Author Topic: Optimal investment allocation in taxable account for ACA subsidies?  (Read 835 times)

leavesofgrass

  • 5 O'Clock Shadow
  • *
  • Posts: 53
Hi! New here. :)

For those of you out there with a sizable taxable account, how have you structured your assets while qualifying for ACA subsidies?

I'm currently fully employed, but I would like to quit my job and take time off in 2019 to focus on personal pursuits and some travel. I plan to go back to work in 2020. I live in California, and I'm trying to get some tips on the most optimal taxable asset allocation. I inherited $1.6M taxable money mid-2018: mostly cash, interest exempt MM and bonds, International Index and Total Stock Market Index, and a couple of tax-inefficient funds (Vanguard Wellington & TRP Capital Appreciation). I'm trying to figure out the best recipe for asset allocation so as to estimate income, and this is what I'm having trouble with. I plan to work during the first few months of 2019, and I think I can estimate/manipulate this income with 401k & HSA contributions, but once I quit, I feel very unsure about the taxable investment income and where I would land with that. Does anyone have any suggestions? What have you done?

secondcor521

  • Handlebar Stache
  • *****
  • Posts: 2165
  • Age: 50
  • Location: Boise, Idaho
  • Big cattle, no hat.
    • Age of Eon - Overwatch player videos
Re: Optimal investment allocation in taxable account for ACA subsidies?
« Reply #1 on: November 03, 2018, 11:51:49 AM »
My taxable account isn't really sizeable.

My taxable is entirely in VTSAX, which throws off ~1.8%-2.0% in income.  I like it as an investment, and I also like it for the fact that its impact on my ACA MAGI is negligible.

As far as estimating income when you're FIREd, what I do is I have a very simple AGI spreadsheet that lists what my income from all sources is estimated to be (interest, dividends, capital gains, and other income).  By mid-December, I can pretty much finalize it because I've already received the income.  I then decide how much to do in Roth conversions and how much 0% LTCG to harvest based on the impacts to my cash flow and taxes.  I execute those transactions in the last week or so of the year.

If you want a rough estimate earlier in the year, you can usually look up the mutual funds you hold and see what their distributions have been over the past year and just use that.  Some funds have more variability in their distributions; I'm not sure how to account for those because I don't own any of them.

Frankies Girl

  • Magnum Stache
  • ******
  • Posts: 2953
  • Age: 81
  • Location: The laboratory
  • Typical Ghoul Next Door
Re: Optimal investment allocation in taxable account for ACA subsidies?
« Reply #2 on: November 03, 2018, 01:56:12 PM »
If you just inherited the taxable account, you're going to likely have stepped up cost basis on all the funds held in the taxable account, therefore selling them off ASAP is likely going to minimize the cap gains (due to stepped up cost reset). So figuring out NOW what you want to hold fund-wise in there is going to be a priority.

For me, when I inherited from my dad, I had no real working knowledge of how investing worked, so it took me about a year to get up to speed before I knew what to put where. As soon as I knew what I wanted to do (index investing/self manage), I figured out my investing policy statement, then my asset allocation and after that, I sold off all the stinkers and bought the funds that were the most tax efficient to hold in my taxable account that fit with my AA.

https://www.bogleheads.org/wiki/Investment_policy_statement
https://www.bogleheads.org/wiki/Asset_allocation

This helped quite a bit:
https://www.bogleheads.org/wiki/Principles_of_tax-efficient_fund_placement

Buying long term CDs or other more stable value/cash may also be an option as well.

If you want growth in that taxable account, then Vanguard's total market index fund VTSAX is actually a patent holder for how they handle/minimize dividends, so they are more tax efficient than most any other decent fund out there.


I am FIREd and the way I figure out how I'm doing is I use a budget/monitoring service (Mint) to track stuff in general, I keep a spreadsheet with all the monthly taxable income documented, and I can see at a glance where I am as far as interest earned, cap gains/dividends, and any surprises like jury duty or part time income generated. If it is taxable income, it gets counted.

