Author Topic: Should I keep some money in a taxable account?  (Read 5329 times)

nixjasr

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Should I keep some money in a taxable account?
« on: December 22, 2015, 06:11:53 PM »
Being new to investing, I've only begun to see the full impact of pretax savings (thanks to Mad Fientist and others).
The result is that I have about $38k in VTSAX in my Vanguard account that was placed there after tax, and which will be taxed upon withdrawal (no tax advantage at all).

Should I start selling this off and use these funds for living expenses for a couple of years to offset maxing out my pre-tax investments?
Between my wife and myself, I have access to two 403b's, a 457, and two traditional IRA's, and I could put quite a bit into these accounts if I were to max them out. ($18K x 3; and $5,500 x2)
Our yearly combined income is about $140k and living expenses low, so it's possible, especially if I were to use some of this money sitting in the taxable Vanguard account for expenses.
Question is this: Is there an advantage to me leaving a pile of cash in the Vanguard taxable VTSAX, or should I use it and focus on maxing out the pretax contributions? Any advice is appreciated.

johnny847

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Re: Should I keep some money in a taxable account?
« Reply #1 on: December 22, 2015, 06:33:28 PM »
Before I start answering, let's see if this discussion is even relevant:

Do you have unrealized gains in VTSAX? Or unrealized losses? Because if it's unrealized losses, then you can sell and get a tax deduction.

nixjasr

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Re: Should I keep some money in a taxable account?
« Reply #2 on: December 22, 2015, 06:42:18 PM »
This is my first year in these investments, so it's looking like it will be almost even. It's currently down $800 from about $38,000 total.
The market's back and forth, of course, so I'm not sure where it will end up, but I'll bet I'll be about even come Dec. 31.

I've read some about tax loss harvesting, which is what I think you're alluding to, and I'll confess it seems a bit confusing to me to lock in losses when the stock is down. I'm open to the idea, though. Just figuring it out.

johnny847

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Re: Should I keep some money in a taxable account?
« Reply #3 on: December 22, 2015, 07:00:43 PM »
Alright lets crunch some numbers shall we? For 2016

I'm going to assume each of you makes less than $118.5k (the SS tax of 6.2% is assessed on the first $118.5k in income per person)

$140k household income
-$18k 403b (earner 1)
-$18k 403b (earner 2)
-$18k 457b (but if this is not a governmental 457b, then please say so, because there are some downsides if it isn't one)
$-11k 2x tIRAs

= $75k AGI

-12600 standard deduction (idk if you itemize, I assumed not)
-8100 exemptions (4050x2)

= $54300 federal taxable income

Fed tax: $7217.50
State tax: $3616 (idk what state you live in, but I'm going to just use GA numbers because I know these brackets)
FICA: $10710

Take home pay (Gross - fed - state - FICA tax - 403b/457b/IRA contributions) = $53456.50

I don't see the need for you to sell any shares in VTSAX.

I've read some about tax loss harvesting, which is what I think you're alluding to, and I'll confess it seems a bit confusing to me to lock in losses when the stock is down. I'm open to the idea, though. Just figuring it out.

No you don't lock in losses. The idea is you sell and then either
1) Buy a similar security, thereby maintaining your overall investment position while grabbing a tax deduction
2) Sit out of the market in 30 days. So long as the market hasn't moved upwards in excess of the value of your tax deduction, you come out ahead*. Of course, we don't know what the market will do.

I advocate option 1, but there are people who use option 2 and still do well.


*This makes some implicit assumptions about tax brackets now and in retirement, but I don't want to get you too bogged down in the details just yet.
« Last Edit: December 22, 2015, 07:05:09 PM by johnny847 »

nixjasr

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Re: Should I keep some money in a taxable account?
« Reply #4 on: December 22, 2015, 07:11:52 PM »
Thanks! This is a helpful start in terms of a way to look at my options.
We're in Washington state, so no income tax (used to live in St. Simons Island, GA, though).

While our income will go down somewhat this year (by about $4,000) I agree that we should be able to leave the VTSAX alone and max out contributions. We're a family of three, and have a mortgage of $1,100 per month, which we've been paying off in a hurry, but are considering slowing down the overpayments in order to capture the tax advantage of the pre-tax contributions (I realize that's a separate discussion, and one with different opinions floating around).

In general, it seems like keeping the money in VTSAX where it's pretty liquid seems at the very least not too detrimental, especially if we can live off our income this year while maxing out the contributions.

Any articles you recommend on selling the losses by the end of the year? I've read the Mad Fientist's Tax Loss Harvesting, which seems like a good start. I'd like to get a grasp on the mechanics of it.

*It's a governmental 457, FWIW.

johnny847

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Re: Should I keep some money in a taxable account?
« Reply #5 on: December 22, 2015, 07:20:47 PM »
Thanks! This is a helpful start in terms of a way to look at my options.
We're in Washington state, so no income tax (used to live in St. Simons Island, GA, though).

