Using taxable accounts efficiently

[chieftain]

We are early 40s, with one child, have total assets around $1.2m, around 89% index funds, 4% bonds, 7% cash/I-bonds.

While we generally max out all available tax-advantaged accounts, we have a total of three taxable accounts, totaling around $400k.

Aside from holding tax-efficient investments (like VTI/equivalents) in the taxable accounts, are there other strategies we should be using (eg., tax loss harvesting, etc.)

[seattlecyclone]

Sure, might as well harvest losses when you have them. It provides a bit of tax deferral, though the benefit is limited to $3,000 of net losses per year.

If you plan to donate to charity, the tax code favors donations of appreciated stock: you get to claim an itemized deduction of the full current value of the stock and you don't need to pay any capital gains taxes on the transfer.

[SilentC]

If you want to make gifts to any kids including yours do it in stock so they pay the taxes when they sell.  They get your basis but they might be in 0% cap gains rate. For your kid don’t fall astray from the “kiddie tax” rules though.

[secondcor521]

Note that the favorable rules on donation of capital assets to charity requires that the assets be long-term.

Depending on the relationship between your standard and itemized deductions, you could look into bunching deductions.

Note that you can do all of the techniques listed above together if you want to.

Actually, depending on your opinion on charitable giving and overall investment picture, doing QCDs after age 70.5 might be more tax efficient over your lifetime than giving appreciated shares.  That would require delaying charitable giving for about 30 years, which may not be acceptable.

[NWOutlier]

'Rule No. 1: Never Lose Money. Rule No. 2: Never Forget Rule No. 1' ~buffet.  I don't even consider losses... it's not an option.

[SeattleCPA]

This maybe obvious rule: You want to have the bonds inside your tax-deferred space.

The reason is something like a stock index fund is extremely tax efficient. In retirement for example the dividends and capitali gains generated by your "taxable" stock index fund probably won't be subject to federal income taxes.

[chieftain]

Currently, all individual taxable accounts have VTI or equivalents. A Fidelity advisor is trying to talk us into selling the VTI, tax-loss harvesting, and investing in Fidelity Tax-Managed US Equity Index Strategy, which is actively managed to leverage tax-loss harvesting, and which has a 0.4% annual expense ratio. Over the past ten years, it's outperformed VTI even with the expense ratio considered. However, I'm loathe to commit to a high expense ratio without guarantee of improved returns moving forward.

Which gets me thinking more about tax-loss harvesting on my own. From what I understand, this would require consolidating the several individual taxable accounts to ensure there aren't unintended wash sales across them.

I've read contradictory things about whether tax-advantaged accounts should hold different asset classes than taxable accounts (Physician on FIRE recommends doing so, for example).

Any thoughts on:

- Fidelity's Tax-Managed US Equity Index Strategy
- Tax-loss harvesting independently
- none of the above?

[SeattleCPA]

I'm not a big fan of tax loss harvesting. The financial planners all seem to think this is a great "service" they can add. But it always strikes me as fairly pointless.

You're just increasing the gains you'll recognize later on. Later on you'll probably pay NIIT (aka "Obamacare" tax).

Regarding the fidelity tax efficient fund, I don't know anything about that. But the index funds in general are really tax efficient. Seems like paying .08% for an index fund vs paying .4% for a tax-managed fund would not be that compelling. But again I haven't looked at that. Sorry.

BTW in Washington state where I live, it's actually a tax mistake to tax loss harvest I think. The reason: There's a 7% state-level capital gain that kicks in at $250K of gains. So by intentionally pushing down your basis you push up (at least a little bit) the gain you'll possibly have subject to that 7% tax later on.

[seattlecyclone]

I'm not a big fan of tax loss harvesting. The financial planners all seem to think this is a great "service" they can add. But it always strikes me as fairly pointless.

You're just increasing the gains you'll recognize later on. Later on you'll probably pay NIIT (aka "Obamacare" tax).

Yes, there's no free lunch. You're trading a tax deduction now for more tax later...unless you die before you sell the appreciated shares, in which case your heirs get a bigger tax-free basis step-up. The question is whether the tax deduction now is at a higher or lower rate than the tax you might pay later.

