Quick (I hope) question: which account should I take the money (TAXES/CAP GAINS)

[Frankies Girl]

I am going to try to condense this down so I don't bore anyone nice enough to provide any insight here.


FIREd. 2 adults, no kids. On ACA, and have a specific cutoff hardline I'm using for my income (MAGI) to make sure I'm getting the best subsidies.

I currently use for yearly expenses: dividend/cap gains thrown from my taxable (containing 1 total market index fund) and RMDs (required minimum distributions) from an inherited IRA (iIRA) that is old school cool in that I am on the lifetime depletion schedule so will likely have this account for the rest of my life as it just keeps filling back up (even when I take additional distributions).

I do not reinvest dividends/cap gains in taxable. Due to my taxable income levels, I am in the lowest tax bracket and I pay zero tax on these.

Barring a surprise end of year cap gains distribution (the taxable fund has not paid cap gains in ~1.5 years), there are no other income hits coming in, so for this year I have ~$8,800 LEFT of space in my income bucket, and I plan to take roughly that amount out so I have extra money to fill in my savings/E fund and pad next year's expenses.

Extra consideration: have been house hunting and also like the idea of using a larger chunk of money to create monthly transfers to my checking account so it appears I have regular income for the purposes of qualifying for a home mortgage the easy way (instead of asset depletion underwriting or asset amortization underwriting).



So the question: should I go ahead and take the top-up $ from my taxable account or take an additional distribution from my iIRA? I usually do the iIRA but it's actually a pretty sweet deal and thinking maybe leave it be since it is a lovely setup (tax deferred, no penalty withdraw), and my taxable is HUGE and I am thinking I might even kick a few thousand into reinvesting if we get another drop soon.

I don't think it will make that much difference, but other than being aware of the cutoffs for my ACA subsidies, I'm laughably far away from the taxable account causing me to be taxed... so DOES it make any difference?

[terran]

You'll get more spendable cash for the realized income from taxable than from an IRA withdrawal. I'd want to fill the standard deduction with IRA withdrawals or Roth conversions since the amount of capital gains you can realize without paying tax is much larger than the IRA income you can realize without paying tax, but you've probably already done that. I think it really comes down to the amount of spendable money you want to get out of your $8800 of taxable income.

[Frankies Girl]

You'll get more spendable cash for the realized income from taxable than from an IRA withdrawal. I'd want to fill the standard deduction with IRA withdrawals or Roth conversions since the amount of capital gains you can realize without paying tax is much larger than the IRA income you can realize without paying tax, but you've probably already done that. I think it really comes down to the amount of spendable money you want to get out of your $8800 of taxable income.

Hey @terran thanks for this but I'm going to sound like a huge dummy...

You are saying that the taxable somehow would give me more realized income - is confusing to me. :(

It's my understanding I put in an order in my taxable brokerage account to sell off enough funds to give me $8800, they do that, and there is no fee for selling the fund, and I won't pay any taxes on it since I'm not making enough taxable income to do so. So they'll do the sell order, the cash is available to sit there, transfer out or reinvest, and they send the IRS/me a 1099-B and I have to fill out a schedule D on my 2020 taxes so it gets reported, but otherwise the money I claim out of the taxable account is exactly what I sell off, no extras pulled out for taxes/fees/whatever.

From researching this, they automatically do the FIFO rule (first in/first out) and all fund holdings in the taxable are over 5+ years old and would be reported as long term cap gains anyway. And I also read that retirement investments are taxed as ordinary income, but I'm well below the tax bracket that would pay any taxes so the differences here are moot (?) -- no tax owed, just the income/transaction generates a tax form to the IRS and gets reported on my tax return.

Is this wrong?



And holy beans I completely forgot about the Roth pipeline thing! I may need to step back and consider using most of this income space now just to start working on my rollover IRA...

[terran]

I probably just wasn't being clear enough. All the money that comes out of an IRA (or is converted from IRA to Roth IRA) is taxable, so if you realize $8800 of income you'll have $8800 of spendable cash. However, if you realize $8800 of taxable capital gains from a taxable account you'll have something more than $8800 of spendable cash. Say 50% of the taxable account is gains and 50% is basis, then when you realize $8800 of taxable gains you'd have $17,600 of spendable cash. The tax treatment is different too such that you'd likely owe more tax on the IRA withdrawal than the taxable account gains, but I was really talking about the amount of cash you'd receive vs the amount of that cash that would be taxable and therefore count towards your MAGI target.

You might want to consider seeing if your brokerage will let you switch from FIFO to specific identification cost basis tracking as that would give you more control. That way you could pick the specific tax lots you want to sell depending on how much you want to withdraw vs the amount of gains you want to realize based on selecting tax lots with higher/lower cost basis.

[Frankies Girl]

I'm confirming I'm a dummy. :)

I am also going to have to do some serious math now because if this is true (and I'm sure it is) I can pull MUCH more out and not have it actually counted in my MAGI in actual cash money since the basis is NOT counted as income...

that's a game changer there. :D

[Paul der Krake]

If this is news to you, I take it you've never taken a distribution from taxable in FIRE before? Prepare to have your mind blown.

Ready?

