Author Topic: What to do with a gifted taxable mutual fund?  (Read 2408 times)

mostlybeardy

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What to do with a gifted taxable mutual fund?
« on: February 02, 2014, 10:26:04 PM »
Hi everyone,

Longtime reader, first time poster. I feel like Im pretty well-versed in the basics of personal finance since I started reading MMM and the forums (and some other key resources) about half a year ago, but today my girlfriend put a question to me that I wasnt completely sure about how to answer, and I thought maybe the community could lend some wisdom. First, the necessary/unnecessary/miscellaneous background:

  • Im 28, shes 26, we live together and are the most part both pretty frugal, or as much as you can be in a large, expensive American city. Our rent is just a little high for the area but we love our apartment and its perfect for us in all the ways that matter. We both hate moving and wanted a place we could grow into when we moved in together a few years back, and our landlord has raised the monthly rate a whopping $20 in the last three years. On the other side of things, we eat like royalty below the poverty level (according to the USDA, anyway) because the local ethnic grocery has amazing produce for cheap. Works for me.
  • She makes more than I do ($44k, soon to be $48k once a recent raise kicks in, vs. $39k for me), but she has student loan debt, about $30k, and I dont, so Ive managed to save a lot lately while she often seems to be feeling the financial pinch. Ive got an emergency fund (3 months of my own expenses at the moment, building that up to 6 months this year and ultimately to 12), while Im not sure if she has any savings beyond a 401k. But her job is far more secure than mine (shes been promoted twice in the last year, while my work is funded by grants), so maybe that evens out. I would also help her if times got really tough, as I know she would do for me.
  • She also carries a small amount of credit card debt, maybe $500-$1k worth last she mentioned it I dont ask about it because I know shes not thrilled about it either, but I also get the impression that she doesnt feel like shes in a position to pay it down given her student loans. If it were me, Id find a way to do it anyway, but its not me, and I dont go looking for conflict!

We differ in a few areas when it comes to money, namely that while she is pretty resourceful and tries not to be wasteful, shed just rather not deal with the specifics of personal finance, and maintains that ultimately, money is for spending. (On what? Not sure we often talk about how we already have pretty much everything we might need right now, but I know she appreciates going out on [reasonably priced] date nights and would like to travel more than we do now.) Shes been somewhat skeptical of my recent efforts to cut spending and sock away some loot, so I finally explained to her the other day that no, my ultimate aim is not to have a vault full of gold coins that I can go swimming in Scrooge McDuck-style, but rather to ensure personal freedom for myself and, ultimately, for her and any kids we might have down the road (been together 5 years, so this is serious longterm relationship stuff, and marriage is probably in the cards sooner than later). I guess she must have warmed to this explanation, because for the first time, she asked me some questions about her money situation this afternoon because I dont know what this means and you understand this stuff, which was a nice compliment for a budding Mustachian to hear!

Basically, she got a college graduation gift about 5 years ago from her now-late grandfather in the form of a $5k mutual fund investment in a taxable account in her name. As of today, the investment is at about $7300. She asked me what was going on with it because she has to report taxable income from it each year and she had thought it was a retirement account. Clearly, its not. I looked at it and saw that it had a 2% expense ratio, which, combined with annual taxes on the dividends, makes it less than ideal as far as Im concerned. It pulled something like a 15% return last year, so its not doing terribly, but past results are not a predictor yada yada yada, and the MMM reader in me recognizes that there are a few possible strategies where she could be utilizing that money for a better return. I basically laid out a few options for her based on my understanding of the situation:

  • She can leave it where it is and continue to let it grow, but shell continue to pay annual taxes on the dividends and the higher fees will definitely stunt its growth. On the upside, she doesnt have to change anything. I guess in this way it would function as semi-liquid emergency fund of sorts (I wasn't going to recommend she sell it and put it in a bank account), but for reasons given above I think there are better ways for her to go about establishing an emergency fund.
  • She can sell it, take the capital gains hit, and use most of it to fund an IRA for the tax deduction or a Roth IRA if she would rather go that way (I explained the difference, as well as the rollover technique, but I think choosing one or the other will take some further consideration on her part).
  • She can sell it, take the capital gains hit, and plow the proceeds directly into her credit card debt and higher-interest student loans (most are at 4.5%, but theres a chunk of about $5k divvied up between 5.5% and 6.5%, and then another $7k or so at 5%).

