Author Topic: WHY do tax gain harvesting in RE?  (Read 1122 times)

agusus

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WHY do tax gain harvesting in RE?
« on: December 31, 2018, 05:47:02 AM »
There are many blogs that talk about doing tax *gain* harvesting after FI (physicianonfire, madfientist, etc). They seem to neglect addressing the ACA healthcare subsidy though, which seems like a tremendous oversight. Is this just a mistake on their part (some of these posts were written around 2016 when ACA was fairly new) or maybe they have alternate healthcare plans?

Assuming one is eligible for and planning to use an ACA subsidy in 2019, and is FI/RE and within the 15% tax bracket, it seems really dumb to me to harvest cap gains. The subsidy decreases on a sliding scale from 100% of FPL (federal poverty level) to 400%.

So if you harvest gains (raising your MAGI), you're trading an immediate, concrete tax benefit for a theoretical potential future benefit.

Is there something I'm missing? (note: not interested in political what-ifs, just the facts of what logically makes sense for 2019).

Arbitrage

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Re: WHY do tax gain harvesting in RE?
« Reply #1 on: December 31, 2018, 10:00:36 AM »
I think you'd have to run the numbers for each scenario and make the decision.  Sometimes, tax gain harvesting is more reasonable if you think your drop in income is temporary; for FIRE, that may not be the case.  Certainly, you'd never want to drop off the ACA cliff, but beyond that you'd have to compare.  You'd probably also want to consider your state taxes; my state taxes cap gains as ordinary income (though I'm hoping to leave this state to RE).

Also, the 15% bracket is gone :).

maizefolk

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Re: WHY do tax gain harvesting in RE?
« Reply #2 on: December 31, 2018, 10:19:34 AM »
There are many blogs that talk about doing tax *gain* harvesting after FI (physicianonfire, madfientist, etc). They seem to neglect addressing the ACA healthcare subsidy though, which seems like a tremendous oversight. Is this just a mistake on their part (some of these posts were written around 2016 when ACA was fairly new) or maybe they have alternate healthcare plans?

I probably couldn't do it, but I could see a case to be made in certain scenarios.

If you're doing a standard 4% rule based FIRE from the stock market, about half of your spending each year come from selling stock. In early years very little of that sale is capital gains, after 20-30 years a lot of it is capital gains. So you could imagine a retiree who would start out below the ACA subsidy cliff and end up above it in later years even while spending the same number of dollars in inflation adjusted terms because selling the same dollar value of stock was producing more and more capital gains.

In that case, doing some capital gains harvesting in early years would mean an immediate cost, but might put off the year they fell off the ACA subsidy cliff.

secondcor521

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Re: WHY do tax gain harvesting in RE?
« Reply #3 on: December 31, 2018, 10:34:35 AM »
The ACA premium tax credit is, as you point out, on a sliding scale from about 3% to about 9% of AGI between 100% and 400% of FPL.

Being FIREd, within broad limits I get to decide how much income to realize each year, mostly through Roth conversions and LTCG.  I view myself as having four distinct taxes on AGI:  federal income tax, state income tax, loss of premium tax credit, and FAFSA EFC.  When deciding how much income to realize, I look for significant "breakpoints" and the overall marginal tax rate.  So for example, I may be paying 10% federal, 7% state, 5% ACA PTC, and 5% FAFSA, for a total of 27% tax.

There are three reasons I can think of to do tax gain harvesting in FIRE:

1.  To lock in the tax rate on the gain at current rates.  Some people think tax rates will go up in the future, either because of US government tax law changes or because their personal income overall is going to go up.  So paying 0% LTCG now (assuming a modest FIRE income) is preferable to paying 15% LTCG later.

2.  To absorb non-refundable tax credits.  There are a few non-refundable tax credits which are wasted if there is no tax to  offset.  The ACA PTC and federal taxes can be offset by these credits.

3.  As a more specific case of #1, there is something called the tax torpedo.  Basically at age 70, a person who has FIREd will have Social Security and RMDs which will put them into a fairly high tax bracket.  Realizing taxable income (through either Roth conversions or LTCG) now at a total of 27% and getting those monies into an essentially tax free state may be better than paying 45% or more later.

