Author Topic: New to investing, very basic tax questions...?  (Read 3126 times)

Valencia de Valera

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New to investing, very basic tax questions...?
« on: July 31, 2015, 08:39:07 AM »
Hi all, I am new to investing and need some advice on taxable accounts. Currently I have about 30K in a taxable account. I also have $16K in a checking account earning .89% interest, which I know is terrible. DH and I save 20% in retirement accounts and are considering what to do with the rest of our savings (another 30%). We want to get better returns than the bank obviously but I'm concerned about being able to access the money if needed. My questions:

1) If I move all/part of the 30K to a different fund (it's currently in Vanguard Windsor II and I would like to move at least some of it to index funds for lower expenses and more diversification), how will that affect our taxes? We're currently in the 15% tax bracket. If I transfer money between funds, will that be reflected as income and possibly bump us up to the next bracket? DH and I are making 60-65K and the next tax bracket starts at $74K if I'm remembering right. I'm not sure if this is relevant to the tax situation but this was a trust fund from a relative that was turned over to my name about 2 years ago and it has grown by 10K since then.

2) I'm worried about putting more of my cash into investments because of some large expenses that I know are coming up, for a re-roof and possibly a car replacement. Part of my concern here is that I don't know when I'm going to need this money, and might end up needing some within the next year for the roof. If I withdraw it within a year, that would be subject to short-term capital gains, right?  Is it worth it to save the money in the bank to try and avoid this or better to just invest it and pay the taxes if I end up needing it soon? I've read on some other websites that you shouldn't invest anything you might need in the next 5 years but wanted to get a Mustachian perspective on this.

Thank you for your help!

grantmeaname

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Re: New to investing, very basic tax questions...?
« Reply #1 on: July 31, 2015, 08:58:31 AM »
Hi all, I am new to investing and need some advice on taxable accounts. Currently I have about 30K in a taxable account. I also have $16K in a checking account earning .89% interest, which I know is terrible. DH and I save 20% in retirement accounts and are considering what to do with the rest of our savings (another 30%). We want to get better returns than the bank obviously but I'm concerned about being able to access the money if needed. My questions:

1) If I move all/part of the 30K to a different fund (it's currently in Vanguard Windsor II and I would like to move at least some of it to index funds for lower expenses and more diversification), how will that affect our taxes? We're currently in the 15% tax bracket. If I transfer money between funds, will that be reflected as income and possibly bump us up to the next bracket? DH and I are making 60-65K and the next tax bracket starts at $74K if I'm remembering right. I'm not sure if this is relevant to the tax situation but this was a trust fund from a relative that was turned over to my name about 2 years ago and it has grown by 10K since then.
If you sell Windsor II shares to invest in another mutual fund that will generate a capital gain to the extent that the shares have appreciated since you got them. Vanguard should tell you your basis online if you look, and the capital gain is only the amount that the proceeds exceed your original basis. If you move little enough that you stay in the 15% bracket, the applicable long-term capital gains rate is 0%. If you bump yourself up into the next bracket, only the part that falls into the next bracket is taxed at 15% and the rest will still be 0%.

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2) I'm worried about putting more of my cash into investments because of some large expenses that I know are coming up, for a re-roof and possibly a car replacement. Part of my concern here is that I don't know when I'm going to need this money, and might end up needing some within the next year for the roof. If I withdraw it within a year, that would be subject to short-term capital gains, right?  Is it worth it to save the money in the bank to try and avoid this or better to just invest it and pay the taxes if I end up needing it soon? I've read on some other websites that you shouldn't invest anything you might need in the next 5 years but wanted to get a Mustachian perspective on this.
This depends more on your risk tolerance than anything. For money like that, I'd put it in the market. If it generates some capital gains it's not the end of the world because you'll still get to keep at least 80% of the appreciation. What's more of an issue is that when you need to withdraw it the market could be down 40% - but it also could be up just as much. Since that risk doesn't bother me, I'd keep money for big expenses in the market. If that risk bothers you, you definitely should put it in a savings account or money market fund instead.