She was wary of parting with such a large sum all at once, but I did explain that if she used it to pay off those debts, shed save a bunch of money on interest, and she could pretty quickly use those savings to build up an IRA at Vanguard, for instance, where the money could grow without taxes and fees in other words, that she wouldnt be parting with the money in the long run, just temporarily diverting it to knock out some debt and ending up in a better place retirement-fund-wise. This line of thinking definitely appealed to her.

The unspoken fourth option would be to sell it and buy a better fund elsewhere, i.e. VSTMX, but in another taxable account. However, I dont think she intends to use this money for anything in the short term. I mean, she had already assumed it was a retirement account and was unable to touch it.  Even if she did, would it be worth the tax hit to pull the money out of one taxable account just to put it in another?

So what do you think? My gut says knock out at least the credit card debt and the 6.5% loan and maybe start an IRA with the balance if she wants to hang on to some of the money, or maybe just take out as much of the student debt as possible and worry about the IRA later. But I have no experience selling off taxable investments, so Im also saying this under the impression that the capital gains shed pay would be based on the $2300 growth and not the original $5000 investment, minus any dividend reinvestments over the last few years, which by my count have already been taxed. Im assuming that the capital gains tax in this case would work out to be a few hundred dollars. However, if I'm mistaken and its going to be a tax on the full amount, gift included, Im less sure of how good an idea it is to sell it off all at once.

Id rather not lead her in the wrong direction, given how hesitant shes been to talk much about financial planning with me thus far Im hoping this is the start of something good and leads to more Mustachian conversations in the future, so I dont want to mess up the opportunity! And at any rate, at the end of the day shes going to make her own decision, because shes tough and intelligent and fiercely independent (all great things about her as far as Im concerned), so Id at least like to provide her with the best possible information to make that choice.

For what its worth, shes told me on more than one occasion that, if we were married, shed be happy to put me in charge of our combined finances and be done with it, but I want her to be comfortable and confident about how all this stuff works. Id hate to get to a point where she doesnt see why were saving X amount here or investing Y amount there because were not on the same page yet. I want to get on that page starting right now if possible by showing her that we can work together on this stuff.

Thanks in advance for your feedback!

DaKini

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Re: What to do with a gifted taxable mutual fund?
« Reply #1 on: February 03, 2014, 12:14:53 AM »
Getting rid of debt seems to be always a good idea to me. It is a guaranteed riskless return and also releases a burden off your shoulders. I think it will also free up mind energy you can then focus on your growing stache.
That said, i never had any significant debt and thus can ony speak out of theory.

As with the financial management i'm in a comparable situation. In my relationship i'm also the "financial manager". My wife has nearly no interest in financial things (she is quite busy with our children) and as we started out half a year ago i worried how i could show her the ideas behind this blog here. I also wanted her to share my insigts but had a hard time doing so. This proved to be a hard part because currently we have a high load of work with our children and financial things are not that easy to get if you dont have the mind free for such things. I got clearance from her to manage our money myself so i am free to take decisions without always asking her. Her part is currently just to pass me any bill and tell me any expense she makes, so i can account for it in our booking.


From my point of view i would give you he following hints (if it currently only applies to your own financials, you can skip the reporting part):

Preparation:
- Take up this gauntlet. From now on, be responsible for your financial situation.
- Educate yourself about the markets so you can make decisions based on science and thus you have strong arguments for your decisions
- Write down your principal investment decisions (some kind of "investment policy statement") so you have your fundament in written form. This will also be helpful for her in case she finds interest in financials. For you it will be helpful in stress situations. This should clearly tell how you want your money working for you, eg. what accounts, what products and when you bay and sell etc. I did this especially for the case if anything should hapen to me and it is written in such a form that she could pick it up and continue the investment plan.