Catbert

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Re: WHY do tax gain harvesting in RE?
« Reply #4 on: December 31, 2018, 10:53:33 AM »
I read in someone's journal (Ihamo's I think) that in her state once you qualified fo an ACA subsidy random, income that didn't repeat more than 2 months in a row wouldn't impact qualification for the subsidy.  She sold a house (impacts only one month's income) after initially qualifying.  Ensures that dividends aren't more than two months in a row.

I don't know if this applies to all states or even if she's correct.  Worth checking out if tax gain harvesting would otherwise work for you.

agusus

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Re: WHY do tax gain harvesting in RE?
« Reply #5 on: December 31, 2018, 02:33:53 PM »
...
If you're doing a standard 4% rule based FIRE from the stock market, about half of your spending each year come from selling stock. In early years very little of that sale is capital gains, after 20-30 years a lot of it is capital gains. So you could imagine a retiree who would start out below the ACA subsidy cliff and end up above it in later years even while spending the same number of dollars in inflation adjusted terms because selling the same dollar value of stock was producing more and more capital gains.

In that case, doing some capital gains harvesting in early years would mean an immediate cost, but might put off the year they fell off the ACA subsidy cliff.

I see your point that capital gains will increase later in life. But I don't see that as justifying harvesting gains now. If I can choose between maximizing my ACA subsidy in the present or in the future, I would always choose the present, because of the time value of money. Ie, $100 saved in 2019 is worth more than $100 saved in 2030.

Note the subsidy cliff isn't really a cliff, from what I understand. It's a smooth dropoff - more like a small step. Ie, if your income is increasing gradually you don't suddenly go from $1000 subsidy to $0, you'd be going from like $50 to 0.

secondcor521

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Re: WHY do tax gain harvesting in RE?
« Reply #6 on: December 31, 2018, 02:50:01 PM »
I read in someone's journal (Ihamo's I think) that in her state once you qualified fo an ACA subsidy random, income that didn't repeat more than 2 months in a row wouldn't impact qualification for the subsidy.  She sold a house (impacts only one month's income) after initially qualifying.  Ensures that dividends aren't more than two months in a row.

I don't know if this applies to all states or even if she's correct.  Worth checking out if tax gain harvesting would otherwise work for you.

That's for Medicaid, not ACA.  ACA subsidies are based on AGI, which is calculated annually and reconciled at tax time.

Note the subsidy cliff isn't really a cliff, from what I understand. It's a smooth dropoff - more like a small step. Ie, if your income is increasing gradually you don't suddenly go from $1000 subsidy to $0, you'd be going from like $50 to 0.

This is incorrect.  There is quite an ACA cliff at 400% of FPL.  It tends to hit people in middle age more because their insurance costs are higher.  For a middle income 55 year old, $1 of income can easily result in the loss of $5K+ of subsidies.

maizefolk

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Re: WHY do tax gain harvesting in RE?
« Reply #7 on: December 31, 2018, 02:51:39 PM »
Eh, you asked why someone might choose to do it, that's the most plausible reason I can think of. If you want to get into an argument about whether it's a good reason or not, you'll need someone who actually advocates doing so.

Note the subsidy cliff isn't really a cliff, from what I understand. It's a smooth dropoff - more like a small step. Ie, if your income is increasing gradually you don't suddenly go from $1000 subsidy to $0, you'd be going from like $50 to 0.

Now about the subsidy cliff I believe you are, in fact, incorrect. ACA subsidies do ramp down with higher income until you hit 400% of the federal poverty line. At 400% of the federal poverty line, your out of pocket health insurance costs are capped at 9.5% of MAGI. Anything above that cost (pegged to the second cheapest silver plan in your region), is covered by ACA subsidies.

At 400% of the federal poverty line + $1 there is no cap and no subsidy.

Especially for older folks or people with children, an extra dollar of taxable income could mean hundreds or thousands of dollars in extra insurance payments.

https://www.gocurrycracker.com/obamacare-optimization-early-retirement/

Edit: thanks secondcor521

agusus

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Re: WHY do tax gain harvesting in RE?
« Reply #8 on: December 31, 2018, 02:55:46 PM »
The ACA premium tax credit is, as you point out, on a sliding scale from about 3% to about 9% of AGI between 100% and 400% of FPL.

Being FIREd, within broad limits I get to decide how much income to realize each year, mostly through Roth conversions and LTCG.  I view myself as having four distinct taxes on AGI:  federal income tax, state income tax, loss of premium tax credit, and FAFSA EFC.  When deciding how much income to realize, I look for significant "breakpoints" and the overall marginal tax rate.  So for example, I may be paying 10% federal, 7% state, 5% ACA PTC, and 5% FAFSA, for a total of 27% tax.