Oh excellent. I know they have a pretty high sales tax, but as a high income Mustachian household, I'm sure you're glad to make that trade

We're a family of three, and have a mortgage of $1,100 per month, which we've been paying off in a hurry, but are considering slowing down the overpayments in order to capture the tax advantage of the pre-tax contributions (I realize that's a separate discussion, and one with different opinions floating around).

So long as the interest on your mortgage rate isn't crazy high, I totally agree.

Any articles you recommend on selling the losses by the end of the year? I've read the Mad Fientist's Tax Loss Harvesting, which seems like a good start. I'd like to get a grasp on the mechanics of it.
I like this one.

*It's a governmental 457, FWIW.

Nice.
I asked because a non governmental 457b's assets are not held in trust on the behalf of the employees. That is, if you work for a non governmental employer that offers a 457b, and you contribute money to the 457b, that money can be used in bankruptcy proceedings if your employer were to ever go bankrupt.
Crazy right?

aj_yooper

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Re: Should I keep some money in a taxable account?
« Reply #6 on: December 22, 2015, 07:37:49 PM »
Way to go on being a good saver and managing a lower family budget.

A taxable account can be very useful (no capital gains taxes if you are in the 15% or less tax bracket) and tax sheltered money won't save you money from taxes if you retire in the same tax bracket that you currently pay.  Long term capital gains in taxable do not pay income taxes, just capital gains tax.  So, I personally would not mess with the taxable account.

If you do plan to retire in a lower tax bracket (meaning less income), then the tax sheltered accounts are very good.




Vilgan

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Re: Should I keep some money in a taxable account?
« Reply #7 on: December 22, 2015, 11:24:26 PM »
... tax sheltered money won't save you money from taxes if you retire in the same tax bracket that you currently pay...

If you do plan to retire in a lower tax bracket (meaning less income), then the tax sheltered accounts are very good.

I see people say this all the time and it seems misleading. In most circumstances it WILL save you money to defer taxes. If you are in the 25% bracket, any tax you can defer saves you from a 25% tax. Then when you actually take out the income, that income that WAS in the 25% tax bracket will be spread out over the lower brackets before getting back to 25%. The main exception would be someone who has a very large defined benefit program who will actually see their income go up in retirement.

You don't need to retire in a low tax bracket to make tax deferral a good thing. I didn't realize this when I first started saving and I see people who get this wrong all the time.

aj_yooper

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Re: Should I keep some money in a taxable account?
« Reply #8 on: December 23, 2015, 04:53:32 AM »
Vilgan, I said "tax sheltered money won't save you money from taxes if you retire in the same bracket that you currently pay".  Further, if you save in a tax sheltered account, say, while in the 15% bracket, and then, through good fortune, end up in the 25% bracket when you retire, you are paying a bigger tax on your earnings sheltered when you were paying the 15% marginal rate.  Tax sheltered savings are based on what marginal rate you have in retirement compared to your working time. 
« Last Edit: December 23, 2015, 05:16:51 AM by aj_yooper »

DK

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Re: Should I keep some money in a taxable account?
« Reply #9 on: December 23, 2015, 05:55:33 AM »
Being new to investing, I've only begun to see the full impact of pretax savings (thanks to Mad Fientist and others).
The result is that I have about $38k in VTSAX in my Vanguard account that was placed there after tax, and which will be taxed upon withdrawal (no tax advantage at all).


Just to make sure you understand since you said you were new to investing and the way it was worded, if you put 38K in, and then sold 38K, you would owe NOTHING in taxes, taxes are only on gains. So if you put 38K in, it increase to 39K, and you sold all 39K, you would only owe taxes on 1K.

Cromacster

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Re: Should I keep some money in a taxable account?
« Reply #10 on: December 23, 2015, 07:16:33 AM »
Vilgan, I said "tax sheltered money won't save you money from taxes if you retire in the same bracket that you currently pay".  Further, if you save in a tax sheltered account, say, while in the 15% bracket, and then, through good fortune, end up in the 25% bracket when you retire, you are paying a bigger tax on your earnings sheltered when you were paying the 15% marginal rate.  Tax sheltered savings are based on what marginal rate you have in retirement compared to your working time.

See bolded.

This simply isn't true.

Vilgan's point still stands.  Assuming the person is in the 25% tax bracket, they are saving 25% by deferring the taxes, note the marginal rate doesn't factors in here.  When the money is withdrawn you have to consider the marginal average tax rate.  Even if their AGI is at the top of the 25% tax bracket in retirement, their average tax rate is around 18%.

Edit: Sorry, I'm messing up some terminolgoy here.  Point still stands.


« Last Edit: December 23, 2015, 07:24:29 AM by Cromacster »

seattlecyclone

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Re: Should I keep some money in a taxable account?
« Reply #11 on: December 23, 2015, 09:48:48 AM »
Vilgan, I said "tax sheltered money won't save you money from taxes if you retire in the same bracket that you currently pay".  Further, if you save in a tax sheltered account, say, while in the 15% bracket, and then, through good fortune, end up in the 25% bracket when you retire, you are paying a bigger tax on your earnings sheltered when you were paying the 15% marginal rate.  Tax sheltered savings are based on what marginal rate you have in retirement compared to your working time.