Are you maxing your IRAs? If not, the Roth IRA is a good vehicle for an emergency fund like this. You can take out your original contribution consequence-free for any reason at any time, and the capital gains stay in the account tax free unless you withdraw all of your original contributions and then more.

MDM

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Re: New to investing, very basic tax questions...?
« Reply #2 on: July 31, 2015, 10:55:00 AM »
We're currently in the 15% tax bracket. If I transfer money between funds, will that be reflected as income and possibly bump us up to the next bracket? DH and I are making 60-65K and the next tax bracket starts at $74K if I'm remembering right.
grantmeaname has covered things well already.  One other note: tax brackets are based on taxable income, not gross income.  Among other things, taxable income is lower than gross income by your deduction (standard or itemized) and exemptions.  For 2015 gross income can be $95,500 and still be in the 15% bracket:

Valencia de Valera

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Re: New to investing, very basic tax questions...?
« Reply #3 on: July 31, 2015, 03:59:27 PM »
Thank you both for the information!

grantmeaname, I do have a Roth IRA but I've only had it for 3 years, and I think I read somewhere that you have to have it open for at least 5 years before you're allowed to withdraw the contributions, is that right? We're putting $300 per month in it but I'm planning to max it out once we can withdraw from it if needed. One other question about that, is the amount that is considered "contributions" calculated based on total dollar amount of what you originally put in regardless of what gains or losses you've had in the meantime, or is there some other more complicated way that they do this based on proportions or something? I'm assuming it's just by dollar amount, but I just wanted to be sure.

MDM, I couldn't remember our AGI when I posted this so I just put our gross income. I just looked at it for last year it was only $48,000; I didn't realize it was that different, so I feel better knowing that we have more room.


Part of my concern with the 30K is that I didn't have to pay any taxes when it went into my name so I thought maybe I'd have to pay them now that I'm actually wanting to do something with it. However as I said it was a trust, which was set up in my name and my relative's name in childhood so maybe I just didn't have to pay any taxes at all(?).

Thanks again!

grantmeaname

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Re: New to investing, very basic tax questions...?
« Reply #4 on: August 01, 2015, 06:20:23 AM »
grantmeaname, I do have a Roth IRA but I've only had it for 3 years, and I think I read somewhere that you have to have it open for at least 5 years before you're allowed to withdraw the contributions, is that right?
Nope, you can take contributions out of a Roth IRA any time without penalty or tax. The five year rule applies to withdrawal of earnings.

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We're putting $300 per month in it but I'm planning to max it out once we can withdraw from it if needed. One other question about that, is the amount that is considered "contributions" calculated based on total dollar amount of what you originally put in regardless of what gains or losses you've had in the meantime, or is there some other more complicated way that they do this based on proportions or something? I'm assuming it's just by dollar amount, but I just wanted to be sure.
Nothing complicated at all! It's by dollar amount, and the "ordering rules" for IRA distributions automatically mean that when you take money out of the IRA that money reduces your contribution first and only is deemed to come from earnings after you withdraw all your contributions.

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Part of my concern with the 30K is that I didn't have to pay any taxes when it went into my name so I thought maybe I'd have to pay them now that I'm actually wanting to do something with it. However as I said it was a trust, which was set up in my name and my relative's name in childhood so maybe I just didn't have to pay any taxes at all(?).
I don't know a lot about the operation of trusts because I've never worked with them, but in general gifts and inheritances are never taxable income to the recipient in the US. They are taxed to the giver (if they're larger than the $5.4 million that can be given tax-free).