All funds have a spot listing their "fees and distribution" schedules. Most all of the funds I'm familiar with do a small distribution in April and then a large one in December. You can look back and see what they assessed, and the companies also put out a year end distribution schedule with estimates for the big distribution in December. I can figure out pretty easily now what is going to hit when since I've been monitoring this for a few years now, and once you start tracking it, it will be pretty easy going forward.
« Last Edit: November 03, 2018, 01:57:57 PM by Frankies Girl »

leavesofgrass

  • 5 O'Clock Shadow
  • *
  • Posts: 53
Re: Optimal investment allocation in taxable account for ACA subsidies?
« Reply #3 on: November 04, 2018, 08:18:16 AM »
Thank you, this is all very helpful. Putting together a simple spreadsheet with all my holdings and then looking back at historical distributions is a great idea. Also, buying CD's that don't mature until after 2019 -- duh, that would be a good way to avoid interest in 2019. I didn't even think of that!

I follow the Bogleheads philosophy and forum and that's helped me a lot. I intend to put 50% of assets into Total Stock Market and Total International Index Funds. But I'm DCAing this over the next few months. I'm mostly using Fidelity for this since I got a promotion from transferring my funds from TRP. Ideally I'd like to use VTSAX, but it looks like most will be going to FZROX - Fidelity ZERO Total Market Index Fund. Hopefully that is similarly tax efficient.

FatFI2025

  • Stubble
  • **
  • Posts: 149
  • Location: California
Re: Optimal investment allocation in taxable account for ACA subsidies?
« Reply #4 on: November 04, 2018, 08:57:51 AM »
To answer your question exactly, MM, zero coupon bonds or zero coupon CDs. But IMO I don't think you're asking the right question. First thing, why aren't you using COBRA? With a $1.6M portfolio and W2 income, why would you want to get under 400% FPL to qualify for ACA subsidies? It seems like the tax tail is wagging the dog.

leavesofgrass

  • 5 O'Clock Shadow
  • *
  • Posts: 53
Re: Optimal investment allocation in taxable account for ACA subsidies?
« Reply #5 on: November 04, 2018, 11:21:55 AM »
To answer your question exactly, MM, zero coupon bonds or zero coupon CDs. But IMO I don't think you're asking the right question. First thing, why aren't you using COBRA? With a $1.6M portfolio and W2 income, why would you want to get under 400% FPL to qualify for ACA subsidies? It seems like the tax tail is wagging the dog.

I see your point, but my goal is not to work in 2019, so if there's a way I can reasonably estimate my income while having a tax-efficient plan for that year so as to reduce my health insurance costs, which is a big line item, I think it's a route worth pursuing. COBRA is an option.

secondcor521

  • Handlebar Stache
  • *****
  • Posts: 2165
  • Age: 50
  • Location: Boise, Idaho
  • Big cattle, no hat.
    • Age of Eon - Overwatch player videos
Re: Optimal investment allocation in taxable account for ACA subsidies?
« Reply #6 on: November 04, 2018, 05:26:54 PM »
To answer your question exactly, MM, zero coupon bonds or zero coupon CDs. But IMO I don't think you're asking the right question. First thing, why aren't you using COBRA? With a $1.6M portfolio and W2 income, why would you want to get under 400% FPL to qualify for ACA subsidies? It seems like the tax tail is wagging the dog.

I'm not MM, but I can think of several reasons to manage MAGI to get ACA subsidies in the OP's situation.  You might prefer COBRA if you woke up in MM's situation, but there are factors that may differ and produce a different choice.  A few factors off the top of my head would be the size of MM's family, if they have any children in college, if they have a paid off home, other assets besides the $1.6M inherited taxable account, what kind of lifestyle they want, and whether they are planning to stay in California.

FatFI2025

  • Stubble
  • **
  • Posts: 149
  • Location: California
Re: Optimal investment allocation in taxable account for ACA subsidies?
« Reply #7 on: November 05, 2018, 07:22:25 AM »
To answer your question exactly, MM, zero coupon bonds or zero coupon CDs. But IMO I don't think you're asking the right question. First thing, why aren't you using COBRA? With a $1.6M portfolio and W2 income, why would you want to get under 400% FPL to qualify for ACA subsidies? It seems like the tax tail is wagging the dog.

I'm not MM, but I can think of several reasons to manage MAGI to get ACA subsidies in the OP's situation.  You might prefer COBRA if you woke up in MM's situation, but there are factors that may differ and produce a different choice.  A few factors off the top of my head would be the size of MM's family, if they have any children in college, if they have a paid off home, other assets besides the $1.6M inherited taxable account, what kind of lifestyle they want, and whether they are planning to stay in California.