See bolded.

This simply isn't true.

Vilgan's point still stands.  Assuming the person is in the 25% tax bracket, they are saving 25% by deferring the taxes, note the marginal rate doesn't factors in here.  When the money is withdrawn you have to consider the marginal average tax rate.  Even if their AGI is at the top of the 25% tax bracket in retirement, their average tax rate is around 18%.

Edit: Sorry, I'm messing up some terminolgoy here.  Point still stands.


You had it right the first time. Compare marginal rate now to marginal rate in retirement. If you have $0 in traditional retirement accounts now, you can probably expect that first dollar you contribute to be withdrawn at a marginal tax rate of 0%. After you contribute a certain amount to the traditional retirement accounts, you probably have enough in there to fill up the 0% bracket for your whole retirement, so the next dollar you contribute will be withdrawn at a marginal rate of 10%, and so on. The fact that your average tax rate is still close to 0% when you're withdrawing $1 in the 10% bracket is irrelevant. Your 0% bracket is already spoken for with savings you have already made. More dollars contributed will now be withdrawn at 10%.

aj_yooper

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Re: Should I keep some money in a taxable account?
« Reply #12 on: December 23, 2015, 10:33:56 AM »
I probably am not writing this as clearly as needed so I hope Kitces can clarify things:

https://www.kitces.com/blog/roth-vs-traditional-ira-the-four-factors-that-determine-which-is-best/

Current Vs Future Tax Rates

"By far, the most dominating factor in determining whether a Roth or traditional retirement account is better is a comparison of current versus future tax rates. Current tax rates means the marginal tax rate that will be paid today (or the marginal tax rate on the deduction that would be received) by contributing or using a pre-tax retirement account versus contribution or converting to a Roth account. Future tax rates means whatever tax rate would apply to the funds in the retirement account when withdrawn in the future – ostensibly in retirement, or possibly even by the next generation if the retirement account is not expected to be depleted during the lifetime of the owner.

The principle of this equation is remarkably straightforward – the greatest wealth is created by paying taxes when the rates are lowest. If rates are low today and higher in the future – e.g., for the young worker, or someone in between jobs – go with the Roth and pay taxes at today’s low rates. If rates will be lower in the future – e.g., for someone whose taxable income will drop in retirement, or where the retirement account may be spent by the next generation at their lower personal tax rates – the traditional retirement account is the winner. Getting the tax rate equation wrong can result in a significant destruction of client wealth, by unnecessarily paying taxes at high rates!"


nixjasr

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Re: Should I keep some money in a taxable account?
« Reply #13 on: December 23, 2015, 10:38:57 AM »
I appreciate the input, and it sounds like my plan for pretax seems to be on the right track: Lower my current AGI through pretax deductions (some of which would be taxed at 25 percent, 15 percent at minimum), then withdraw them mostly at a lower rate (in today's tax structure, the first $18k or so of taxable income would be at 10 percent).
For the record, we do plan to live using much less money than our current salaries, which shouldn't be too difficult if we get used to saving most of it anyway. I can't imagine needing 80 percent of current salary when no longer tied to full-time employment (especially once we knock out the mortgage). That model seems to benefit only the managed fund firms, not the investors/retirees.

Mr.Tako

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Re: Should I keep some money in a taxable account?
« Reply #14 on: December 23, 2015, 11:54:37 AM »
Depends upon your goals.

I would say if you want to retire early, then YES absolutely have a taxable account as well as deferred tax accounts.  You never know when you'll need to get access to some money quickly (life happens).  Even if you setup a Roth IRA conversion ladder it will be 5 years before you can touch that money.  What will you live off of before you can withdraw from the Roth IRA?

For us, we're living off our taxable accounts (right now) and let our deferred tax accounts continue to grow for the next 20 years.

seattlecyclone

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Re: Should I keep some money in a taxable account?
« Reply #15 on: December 23, 2015, 07:25:07 PM »
Even if you setup a Roth IRA conversion ladder it will be 5 years before you can touch that money.

False. You may withdraw any IRA money at any time. The tax rate is more favorable if you wait five years after converting. However if you're in the 25% tax bracket now and plan to be in the 15% bracket when you retire (as an example), 15% + 10% early withdrawal tax is the same as the 25% you would pay to put it in a taxable account now, and that's before you consider all the taxes you'll pay on dividends and/or capital gains in the taxable account between now and retirement.

aj_yooper

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Re: Should I keep some money in a taxable account?
« Reply #16 on: December 24, 2015, 05:27:53 AM »
In a taxable account, the tax rate is 0 for long term capital gains when you are in the 15% or less marginal tax rate; that is a great advantage.  Short term gains are taxed at the marginal rate.