw from Roth to make up the rest of your spending. This would keep your taxes below what they are currently despite living on the same amount.

Thank you. Maybe you can dumb it down in a hypothetical. Suppose we retired this year with these buckets and wanted income of $120k with a mandatory withdrawal of $20k from the inherited IRA. What amounts would you withdraw from the various accounts and how much would you convert to Roth?

terran

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Re: Tax implications of reallocating
« Reply #12 on: January 03, 2018, 03:01:23 PM »
It's all kind of a judgment call each year because tax brackets change and the amount in each account type changes. For the hypothetical, could you also include how much is in taxable, how much of that is gains (remember you received a stepped up basis on death), how much in traditional IRA/401k (both inherited and your own) and how much in Roth IRA/401k?

terran

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Re: Tax implications of reallocating
« Reply #13 on: January 03, 2018, 03:15:55 PM »
I haven't messed around with it too much, but you might find the calculators here helpful: https://www.i-orp.com.

BuzzFire

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Re: Tax implications of reallocating
« Reply #14 on: January 03, 2018, 03:58:35 PM »
It's all kind of a judgment call each year because tax brackets change and the amount in each account type changes. For the hypothetical, could you also include how much is in taxable, how much of that is gains (remember you received a stepped up basis on death), how much in traditional IRA/401k (both inherited and your own) and how much in Roth IRA/401k?
Inherited taxable $1.2M  $180k in gains
Inherited IRA $732k $110k in gains
My rollover IRA $584k
DW Roth 401k $602k

MMbergmann

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Re: Tax implications of reallocating
« Reply #15 on: January 03, 2018, 08:28:05 PM »
It's all kind of a judgment call each year because tax brackets change and the amount in each account type changes. For the hypothetical, could you also include how much is in taxable, how much of that is gains (remember you received a stepped up basis on death), how much in traditional IRA/401k (both inherited and your own) and how much in Roth IRA/401k?
Inherited taxable $1.2M  $180k in gains
Inherited IRA $732k $110k in gains
My rollover IRA $584k
DW Roth 401k $602k

Answering your question so you might have two answers to choose from. I would do 4k more so 24k from the inherited IRA to fill up the new 24k standard deduction. 14.5k from your IRA. That would be about 2.5% of your IRA per year. 15k from her Roth. This leaves 66.5k from the taxable inherited.

14.5 would be taxed @ 10%. The gains, something less than the 66.5k from the taxable, would be taxed @ 0% until your total between gains and 14.5 from your IRA hit 77,200, which it probably wouldn't hit.

This is not meant as tax advice.

terran

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Re: Tax implications of reallocating
« Reply #16 on: January 03, 2018, 10:22:21 PM »
It's all kind of a judgment call each year because tax brackets change and the amount in each account type changes. For the hypothetical, could you also include how much is in taxable, how much of that is gains (remember you received a stepped up basis on death), how much in traditional IRA/401k (both inherited and your own) and how much in Roth IRA/401k?
Inherited taxable $1.2M  $180k in gains
Inherited IRA $732k $110k in gains
My rollover IRA $584k
DW Roth 401k $602k

Answering your question so you might have two answers to choose from. I would do 4k more so 24k from the inherited IRA to fill up the new 24k standard deduction. 14.5k from your IRA. That would be about 2.5% of your IRA per year. 15k from her Roth. This leaves 66.5k from the taxable inherited.

14.5 would be taxed @ 10%. The gains, something less than the 66.5k from the taxable, would be taxed @ 0% until your total between gains and 14.5 from your IRA hit 77,200, which it probably wouldn't hit.

This is not meant as tax advice.

This sounds like great advice to me.

Here's how I might think of it:
IRA withdrawals/conversions to roth: $24000 standard deduction + $19050 10% bracket = $43050

Capital gains harvesting: up to top of 0% capital gains rate ($77,200), so another $58,150. Since 180k/1.2M = 15% of your taxable holdings are gains, this would mean you're selling 58150/0.15 = $387,666 worth of stock. Of course, you'll need to reinvest some of that since it's more than you need to live on. You can buy back exactly what you sold if you want (wash sales only count when you sell at a loss, not a gain). This math will of course change every year as you have different amounts of gains.

This would result in a total federal tax bill of $1905.

Since you'll have plenty to live off of from the taxable account sale, I would make the IRA withdrawals conversions to roth to the extent possible (so the $14150 over your RMD).

I think going into the 12% bracket for roth conversions would also be a decent option. In this case, you need $100k of spending money over your $20k RMD, which would have a $15k gain if you sell taxable. So you would have $20,000 RMD, $100k taxable sale (for $15k gain) which make up your spending money and as much as a $66,200 IRA to roth conversion (if I did the math right -- definitely double check and/or run it through some tax software). This would result in a total federal tax bill of $7083.

Anywhere in between those options would work out just fine. At some point you'll probably run out of IRA to be converted and/or gains to be harvested at which point you may consider withdrawing more from the inherited IRA to live off of than the RMD since you can't roth convert an inherited IRA (according to the google search I just did).

 

BuzzFire

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Re: Tax implications of reallocating
« Reply #17 on: January 04, 2018, 11:51:17 AM »
These are some great examples, thank you. I love reading about saving/investing, accumulation phase, frugality etc, but the withdrawal phase, turning off the fire hose, and tax efficiency is scary and hurts my brain lol. It seems that no matter how we play it, our taxes will be a lot less than what we pay now living off of my wife's salary.

terran

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Re: Tax implications of reallocating
« Reply #18 on: January 04, 2018, 01:57:15 PM »
These are some great examples, thank you. I love reading about saving/investing, accumulation phase, frugality etc, but the withdrawal phase, turning off the fire hose, and tax efficiency is scary and hurts my brain lol. It seems that no matter how we play it, our taxes will be a lot less than what we pay now living off of my wife's salary.

Yeah, between favorable capital gains rates and no payroll taxes the tax system is much nicer once you don't have earned income

MustacheAndaHalf

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Re: Tax implications of reallocating
« Reply #19 on: January 05, 2018, 09:25:07 AM »
I thought when you inherit an IRA, you can't wait until retirement to make withdrawals.  Here's Fidelity's take on it, since the IRS description is a bit complicated: 
https://www.fidelity.com/building-savings/learn-about-iras/inherited-ira-rmd

If this IRA plus your overall income puts you in a higher tax bracket, consider using tax-exempt bonds.  Using tax-exempt bonds lets you put the bonds in taxable, where they are not part of your tax bill.  That leaves more room in your retirement accounts for stocks.  (But for the purpose of rebalancing in the future, you might consider having some allocation to bonds in your retirement accounts).