NIIT kicks in at $200k income (single) or $250k (MFJ). Some folks on this forum may plan to have that much income later in life when they're drawing down their assets, but I'd guess most of us don't.

In my case I harvested just enough losses last year to max out the $3,000 net loss limit. I'm in the 22% bracket so I'll get $660 immediately that I can put toward more investments. Even taking NIIT into account the 15% capital gains bracket becomes 18.3% after $250k, which is still less than 22%. I'd need income over $500k to break into the 20% + NIIT bracket in retirement under current law. If that happens I will have so completely and totally won the game that paying 23.8% instead of 22% on that little bit of extra capital gain won't bother me in the slightest.

BTW in Washington state where I live, it's actually a tax mistake to tax loss harvest I think. The reason: There's a 7% state-level capital gain that kicks in at $250K of gains. So by intentionally pushing down your basis you push up (at least a little bit) the gain you'll possibly have subject to that 7% tax later on.

Again, harvesting losses is only a mistake in Washington if you expect to have $250k capital gain years later on. I don't.

[SeattleCPA]

I'm not a big fan of tax loss harvesting. The financial planners all seem to think this is a great "service" they can add. But it always strikes me as fairly pointless.

You're just increasing the gains you'll recognize later on. Later on you'll probably pay NIIT (aka "Obamacare" tax).

Yes, there's no free lunch. You're trading a tax deduction now for more tax later...unless you die before you sell the appreciated shares, in which case your heirs get a bigger tax-free basis step-up. The question is whether the tax deduction now is at a higher or lower rate than the tax you might pay later.

NIIT kicks in at $200k income (single) or $250k (MFJ). Some folks on this forum may plan to have that much income later in life when they're drawing down their assets, but I'd guess most of us don't.

In my case I harvested just enough losses last year to max out the $3,000 net loss limit. I'm in the 22% bracket so I'll get $660 immediately that I can put toward more investments. Even taking NIIT into account the 15% capital gains bracket becomes 18.3% after $250k, which is still less than 22%. I'd need income over $500k to break into the 20% + NIIT bracket in retirement under current law. If that happens I will have so completely and totally won the game that paying 23.8% instead of 22% on that little bit of extra capital gain won't bother me in the slightest.

BTW in Washington state where I live, it's actually a tax mistake to tax loss harvest I think. The reason: There's a 7% state-level capital gain that kicks in at $250K of gains. So by intentionally pushing down your basis you push up (at least a little bit) the gain you'll possibly have subject to that 7% tax later on.

Again, harvesting losses is only a mistake in Washington if you expect to have $250k capital gain years later on. I don't.

I agree with your logic.

The one thing I'd add is NIIT (aka "Obamacare tax") isn't indexed for inflation. So young investors will pay it at some point in the future.

Note that the 2.9% Medicare tax bracket when Mr. Obama proposed ACA ran roughly from $100K to $200K. And after that one paid (directly or indirectly) the 3.8% rate. The bump stems from Obamacare.

Lots of people probably thought they'd never need to worry about it.

Now that 2.9% bracket runs from roughly $160K to $200K. It may be gone by the time Mr. Biden leaves office.

[MustacheAndaHalf]

I'm not a big fan of tax loss harvesting. The financial planners all seem to think this is a great "service" they can add. But it always strikes me as fairly pointless.

You're just increasing the gains you'll recognize later on. Later on you'll probably pay NIIT (aka "Obamacare" tax).

Yes, there's no free lunch. You're trading a tax deduction now for more tax later...unless you die before you sell the appreciated shares, in which case your heirs get a bigger tax-free basis step-up.

So maybe death is the free lunch?

If someone takes a capital loss now, their taxes are reduced now and increase later.  But money has time value - look at any treasury bond.  In between the tax loss harvest and selling for a gain, you can use the money to invest.  But if tax laws change, or someone moves into a higher tax bracket, it can backfire.

Something to add: U.S. demographics have changed, with lower fertility rates likely being permanent.  A functioning Congress might allow more immigration or cut spending... I'm guessing neither of those happen.  Which leaves Congress raising taxes to pay for things, and that could mean capital loss harvesting runs into higher tax brackets later.