Yes, true I am definitely looking at it through my own lens. If this were me and the goal were to take a one year sabbatical, maximizing wealth at the end of the sabbatical, that goal would not be met by shifting around investments to get the ACA subsidies. It would be met by splitting the sabbatical equally across calendar years '19 and '20 to minimize income tax and going with COBRA. The difference between this approach and the one assumed by OP would result in thousands of dollars lower NW at the end of CY21 in my situation.

Here in CA, ACA subsidies tend to be lower because SLCSP costs are among the lowest in the country -- if I lowered my MAGI to $40k, my subsidy would be $459 for the year. If I were to take off all of CY19 instead of splitting across two years, I would pay an additional $14.5k in W2 income taxes. This doesn't count the potential loss of returns from restructuring $1.6M in investments to minimize CY19 income. So let's say the total difference is $25k -- it would be "tail wagging the dog" to implement a strategy that costs me $25k to qualify for a $459 subsidy. This is why I wanted to challenge OP's original assumption that pursuit of ACA subsidies is inherently a wise financial strategy and maybe open up the aperture of the discussion.

secondcor521

  • Handlebar Stache
  • *****
  • Posts: 2165
  • Age: 50
  • Location: Boise, Idaho
  • Big cattle, no hat.
    • Age of Eon - Overwatch player videos
Re: Optimal investment allocation in taxable account for ACA subsidies?
« Reply #8 on: November 05, 2018, 09:14:52 AM »
To answer your question exactly, MM, zero coupon bonds or zero coupon CDs. But IMO I don't think you're asking the right question. First thing, why aren't you using COBRA? With a $1.6M portfolio and W2 income, why would you want to get under 400% FPL to qualify for ACA subsidies? It seems like the tax tail is wagging the dog.

I'm not MM, but I can think of several reasons to manage MAGI to get ACA subsidies in the OP's situation.  You might prefer COBRA if you woke up in MM's situation, but there are factors that may differ and produce a different choice.  A few factors off the top of my head would be the size of MM's family, if they have any children in college, if they have a paid off home, other assets besides the $1.6M inherited taxable account, what kind of lifestyle they want, and whether they are planning to stay in California.

Yes, true I am definitely looking at it through my own lens. If this were me and the goal were to take a one year sabbatical, maximizing wealth at the end of the sabbatical, that goal would not be met by shifting around investments to get the ACA subsidies. It would be met by splitting the sabbatical equally across calendar years '19 and '20 to minimize income tax and going with COBRA. The difference between this approach and the one assumed by OP would result in thousands of dollars lower NW at the end of CY21 in my situation.

Here in CA, ACA subsidies tend to be lower because SLCSP costs are among the lowest in the country -- if I lowered my MAGI to $40k, my subsidy would be $459 for the year. If I were to take off all of CY19 instead of splitting across two years, I would pay an additional $14.5k in W2 income taxes. This doesn't count the potential loss of returns from restructuring $1.6M in investments to minimize CY19 income. So let's say the total difference is $25k -- it would be "tail wagging the dog" to implement a strategy that costs me $25k to qualify for a $459 subsidy. This is why I wanted to challenge OP's original assumption that pursuit of ACA subsidies is inherently a wise financial strategy and maybe open up the aperture of the discussion.

I appreciate the fuller explanation.

I too was looking at the OP's situation through my own lenses as well, as it turns out.  Being FIREd, I totally misread the OP's intention to take a sabbatical rather than FIRE full time :-).  And in Idaho, the ACA subsidies are, for whatever reason, much higher - five figures in my 2019 situation.

Lots of moving parts.  I'm glad you challenged OP's decision.  It's always good to consider alternatives carefully.

Cheers!  :-)

leavesofgrass

  • 5 O'Clock Shadow
  • *
  • Posts: 53
Re: Optimal investment allocation in taxable account for ACA subsidies?
« Reply #9 on: November 05, 2018, 12:42:32 PM »
To answer your question exactly, MM, zero coupon bonds or zero coupon CDs. But IMO I don't think you're asking the right question. First thing, why aren't you using COBRA? With a $1.6M portfolio and W2 income, why would you want to get under 400% FPL to qualify for ACA subsidies? It seems like the tax tail is wagging the dog.

I'm not MM, but I can think of several reasons to manage MAGI to get ACA subsidies in the OP's situation.  You might prefer COBRA if you woke up in MM's situation, but there are factors that may differ and produce a different choice.  A few factors off the top of my head would be the size of MM's family, if they have any children in college, if they have a paid off home, other assets besides the $1.6M inherited taxable account, what kind of lifestyle they want, and whether they are planning to stay in California.