There is this thing called capital gains harvesting. Basically it's the same thing as tax loss harvesting, except you keep ratcheting up your basis as time goes by, while in the 0% bracket. ACA credits make this a little more complicated but if you play your cards right it's possible to essentially never pay taxes on taxable distributions.

Merry Christmas!

[terran]

There is this thing called capital gains harvesting. Basically it's the same thing as tax loss harvesting, except you keep ratcheting up your basis as time goes by, while in the 0% bracket. ACA credits make this a little more complicated but if you play your cards right it's possible to essentially never pay taxes on taxable distributions.

Right, just because you sell to use up that $8800 of MAGI space doesn't mean you can't reinvest the money. In fact, unlike capital loss harvesting, with capital gain harvesting you can reinvest in the exact same thing you just sold with no problems.

[Frankies Girl]

Y'all. Seriously. I'm going to have to do some thinking, and lots of math and make a few phone calls because this definitely is news to me. Wow. Never sold off anything in taxable, just taken the generated distributions/cap gains. So yeah...

[Frankies Girl]

Further research on this is so illuminating!

Fidelity sets mutual funds automatically to First in/first out (FIFO) and average cost basis. I can change it over to actual cost basis since I didn't sell any funds yet, but if I hadn't been aware of the average cost basis before I'd sold anything, I'd have been locked into using that as the basis for the rest of the time I owned that fund, which would have been forever since I have only the one fund in the taxable brokerage account. SOOO tax inefficient and just would become moreso as time went on!

I am also lucky enough to have opened the taxable account in 2013, one year AFTER the new tax law that requires brokerages to track cost basis so I have RECORDS of every single tax lot I bought/own. And fortunately I turned off automatic reinvesting early on so I only have something like 12 tax lots of fund purchases, so that definitely simplifies things.

I've looked into the cap gains harvesting (and resetting the cost basis) and am kicking myself too for not realizing I could do this, but I think I got lulled into not noticing the cost basis at all since I hadn't considered taking $ from the taxable until now.

And I know this is likely so basic/simple that everyone else already knew about the whole "subtract the cost basis from the total and THAT is what counts for income and is reportable/taxable to the IRS" part but I never made the connection. Of course you don't have to count the part you PAID for the fund originally... but I just didn't get it til I saw it here. In my defense, I had zero instruction in any money stuff like this so every time I am told about this stuff I feel both dumb and excited. It's confusing but in a good way. ;)

THANK YOU @terran and @Paul der Krake so much - this really is going to open things up for me. I have some ducks to get into rows, but should have it all neatened up before the end of the year.

[Paul der Krake]

Don't feel bad! Most of our salaried lives we equate "income" with "money that lands in my pocket". We all had this light bulb moment at some point.

Welcome to the Malleable Income Club!

[terran]

Glad to have helped. It gets pretty crazy just how much money you can have/spend while looking "poor" in our earned income centric tax code. In fact, some early retirees will probably have to be careful to always keep their income HIGH enough to not end up on medicaid (if that's something they want to avoid).

[Frankies Girl]

So small update, mixed feelings:

Fido will not reassess any existing tax lots of mutual funds that had the average cost basis. So the existing shares I hold are stuck forever this way. Grrr.

I did switch the total account to be actual cost basis, with the ability to choose individual shares myself. So I could do FIFO, or sell the last bought, whatever. Not a huge difference in pricing as the lots themselves are +/- $5 per share cost basis if I was doing the actual (I reviewed my actual purchase price and have them written out now so I know my REAL cost basis).

And if I do buy anything else in there going forward, they will be actual cost basis. Not that this helps me much now, but would have been nice of them to TELL people that's what they are doing and there were tax ramifications, but I do see that is really the responsibility of the investor anyway (just for folks like me that are still very green and learning, it's a gotcha that could screw things up if you're not aware).

I am going to review if I can report to the IRS differently than what Fido will report so I get true cost basis, but if I'm only looking at a few hundred difference and it is in my favor, I may not bother. Just frustrating as I know what to do now but the tax law change back in 2011/2012 switched to where the financial institutions were made responsible for reporting/tracking cost basis and not relying on the customer to self report.

It is unclear how the average cost basis will be calculated after a sell off. Will it stay frozen at the current cost basis, or will it recalculate based on the acutal cost basis of the remaining shares and then spit out a NEW averaged cost basis? The rep I spoke to was not sure either. It doesn't matter really other than for me to watch and see how it shakes out, as I'm most likely going to be doing the cost basis harvesting eventually so I'll get those things reset to actual some time in the distant future.


Bottom line tho: I get to take out like double the amount I thought I'd be able to take, pad out our savings/emergency fund that may be used to reinvest if there's a dip AND reset my cost basis for even better tax positioning down the road if I do reinvest, AND all while staying within my ACA income limits. So more liquidity, no extra taxes, still getting great subsidies, and I learned something new and exciting. :)

[terran]

Really the only advantage to specific identification is if you need to get the most spendable money for the least realized income (by selling the thing with the highest cost basis). If you're just capital gain harvesting it doesn't much matter as you'd have to sell those low cost basis shares eventually, so by selling things at average cost you're just essentially doing some of both each time you sell. I probably wouldn't worry about it too much unless some of your shares would have much higher cost basis than the average and you're concerned that you'll need lots of spare money at some point.