Execution:
- implement and maintain a form of "book of household accounts"
- from that, compile a monthly report
- Pick a day and explain that report to your partner. While doing that, explain the changes in your accounts, especially if you shuffled money into/out of debt and/or investments.
- Resist the urge to explain every bit and "make her understand". Trust that she will ask you the right questions at the right time once she is ready.


Over time she will notice the progress made and slowly learn what your decisions are based off.
At least, this is the route i currently try to follow.

Frankies Girl

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Re: What to do with a gifted taxable mutual fund?
« Reply #2 on: February 03, 2014, 01:03:24 AM »
I know you didn't ask, but I'm going to go ahead and say if you're heading for marriage, you both need to get over the idea that you don't want to discuss "uncomfortable subjects" like money and debt and spending. Avoiding uncomfortable subjects because you're scared of causing conflict... is a surefire way for things to blow up in your faces down the road. You'll be working as a team, and if she doesn't want to be the one dealing with the day to day stuff, fine if that works for you, but you both need to be honest and transparent in what each other has as far as money coming in and out and how you spend and save as a partnership. It doesn't have to be uncomfortable - you are a couple and should be cool with talking about difficult stuff because you care about each other AND want to make sure you have the best possible future you can. You can't do that if you are acting like ostriches and avoiding having the convos about where you are, where you are going and how you plan to get there.


That being said, her investment account actually did pretty crappy last year if it only earned 15-20%. The market was up over 30%, and with expenses at 2%, she'd be really unwise to leave it as it is.

So the choices (if it was me) would be as follows:

Sell off, and pay off the credit card debt, and NEVER RUN UP A CARD AGAIN. Use credit cards only if there is money in the bank to pay it off in full every month. Since you don't have any idea of how much credit card debt she actually has, or what the interest rate is, I'm just assuming that it's not more than a few thousand, but this is stuff you should know about each other.

With any money left over, there's one of two things to do - but as you don't know the exact amount or interest rate on the school loan, it's predicated on it being above or below certain amounts...

If the school loan rate is higher than 8%, then put the rest of that money left towards the loan, and every bit of money she has extra should be hitting that sucker hard to pay it off ASAP.

If the school loan rate is under 8%, then I'd move whatever money is left over into a Roth IRA and invest it in the total stock index fund with Vanguard. 

Here's the thing on capital gains - you only pay them if you're over 15% marginal taxable rate as far as the IRS is concerned. If she has a 401K, she should make sure to be putting in enough to get her taxable rate to 15% bracket. That means she pays nothing on capital gains. So if she's currently making $44K, I'd assume she's in the 15% bracket (especially if she is contributing to a 401K), a few thousand in realized cap gains is zero tax.

You can run a "what if" scenario here: https://turbotax.intuit.com/tax-tools/calculators/taxcaster/
Just check into the "other income" and put in all the relative info to see how it works out.

And once she moves the money to a Roth, then it's tax sheltered and no tax implications until you actually tap it. BUT you can withdraw penalty free the contribution at any time (no penalty, no taxes), so it can still be a "last resort" emergency fund if she's freaked about it being a "retirement account." Roths are actually quite wonderful in this and many aspects.

But the absolute worst thing in my opinion is to just let it stay where it is and doing nothing.


foobar

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Re: What to do with a gifted taxable mutual fund?
« Reply #3 on: February 03, 2014, 06:57:04 AM »
 There are going to almost no capital gains (she invest 5k + distributions every year for her cost basis, she might be in the 0% tax bracket if she contributes anything to a 401(k),) to be paid and it is a crappy investment. Sell the fund and either pay down debt or invest it in something better.