Yes, true I am definitely looking at it through my own lens. If this were me and the goal were to take a one year sabbatical, maximizing wealth at the end of the sabbatical, that goal would not be met by shifting around investments to get the ACA subsidies. It would be met by splitting the sabbatical equally across calendar years '19 and '20 to minimize income tax and going with COBRA. The difference between this approach and the one assumed by OP would result in thousands of dollars lower NW at the end of CY21 in my situation.

Here in CA, ACA subsidies tend to be lower because SLCSP costs are among the lowest in the country -- if I lowered my MAGI to $40k, my subsidy would be $459 for the year. If I were to take off all of CY19 instead of splitting across two years, I would pay an additional $14.5k in W2 income taxes. This doesn't count the potential loss of returns from restructuring $1.6M in investments to minimize CY19 income. So let's say the total difference is $25k -- it would be "tail wagging the dog" to implement a strategy that costs me $25k to qualify for a $459 subsidy. This is why I wanted to challenge OP's original assumption that pursuit of ACA subsidies is inherently a wise financial strategy and maybe open up the aperture of the discussion.

Thank you, RyaninLA. Your comments have me reconsidering my departure timing. I'm not the very well-versed in W2 taxes, so how are you getting a savings of $25k if I stopped working mid-2019 through mid-2020 ($14.5k/calendar year) rather than say, March 2019 - Dec/Jan 19/2020?

I'm single, no kids, rent, and my salary is about $95k. If I were to work through June 2019, I would have time to fully fund my 401k. Other than my taxable assets, I only have about $150k in Roth/401k.

FatFI2025

  • Stubble
  • **
  • Posts: 149
  • Location: California
Re: Optimal investment allocation in taxable account for ACA subsidies?
« Reply #10 on: November 06, 2018, 08:02:28 AM »
To answer your question exactly, MM, zero coupon bonds or zero coupon CDs. But IMO I don't think you're asking the right question. First thing, why aren't you using COBRA? With a $1.6M portfolio and W2 income, why would you want to get under 400% FPL to qualify for ACA subsidies? It seems like the tax tail is wagging the dog.

I'm not MM, but I can think of several reasons to manage MAGI to get ACA subsidies in the OP's situation.  You might prefer COBRA if you woke up in MM's situation, but there are factors that may differ and produce a different choice.  A few factors off the top of my head would be the size of MM's family, if they have any children in college, if they have a paid off home, other assets besides the $1.6M inherited taxable account, what kind of lifestyle they want, and whether they are planning to stay in California.

Yes, true I am definitely looking at it through my own lens. If this were me and the goal were to take a one year sabbatical, maximizing wealth at the end of the sabbatical, that goal would not be met by shifting around investments to get the ACA subsidies. It would be met by splitting the sabbatical equally across calendar years '19 and '20 to minimize income tax and going with COBRA. The difference between this approach and the one assumed by OP would result in thousands of dollars lower NW at the end of CY21 in my situation.

Here in CA, ACA subsidies tend to be lower because SLCSP costs are among the lowest in the country -- if I lowered my MAGI to $40k, my subsidy would be $459 for the year. If I were to take off all of CY19 instead of splitting across two years, I would pay an additional $14.5k in W2 income taxes. This doesn't count the potential loss of returns from restructuring $1.6M in investments to minimize CY19 income. So let's say the total difference is $25k -- it would be "tail wagging the dog" to implement a strategy that costs me $25k to qualify for a $459 subsidy. This is why I wanted to challenge OP's original assumption that pursuit of ACA subsidies is inherently a wise financial
 strategy and maybe open up the aperture of the discussion.

Thank you, RyaninLA. Your comments have me reconsidering my departure timing. I'm not the very well-versed in W2 taxes, so how are you getting a savings of $25k if I stopped working mid-2019 through mid-2020 ($14.5k/calendar year) rather than say, March 2019 - Dec/Jan 19/2020?

I'm single, no kids, rent, and my salary is about $95k. If I were to work through June 2019, I would have time to fully fund my 401k. Other than my taxable assets, I only have about $150k in Roth/401k.

I'm glad I convinced you to look at some other elements -- that's why we're all here on these forums to point this stuff out. My comparison was taking off Jan '19 - Dec '19 versus Jul '19 - Jun '20. If I plug $95k into the Smart Asset CA tax calculator, including $19k 401k contribution, it gives a total tax liability of $21k. If we split that sabbatical over two years and enter $47.5k of income w/ $19k of 401k contributions, the tax liability is $6k per year -- which I then multiply by two years for a total of $12k. So looking at the W2 impact alone, the estimated difference for you is $9k.