If there was some sort of deferred tax effect on the property from the trust, it wouldn't be like an invisible axe hanging over your head that you knew nothing about - generally the deferral of gains for property is accomplished by adjusting the basis of a piece of property. If I had a deferred $10,000 gain on an investment, it would be accomplished by adjusting the basis of the investment down by $10,000 so that when I sold it my gain would be $10,000 larger. Make sense?

seattlecyclone

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Re: New to investing, very basic tax questions...?
« Reply #5 on: August 01, 2015, 09:45:30 AM »
grantmeaname, I do have a Roth IRA but I've only had it for 3 years, and I think I read somewhere that you have to have it open for at least 5 years before you're allowed to withdraw the contributions, is that right?
Nope, you can take contributions out of a Roth IRA any time without penalty or tax. The five year rule applies to withdrawal of earnings.

For the sake of completeness, there are two "five year rules" for Roth IRAs. The first one says that you need to have the account open for five years AND (be 59 OR disabled OR dead OR buying your first home) to take out any of the earnings tax-free and penalty-free. The second one says that you need to wait five years after converting money from a traditional IRA or 401(k) before you can withdraw the converted amount without paying the 10% penalty. Neither rule restricts you ability to withdraw the contributions freely. You can do that at any time.

Valencia de Valera

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Re: New to investing, very basic tax questions...?
« Reply #6 on: August 02, 2015, 03:54:47 PM »
My Roth IRA was originally a Roth 403(b) that I rolled over, so it does have some employer contributions mixed in, does that affect it?

Thank you again for the advice!

MDM

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Re: New to investing, very basic tax questions...?
« Reply #7 on: August 02, 2015, 04:05:35 PM »
My Roth IRA was originally a Roth 403(b) that I rolled over, so it does have some employer contributions mixed in, does that affect it?

Thank you again for the advice!

There should not be any employer contributions in a Roth 403b.  See http://www.irs.gov/Retirement-Plans/Retirement-Plans-FAQs-on-Designated-Roth-Accounts (particularly the added emphasis sentence):
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Can my employer match my designated Roth contributions? Must my employer allocate the matching contributions to a designated Roth account?

Yes, your employer can make matching contributions on your designated Roth contributions. However, your employer can only allocate your designated Roth contributions to your designated Roth account. Your employer must allocate any contributions to match designated Roth contributions into a pre-tax account, just like matching contributions on traditional, pre-tax elective contributions.

Which leads to the questions:
  - Do you have a traditional IRA that came from your traditional 403b account?  If so, all is likely well and the employer contributions are now properly residing in your tIRA.
  - Did you convert your traditional 403b into a Roth IRA and pay taxes on the conversion?  If so, all is again well.

Otherwise, ...?

Valencia de Valera

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Re: New to investing, very basic tax questions...?
« Reply #8 on: August 02, 2015, 09:19:50 PM »
There should not be any employer contributions in a Roth 403b.  See http://www.irs.gov/Retirement-Plans/Retirement-Plans-FAQs-on-Designated-Roth-Accounts (particularly the added emphasis sentence):
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Can my employer match my designated Roth contributions? Must my employer allocate the matching contributions to a designated Roth account?

Yes, your employer can make matching contributions on your designated Roth contributions. However, your employer can only allocate your designated Roth contributions to your designated Roth account. Your employer must allocate any contributions to match designated Roth contributions into a pre-tax account, just like matching contributions on traditional, pre-tax elective contributions.

Which leads to the questions:
  - Do you have a traditional IRA that came from your traditional 403b account?  If so, all is likely well and the employer contributions are now properly residing in your tIRA.
  - Did you convert your traditional 403b into a Roth IRA and pay taxes on the conversion?  If so, all is again well.

Otherwise, ...?

I only ever had the one Roth account with the 403(b), at least as far as I ever knew, and I rolled it all over (Mutual of America to Vanguard) into one Roth account with no mention of taxes or anything else like that. So I'm not sure what's going on, unless I have a secret traditional account hanging out somewhere. I did have some serious issues with this employer (like, "here are your paychecks but don't cash them yet" type issues, and expecting people to work overtime off the clock) so I honestly would not be surprised if they broke some rules or just didn't put in the match money. It was supposed to be 2% if I remember right. I'll have to see if I can dig up some old statements and figure out what's going on.