Author Topic: Why does Bogleheads say international funds should go in taxable account?  (Read 6174 times)

Aggie1999

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On the Bogleheads three fund portfolio wiki it says the following when talking about tax efficient fund placement:

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In general, the international fund should go into a taxable account, the bond fund should go into a tax-advantaged account, and the domestic equity fund should fill in the remaining space.

Why is it recommending the international fund go in a taxable account? I thought in general international went in a tax advantaged account because of the lower qualified dividend percent ratio, higher dividends paid out, etc than a domestic fund. Not true?

rpr

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From

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

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If all else is equal, international funds have a small tax advantage over US funds, because they are eligible for the foreign tax credit. All else is not necessarily equal; if an emerging market is reclassified as developed, an emerging-markets index fund will have to sell all its stock in that country, infrequently generating a large capital gain. A fund including both developed and emerging markets such as Vanguard FTSE All-World ex-US Index Fund or Vanguard Total International Index Fund avoids this risk.

Aggie1999

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Thanks for the info. The decision to put Vanguard Total International Stock Index Fund also depends on your ordinary tax rate, correct? Based on the 2015 admiral numbers from your Boglehead link if you are in the 15% ordinary tax rate then taxes in the international fund are cheaper than taxes on Vanguard Total Stock Market. If you are in the 25% tax bracket or above then taxes on the international fund are more than the total stock market fund. Basically the foreign tax credit can no longer offset the taxes from the non-qualified dividend portion of the international fund. Am I understanding this correctly? Below are my numbers based on a $4000 investment and being in the 25% tax bracket:

Vanguard Total International Stock Index Fund Admiral Shares:

Foreign tax credit: 4000 x 0.0019 = 7.60
Qualified Dividends Tax: 4000 x .0280 x .6936 x .15 = 11.65
Non-Qualified Dividends Tax: 4000 x .0280 x .3064 x .25 = 8.57
Total Tax: (11.65 + 8.57) - 7.60 = 12.62

Vanguard Total Stock Market Index Fund Admiral Shares:

Qualified Dividends Tax: 4000 x .0196 x .15 = 11.76
Total Tax: 11.76

Thanks.

SeattleCPA

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Aggie, I'm not sure I understand your question but I understand how the foreign tax credit works.

So maybe this helps...

If you have a little bit of credit ($300 or less if single and $600 or less if married file joint), you don't have fill out an 1116 form and so simply get to deduct your foreign taxes from your US taxes. This also means if you're under those thresholds, your tax rate doesn't matter.

If you have to file the 1116 form because you're over these thresholds, you can use the foreign taxes to wipe out the US income taxes you would have paid on the foreign income... but not on other income. In this situation, tax rates matter...

Radagast

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Here is a handy link. It even comes with a spreadsheet for calculating tax efficiency. When I out my 10% 2015 tax rate in it told me the gov't would give free me money to say thank you for being awesome.

https://www.bogleheads.org/forum/viewtopic.php?f=10&t=208818

Aggie1999

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Thanks for the link to that spreadsheet. It confirms what I was trying to calculate myself. In my situation with no state taxes the international fund (VXUS) is more tax efficient when in the 15% tax bracket. On the other hand, when in the 25% tax bracket, the US fund (VTI) is more tax efficient.