Theoretically paying down the cc debt is the way to go and then make sure you have a couple month slush fund. The downside is that is really easy to spend money on CC again. If you can stick the money into an IRA (given your incomes you can make an arguement either way with roth versus tradition but I tend to always vote traditional. Having a bigger pile of cash tends to reduce your maximum (i.e less likely to have 10 million dollars to spend) while increasing your minimum (more likely to have 30k/yr to spend))

Hi everyone,

Longtime reader, first time poster. I feel like Im pretty well-versed in the basics of personal finance since I started reading MMM and the forums (and some other key resources) about half a year ago, but today my girlfriend put a question to me that I wasnt completely sure about how to answer, and I thought maybe the community could lend some wisdom. First, the necessary/unnecessary/miscellaneous background:

  • Im 28, shes 26, we live together and are the most part both pretty frugal, or as much as you can be in a large, expensive American city. Our rent is just a little high for the area but we love our apartment and its perfect for us in all the ways that matter. We both hate moving and wanted a place we could grow into when we moved in together a few years back, and our landlord has raised the monthly rate a whopping $20 in the last three years. On the other side of things, we eat like royalty below the poverty level (according to the USDA, anyway) because the local ethnic grocery has amazing produce for cheap. Works for me.
  • She makes more than I do ($44k, soon to be $48k once a recent raise kicks in, vs. $39k for me), but she has student loan debt, about $30k, and I dont, so Ive managed to save a lot lately while she often seems to be feeling the financial pinch. Ive got an emergency fund (3 months of my own expenses at the moment, building that up to 6 months this year and ultimately to 12), while Im not sure if she has any savings beyond a 401k. But her job is far more secure than mine (shes been promoted twice in the last year, while my work is funded by grants), so maybe that evens out. I would also help her if times got really tough, as I know she would do for me.
  • She also carries a small amount of credit card debt, maybe $500-$1k worth last she mentioned it I dont ask about it because I know shes not thrilled about it either, but I also get the impression that she doesnt feel like shes in a position to pay it down given her student loans. If it were me, Id find a way to do it anyway, but its not me, and I dont go looking for conflict!

We differ in a few areas when it comes to money, namely that while she is pretty resourceful and tries not to be wasteful, shed just rather not deal with the specifics of personal finance, and maintains that ultimately, money is for spending. (On what? Not sure we often talk about how we already have pretty much everything we might need right now, but I know she appreciates going out on [reasonably priced] date nights and would like to travel more than we do now.) Shes been somewhat skeptical of my recent efforts to cut spending and sock away some loot, so I finally explained to her the other day that no, my ultimate aim is not to have a vault full of gold coins that I can go swimming in Scrooge McDuck-style, but rather to ensure personal freedom for myself and, ultimately, for her and any kids we might have down the road (been together 5 years, so this is serious longterm relationship stuff, and marriage is probably in the cards sooner than later). I guess she must have warmed to this explanation, because for the first time, she asked me some questions about her money situation this afternoon because I dont know what this means and you understand this stuff, which was a nice compliment for a budding Mustachian to hear!

Basically, she got a college graduation gift about 5 years ago from her now-late grandfather in the form of a $5k mutual fund investment in a taxable account in her name. As of today, the investment is at about $7300. She asked me what was going on with it because she has to report taxable income from it each year and she had thought it was a retirement account. Clearly, its not. I looked at it and saw that it had a 2% expense ratio, which, combined with annual taxes on the dividends, makes it less than ideal as far as Im concerned. It pulled something like a 15% return last year, so its not doing terribly, but past results are not a predictor yada yada yada, and the MMM reader in me recognizes that there are a few possible strategies where she could be utilizing that money for a better return. I basically laid out a few options for her based on my understanding of the situation:

  • She can leave it where it is and continue to let it grow, but shell continue to pay annual taxes on the dividends and the higher fees will definitely stunt its growth. On the upside, she doesnt have to change anything. I guess in this way it would function as semi-liquid emergency fund of sorts (I wasn't going to recommend she sell it and put it in a bank account), but for reasons given above I think there are better ways for her to go about establishing an emergency fund.
  • She can sell it, take the capital gains hit, and use most of it to fund an IRA for the tax deduction or a Roth IRA if she would rather go that way (I explained the difference, as well as the rollover technique, but I think choosing one or the other will take some further consideration on her part).
  • She can sell it, take the capital gains hit, and plow the proceeds directly into her credit card debt and higher-interest student loans (most are at 4.5%, but theres a chunk of about $5k divvied up between 5.5% and 6.5%, and then another $7k or so at 5%).