There are three reasons I can think of to do tax gain harvesting in FIRE:

1.  To lock in the tax rate on the gain at current rates.  Some people think tax rates will go up in the future, either because of US government tax law changes or because their personal income overall is going to go up.  So paying 0% LTCG now (assuming a modest FIRE income) is preferable to paying 15% LTCG later.

2.  To absorb non-refundable tax credits.  There are a few non-refundable tax credits which are wasted if there is no tax to  offset.  The ACA PTC and federal taxes can be offset by these credits.

3.  As a more specific case of #1, there is something called the tax torpedo.  Basically at age 70, a person who has FIREd will have Social Security and RMDs which will put them into a fairly high tax bracket.  Realizing taxable income (through either Roth conversions or LTCG) now at a total of 27% and getting those monies into an essentially tax free state may be better than paying 45% or more later.

secondcor521, good points. My situation is simpler than yours because I don't have state income tax (Washington) and no kids (FAFSA not relevant). I have no tax credits to offset (child tax credit is the only thing I can think of, which might be what you're referring to).
 
Re: #3, tax torpedo, I hadn't heard of this and think I would need to run some numbers to see what level of 401k/SS that comes into play.

The only reasons I've heard for gains harvesting post-FIRE with ACA subsidies are related to beliefs that tax policy will change to be less favorable. I've decided not to speculate about that though (it's hopeless, and it's about as likely that tax policy could become *more* favorable - ex, brackets/limits being adjusted up).

I'm still surprised no one has done a good thorough analysis of this. I just re-read gocurrycracker's post (https://www.gocurrycracker.com/never-pay-taxes-again/) from 2013 and they put a footnote ("Update (1)") about how gain harvesting might not be worth it with an ACA subsidy.

Maybe bloggers haven't analyzed this because most of them make tons of taxable income, or enough to push them out of subsidy range. I see gocurrycracker has some 2015 articles on ACA optimization, which I'm reading through now. From a 2018 comment though I see he mentions they are pushing over 100k income and starting to have dividends get taxed. FIRE bloggers are starting to have decreased relevancy to me because they're making too much money.

agusus

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Re: WHY do tax gain harvesting in RE?
« Reply #9 on: December 31, 2018, 03:12:27 PM »
You're probably both right that there is a cliff, particularly for older people. I should've clarified that when I looked at my situation last year, the "cliff" dropoff was from only about $125/month (1.5k/year) - not exactly what I would call a cliff, more like a big step. Less than some people's cell phone bill (non-mustachian people of course!). We're in our mid-30's though and I understand the insurance costs go up a lot (and also the subsidy potentially) past mid-40's.

And this interaction of income with subsidies is incredibly complex. Despite reading many articles I still don't fully understand it (that's why I reached out here).

secondcor521

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Re: WHY do tax gain harvesting in RE?
« Reply #10 on: December 31, 2018, 03:58:08 PM »
I'm still surprised no one has done a good thorough analysis of this. I just re-read gocurrycracker's post (https://www.gocurrycracker.com/never-pay-taxes-again/) from 2013 and they put a footnote ("Update (1)") about how gain harvesting might not be worth it with an ACA subsidy.

Maybe bloggers haven't analyzed this because most of them make tons of taxable income, or enough to push them out of subsidy range. I see gocurrycracker has some 2015 articles on ACA optimization, which I'm reading through now. From a 2018 comment though I see he mentions they are pushing over 100k income and starting to have dividends get taxed. FIRE bloggers are starting to have decreased relevancy to me because they're making too much money.

Taxes are pretty complicated, and each person's or family's situation can be fairly unique.  So for people wanting a thorough analysis, we are limited to a few options:  (1) Learn taxes and analysis and do it themselves (this is what I do), (2) Pay a CPA to do the analysis for them (few CPAs do this and it's $250 per hour around here), (3) Try to apply broad generalizations or others' analyses to their own situations (usually not bad, but not often great).

I think most CPA-type articles resort to broad generalizations, and I think most bloggers analyze their own individual situation and put a disclaimer on it that they're not advisors and your situation may be different.

Further complicating all of this is that FIRE people are a small subset of the population, so the generalizations that are out there are either simplistic or not applicable to us.