[almost]

There's lots of talk about loss harvesting but I didn't see any mention of gains harvesting in this thread.  It doesn't make sense for everyone and you have to pay attention to your tax bracket and state taxes, but I think it has value for some folks.  If you have low state tax and are in a lower tax bracket you can build up your cost basis over time.  Eventually you could withdraw enough cash to pay for a house with only a few thousand in taxable gains.


Also, if you keep international funds/ETF's in your taxable account you probably have to deal with the foreign tax credit.  If you move those assets to a tax sheltered account you'll save yourself a tax form or two.  Not a big deal but I always thought the foreign tax credit was a PITA.

[seattlecyclone]

Also, if you keep international funds/ETF's in your taxable account you probably have to deal with the foreign tax credit.  If you move those assets to a tax sheltered account you'll save yourself a tax form or two.  Not a big deal but I always thought the foreign tax credit was a PITA.

Yes that form is a PITA, agreed. IMO better to fill out that form and get some money than move the qualifying investments to a tax shelter where you forgo that benefit entirely.

That said, I discovered during my first year of FIRE that the foreign tax credit can be for less than the amount of foreign tax actually paid when you're in a lower tax bracket. For that reason I did shift a small portion of my international holdings to my IRA in an effort to keep the foreign tax below the $600 threshold where you get to just claim the full amount without filling out the extra form. I was slightly above that level before.

[almost]

Yes that form is a PITA, agreed. IMO better to fill out that form and get some money than move the qualifying investments to a tax shelter where you forgo that benefit entirely.

That said, I discovered during my first year of FIRE that the foreign tax credit can be for less than the amount of foreign tax actually paid when you're in a lower tax bracket. For that reason I did shift a small portion of my international holdings to my IRA in an effort to keep the foreign tax below the $600 threshold where you get to just claim the full amount without filling out the extra form. I was slightly above that level before.

That's a good idea.  I will experiment with turbo tax this year to see if that would work for me.

[NWOutlier]

Hi Everyone,

I have a different take; specifically on tax loss harvesting.  I'm a long term investor, there are no losses... I bought everything decades ago...   how is this even a concern? 

Steve (NWOutlier)

Buffet rules of investing (one of them)
'Rule No. 1: Never Lose Money. Rule No. 2: Never Forget Rule No. 1'

[NWOutlier]

adding another comment - something I've been following for years;

https://www.bogleheads.org/wiki/Tax-efficient_fund_placement

this helped me, I don't know if it will help the group.

Steve (NWOutlier)

[seattlecyclone]

I have a different take; specifically on tax loss harvesting.  I'm a long term investor, there are no losses... I bought everything decades ago...   how is this even a concern? 

I'm a long-term investor too. I do have some investments that have gone down in value since I bought them, primarily ones I bought a year or two ago, rather than older ones. Selling them and buying a similar investment right back again can save a bit of money on taxes in certain situations. Would you really forego that opportunity just to be able to say that you didn't lose money on your investment?

[Catbert]

Consider having mutual fund capital gains/dividends paid out rather than automatically reinvested.  That allows you to use the money to buy different assets in order to keep to your overall asset allocation.  Also avoids any inadvertent tax wash sales from auto reinvesting while you're trying to tax loss harvesting.

I'd like to second seattlecyclone's comment about inflation catching up with tax cutoffs that aren't indexed for inflation.  I remember when they started taxing SS if your total income was over 25K.  I mean, who has 25K in taxable income during retirement? Only the rich!  Then they started phasing out the ability to write-off rental real estate losses at 100K income.  100K.  Again only rich folks had 100K in income.  Then there was that crazy Alternate Minimum Income tax.  It started out only applying to "rich" people who used lots of obscure tax loopholes.  By the end it applied to lots of middle income people with kids.

I did tax loss harvesting this past year because we sold an asset last year and so had new-ish money in the market when it started dipping this year.   I invested in a similar fund.  Mostly will allow me to offset some uncontrollable capital gains but also some income.