Then we add the theoretical income from investments, which I'm just going to plug as 3.5% from dividends and interest from with your portfolio optimized for the long run. That's $56,000 in income that's going to hit your MAGI on 1040.

Now when looking at subsidies and plans for someone at 35 y/o, subsidies max out at $18k/yr income and go to zero beyond $45k of income. To get down to this $18k MAGI, you would figure out how much income to shave off or defer by starting with 18k + $47.5k (salary) - $19k (401k) - $12k (std deduction) + $56k (1099 income) = $90k. So to get the max ACA subsidy of $3,675, you would have to shave off or defer $90k of income, which does not seem like a good deal to me.

Then I thought about COBRA. My 2019 plan premium is $64/mo, which is 50% of the total premium, so if I were to go on COBRA then my share would pop up to $128/mo and $1,536 for the year. It's an $1,850 deductible plan with $3,500 out-of-pocket max. This would cost $350/mo, $4,200/yr, on Covered California, but the max subsidy would bring the cost down to $500/yr.

So looking at this situation for you, it's possible to take advantage of the ACA subsidies, but the tradeoff seems really high. You can definitely wipe out that $56k of investment income, but consider that if your optimal allocation is yielding 7% nominal returns, a dividend-minimizing approach may give you 4%, a difference of $48,000 on a $1.6M portfolio.

This is the longest post I've ever written, but this is a somewhat complex tradeoff analysis so I wanted to show where my brain is at. Also welcome to the 1% -- how to optimize your finances for a sabbatical is definitely a first-world problem ;).

leavesofgrass

  • 5 O'Clock Shadow
  • *
  • Posts: 53
Re: Optimal investment allocation in taxable account for ACA subsidies?
« Reply #11 on: November 06, 2018, 08:59:35 AM »

I'm glad I convinced you to look at some other elements -- that's why we're all here on these forums to point this stuff out. My comparison was taking off Jan '19 - Dec '19 versus Jul '19 - Jun '20. If I plug $95k into the Smart Asset CA tax calculator, including $19k 401k contribution, it gives a total tax liability of $21k. If we split that sabbatical over two years and enter $47.5k of income w/ $19k of 401k contributions, the tax liability is $6k per year -- which I then multiply by two years for a total of $12k. So looking at the W2 impact alone, the estimated difference for you is $9k.

Then we add the theoretical income from investments, which I'm just going to plug as 3.5% from dividends and interest from with your portfolio optimized for the long run. That's $56,000 in income that's going to hit your MAGI on 1040.

Now when looking at subsidies and plans for someone at 35 y/o, subsidies max out at $18k/yr income and go to zero beyond $45k of income. To get down to this $18k MAGI, you would figure out how much income to shave off or defer by starting with 18k + $47.5k (salary) - $19k (401k) - $12k (std deduction) + $56k (1099 income) = $90k. So to get the max ACA subsidy of $3,675, you would have to shave off or defer $90k of income, which does not seem like a good deal to me.

Then I thought about COBRA. My 2019 plan premium is $64/mo, which is 50% of the total premium, so if I were to go on COBRA then my share would pop up to $128/mo and $1,536 for the year. It's an $1,850 deductible plan with $3,500 out-of-pocket max. This would cost $350/mo, $4,200/yr, on Covered California, but the max subsidy would bring the cost down to $500/yr.

So looking at this situation for you, it's possible to take advantage of the ACA subsidies, but the tradeoff seems really high. You can definitely wipe out that $56k of investment income, but consider that if your optimal allocation is yielding 7% nominal returns, a dividend-minimizing approach may give you 4%, a difference of $48,000 on a $1.6M portfolio.

This is the longest post I've ever written, but this is a somewhat complex tradeoff analysis so I wanted to show where my brain is at. Also welcome to the 1% -- how to optimize your finances for a sabbatical is definitely a first-world problem ;).

First of all, thank you so much for taking the time to write such a thorough reply. Your walk through was great! It makes sense, and now I have a lot to think about.

I'm going to continue running scenarios and estimating income.

Ultimately though, I think you are right: it sounds like I'm being penny wise, pound foolish by trying to reduce investment income so as to get what could potentially be a very small amount of tax credits/health insurance savings.

Again, thank you for this perspective! I need to look at the full picture and consider all the factors :)