Author Topic: taxable account  (Read 2562 times)

badman

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taxable account
« on: April 15, 2015, 05:08:25 PM »
Hello all my money mustache mentors.  I'm new to this forum and can't believe all the wonderful information here.  It's truly amazing.  I which I found this a long time ago.

I'm a super savor by nature and max out my 401k and Roth IRA, but still have 50% of my take home that I shove in an online savings account just sitting there getting eaten up by inflation.  I've always avoided a taxable account out of fear due to a lack of understanding of how the taxes will work.  I finally feel inspired enough to move forward and have a question.

Say I buy a MF at Vanguard and then contribute to it monthly.  Years go by and I keep adding to the pot.  One day I decide to withdraw some small amount.

I have some principle that's very old from when I first bought the fund and new principle from the last time I contributed and everywhere in between.
I also have the returns or growth that could have grown from any of the principle.

When I withdraw a small amount, what comes out?
The oldest investment returns? (from the oldest principle earning profit?)
The newest investment returns?
Can I withdraw the principle and leave the profit untouched to avoid taxes? (I donít think so)

What if the market tanked and I lost all profit except a little profit from the very last month I contributed.  But I contributed that amount less than a year ago.  Now if I withdraw is the profit a short term capital gain even though I had money in the account for years?  But the only amount that earned a profit was the newest money I put in.
Itís so complicated unless you buy 1 time and sell 100%

How does this work?











JasonS

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Re: taxable account
« Reply #1 on: April 15, 2015, 05:32:02 PM »
You can designate exactly which shares you want to cash in when the time comes.  Or you can do FIFO (first in first out).
Let's assume the market keeps steadily going up, and you're making monthly contributions. You decide to cash out the whole thing, you will pay mostly long term capital gains (anything held more than a year) with some short term as well.

badman

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Re: taxable account
« Reply #2 on: April 18, 2015, 05:59:56 AM »
thank you Jason

Leisured

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Re: taxable account
« Reply #3 on: April 20, 2015, 05:53:37 AM »
I am Australian, but as I understand it, the US has two income tax scales; one for those receiving personal effort income; and another, lower, for those receiving investment income, no personal effort, taxed at a maximum of 15%. There is a generous tax free threshold, then 15%. Is this a problem?


mikesinWV

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Re: taxable account
« Reply #4 on: April 20, 2015, 06:21:23 AM »
Designating what shares is important b/c you need to determine your cost basis in order to calculate your income and thus your tax liability (this includes reinvesting capital gains as well as dividends that are reinvested).  Also, you may determine that some of the shares you purchased are higher than the price now.  You could sell those shares specifically and have a loss.  You could use that to offset gains (read up on tax harvesting).  Before you pull the trigger and move into taxable accounts make sure you understand how all this works-- as you are doing now.  I believe that most brokerages will keep track for you on the dates of purchase, shares purchased, and costs of those shares. 

Be sure to look for funds that are tax efficient.

Wolf359

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Re: taxable account
« Reply #5 on: April 20, 2015, 08:13:09 AM »
When you set up a mutual fund you can specify how you want its "cost basis" to be tracked.  If you don't select anything, your default is Average Cost, and First-In/First-Out.  Translated, they just calculate your average cost per share, and assume that the first shares you bought were the ones you sold.  Record keeping is very simple, but you have no flexibility in taxes (you pay the most.)

In my opinion, you want to select "Specific Identification."  This means that every time you buy into the mutual fund, you create a "tax lot" for that date, number of shares, and price.  When you sell, you specify which tax lot(s) you want to sell.  That lets you decide how much tax you want to get hit with (maximize or minimize your capital gains.)

An example of this flexibility -- if you bought repeatedly over a ten year period, you probably have lots of capital gains, especially from your earliest purchases.  If the market drops, your most recent purchases may be showing a loss, even if your overall account is showing a gain.  You can sell those losing tax lots to harvest the losses (so you can report it as a loss, reducing your tax bill.)  Your profitable positions would be left alone.  (If you do this, google "Tax Loss Harvesting" to learn about wash sale rules and how to do this properly.)

You can change your cost basis if you didn't select it when you opened the account.  Also, you have to select or validate the cost basis for each individual mutual fund you buy.

Vanguard's FAQ on this is here: https://personal.vanguard.com/us/help/FAQCostBasisContent.jsp

seattlecyclone

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Re: taxable account
« Reply #6 on: April 20, 2015, 08:39:16 AM »
I am Australian, but as I understand it, the US has two income tax scales; one for those receiving personal effort income; and another, lower, for those receiving investment income, no personal effort, taxed at a maximum of 15%. There is a generous tax free threshold, then 15%. Is this a problem?

Our tax code works in complex and strange ways here in the US. You're right that capital gain and dividend income are currently untaxed up to a pretty generous threshold. However the amount of this untaxed income can have ripple effects, affecting various things such as your eligibility for certain tax credits, the fraction of your Social Security income that is taxed, and even the amount you pay for health insurance. Many states also tax investment income even in ranges where the federal government doesn't. Therefore the OP is right to ask about how this all works.

Other responses have been correct that Vanguard gives you a few different ways to do the recordkeeping here. "Specific identification" is the way to go for maximum control over your taxable income. To keep your income low, sell the shares with the highest cost basis. If you want a higher income for whatever reason, you can go ahead and sell shares with a low cost basis. You get to choose!