She was wary of parting with such a large sum all at once, but I did explain that if she used it to pay off those debts, shed save a bunch of money on interest, and she could pretty quickly use those savings to build up an IRA at Vanguard, for instance, where the money could grow without taxes and fees in other words, that she wouldnt be parting with the money in the long run, just temporarily diverting it to knock out some debt and ending up in a better place retirement-fund-wise. This line of thinking definitely appealed to her.

The unspoken fourth option would be to sell it and buy a better fund elsewhere, i.e. VSTMX, but in another taxable account. However, I dont think she intends to use this money for anything in the short term. I mean, she had already assumed it was a retirement account and was unable to touch it.  Even if she did, would it be worth the tax hit to pull the money out of one taxable account just to put it in another?

So what do you think? My gut says knock out at least the credit card debt and the 6.5% loan and maybe start an IRA with the balance if she wants to hang on to some of the money, or maybe just take out as much of the student debt as possible and worry about the IRA later. But I have no experience selling off taxable investments, so Im also saying this under the impression that the capital gains shed pay would be based on the $2300 growth and not the original $5000 investment, minus any dividend reinvestments over the last few years, which by my count have already been taxed. Im assuming that the capital gains tax in this case would work out to be a few hundred dollars. However, if I'm mistaken and its going to be a tax on the full amount, gift included, Im less sure of how good an idea it is to sell it off all at once.

Id rather not lead her in the wrong direction, given how hesitant shes been to talk much about financial planning with me thus far Im hoping this is the start of something good and leads to more Mustachian conversations in the future, so I dont want to mess up the opportunity! And at any rate, at the end of the day shes going to make her own decision, because shes tough and intelligent and fiercely independent (all great things about her as far as Im concerned), so Id at least like to provide her with the best possible information to make that choice.

For what its worth, shes told me on more than one occasion that, if we were married, shed be happy to put me in charge of our combined finances and be done with it, but I want her to be comfortable and confident about how all this stuff works. Id hate to get to a point where she doesnt see why were saving X amount here or investing Y amount there because were not on the same page yet. I want to get on that page starting right now if possible by showing her that we can work together on this stuff.

Thanks in advance for your feedback!

mostlybeardy

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Re: What to do with a gifted taxable mutual fund?
« Reply #4 on: February 03, 2014, 09:39:29 AM »
Thanks very much for the quick response, everyone! I appreciate the ideas here. It sounds like our instincts to sell and pay down debt were on track, and I'm glad to learn that capital gains won't be too severe.

DaKini, your roadmap sounds a lot like what I have in mind for a little later on, once finances are combined (which won't happen until marriage). Right now it's very much "I have my money here, you have your money there," and I feel as though I have little ground to tell her what to do with her money other than to make suggestions (and rightly so, I think). She has previously gotten defensive when I try to bring up certain things like her loans, mostly I think because I was fortunate enough to have parents who saw it as their parental duty to get me through college with no debt (lucky me, but I think if it had been my money on the line I would have made some smarter educational choices; oh well) and she has loans. Like I said, she can be fiercely independent; a while back when I found myself on good financial footing, I offered to help her pay down some of her loans and she declined, saying that she wanted to handle it for now because it was her debt, not mine, but that if we were married she'd let me help. (An interesting take on the carrot and stick approach, for sure).

That said, we do know how to work together on basic expenses -- we've had a shared checking account since we moved in together and if one of us puts in money, the other matches. We use it to pay rent, utilities, and groceries together, and we're in agreement about what to spend on food and how to keep our utility bills low. Shared expenses outside of these categories are always discussed before they happen.

I know you didn't ask, but I'm going to go ahead and say if you're heading for marriage, you both need to get over the idea that you don't want to discuss "uncomfortable subjects" like money and debt and spending. Avoiding uncomfortable subjects because you're scared of causing conflict... is a surefire way for things to blow up in your faces down the road. You'll be working as a team, and if she doesn't want to be the one dealing with the day to day stuff, fine if that works for you, but you both need to be honest and transparent in what each other has as far as money coming in and out and how you spend and save as a partnership.

In this regard, I'm totally comfortable with the topic, but since she generally wasn't, I've tried to be patient and approach the issue gradually. I do think we're making progress. I didn't mention this in my first post, but near the end of the conversation I mentioned that, if she was interested, I would be happy to sit down with her and formulate a plan to pay down her loans more quickly. I wasn't expecting much, but she said she would like to do that. In our conversation, we also discovered that while she's been contributing to her 401K (4% of salary), her employer doesn't actually match anything! The literature she received when she started 2.5 years ago indicated that she'd be getting a 40% match of total contributions by now, but we found an old work email from 2012 explaining that the company had suspended matching indefinitely. With that in mind, she is mulling over the prospect of halting contributions and just putting that money toward her loans. I recommended funding an IRA instead (since 401K options are limited and there's nothing below 1% expense), and she's thinking about it, but at the very least she's starting to take some action on these things. We've come a ways from "I'd rather not deal with it." I think she feels empowered to know that she has options and that they're starting to make sense. I'm going to try to keep the conversation going and see if I can steer her in good directions.

I think in particular she's been wary about where I've been coming from on this because I wasn't doing a good job of explaining my intentions. We've talked about marriage and longterm goals. We've talked about whether we might buy a house someday. We've talked about how we might go about saving for vacations together (when we've traveled in the past, we've done so pretty cost-effectively, but didn't save for anything ahead of time, so it's not like we've been able to tour Europe or anything). I think there's a difference in backgrounds, though, to the extent that her parents like to go out for a nice meal, like to travel, and are pretty active. They're old enough to retire and their mortgage is paid off, but they still work because they enjoy their jobs. My parents are a little younger but prefer to stay in (a couple years ago I was home to visit for my dad's birthday and he wouldn't even agree to let me take him out for a beer), never travel unless it's for a family reunion/wedding/funeral/etc, and are frugal in all the wrong ways (buy processed food in bulk to save money because fresh produce is "too expensive," but tend to accumulate hundreds of DVDs they'll never actually watch, etc) -- though credit where due, they did manage to put me through college. I can guarantee you that given the option, she'd rather follow in the footsteps of her parents, and I think she saw me tightening up my budget and maybe got scared I had decided to head down the path my folks have taken. Now that I'm doing a better job of showing her that my goal is to have the freedom her parents have but maybe 20 years sooner, she seems a little more receptive.

That being said, her investment account actually did pretty crappy last year if it only earned 15-20%. The market was up over 30%, and with expenses at 2%, she'd be really unwise to leave it as it is.

Agreed, and I explained this as best I could, but I also had to make clear that I couldn't promise that moving it to another fund would generate better returns this year. It looks like a stock/bond mix, so it wouldn't keep up with the market in a blockbuster year like we just had, but I suspect that was never the intention when it was given. The point I tried to make to her was "you didn't do anything wrong by leaving it alone until now -- you've made $2300 on the original gift. It's just that it could do better elsewhere."

Theoretically paying down the cc debt is the way to go and then make sure you have a couple month slush fund. The downside is that is really easy to spend money on CC again.

Again, I don't know the exact amount she carries, but I know that she only recently got the card and the maximum is probably pretty low. She never had a credit card in college or her early 20s and actually had a hard time getting one because of her lack of credit history. She uses her debit card for 99% of her purchases, which helps to keep things in check. I think her credit card is for larger purchases that she might not have the immediate funds for (eg, her parents very generously take us out for a nice dinner when they're in town, and recently she wanted to return the favor -- by "nice dinner" I mean probably $30-$40 per person, so nothing outrageous for a once-in-a-while thing). That doesn't excuse carrying a balance, but she's not driving up her debt with everyday spending at least.