Holding off new taxable contributions?

[Calm Man]

We do not know what will happen with dividend taxes beginning in 5 days although under current law it will go to ordinary income rates for federal income taxes. There is no pending legislation. In taxable accounts, those following the 3-fund portfolio (or even 2-fund portfolio with only TSM) and a muni fund, for all practical purposes only receive taxable income assuming the don't sell from the dividends. I have calculated, while suffering pains in the stomach, that with the federal income tax, ACA tax (new next year) and NJ tax, my dividends will be taxed at greater than 50%. Others might be more (e.g., if they live in California) or less, but the effect will be profound on almost everybody at this board. I am holding off future investments in taxable stock index funds while awaiting resolution of the tax rate. But maybe I am fooling myself. Assuming the dividends do get taxed at full rates and you ahve done everything else possible with respect to obvious things (I guess shifting equities to tax deferred accounts and moving bonds to munis in taxable), does one just then hold one's stomach and go ahead and put it in to taxable? It somehow is making me very aggravated. Do you just say, well it's only about 1% of the total equity value after taxes are paid? Or does one fundamentally shift allocations to downplay equities and increase munis if the taxable account is the larger part of your assets?

And if somebody wants to slap me and say "shut up", you're making too much of this -- don't change anything ----you are free to do so.
Thank you.

[Grt2bOutdoors]

You make an investment - total return is equal to capital appreciation plus dividends. Today you hold $100 in your hand which you are waiting to invest. Today, I hold a $100 in my hand that I will invest - my return will be equal to capital appreciation plus dividends. The investment pays a cash dividend of $1 pre-tax. Using your math, my after-tax dividend amounts to $0.49 cents. Let's just say for argument's sake - there was zero capital appreciation, just the yield. At the end of the year, my investment is worth $100.49. You still have your $100. Now, compound that over time, I will likely wind up with more money after-tax and you will still have your $100.

Do you still care about paying 51% or less after seeing my value go up while your's just depreciates (inflation)?

[livesoft]

I have been investing since the early 1980s. I've forgotten what you asked. Was it important?

[stan1]

If you were offered a 10% raise at work, would you reject it because you would have to pay more taxes (or move into a higher tax bracket)?
That's called letting the tax tail wag the income dog.

[grabiner]

Given your tax rates, you might seriously consider making any new contributions with the reverse of the usually recommended allocation, adding new money to the NJ long-term muni fund in taxable, and selling tax-deferred bonds to buy more stocks. If you are subject to ACA tax, you will pay 3.8% on dividends, and 5.83% NJ state tax (8.97% reduced by 35% because NJ tax is deductible from federal), for a rate of 9.63% above whatever the federal tax is on dividends. If your qualified dividends are taxed at 15% (all tax breaks continue), that's a 24.63% marginal rate, so you will lose 0.50% to a 2% dividend yield, plus any tax on capital gains. If your qualified dividends are taxed at 20% (rates return to 2001 levels, so the NJ tax is deducted at 39.6% and is 5.42% after tax), that's a 29.22% rate, so you will lose 0.58%. If your qualified dividends are taxed at 39.6%, that's a 49.02% rate, so you will lose 1%.

Admiral shares of NJ Long-Term Tax-Exempt currently yield 2.04%, free of all federal and NJ taxes. If we assume that corporate bonds of comparable risk are break-even in a 25% tax bracket, the effective tax cost is 0.68%. Thus, if the tax break on qualified dividends goes away, you should buy the muni fund; even if the rate goes back to 20%, you might buy the muni fund at current yields, but you'll want to sell it and buy stock if rates go up.

[grabiner]

An additional concern: what are your tax-deferred options? If the only good option in your 401(k) is an S&P 500 fund, you might already have your entire 401(k) in stock and be buying munis. If you work for the US Government, then you should use the TSP G fund for your bond allocation, as the advantage of the G fund is worth more than any tax difference between munis and stocks. If your 401(k) is with a low-cost provider or has already been rolled into a Vanguard IRA, you may have equally good stock and bond options in both tax-deferred and taxable.

[Calm Man]

Grabiner, thanks for your comments. No, I do not work for the US government. I work for companies and/or as a consultant (TBD for 2013) and may retire soon. My taxable assets represent 80% of my total. I have 10% in a Vanguard IRA and self employed 401K and 10% in a Vanguard variable annuity (which I established years ago and hate the fees and am hoping to convert ASAP taxes permitting to regular asset). The VA is fully in TSM. The IRA and 401K already pretty much are TSM and RBM and according to my plan I can convert some more TBM to TSM this year but then I will have all TSM in all tax deferred vehicles. Being 60, I do not want to add anymore to the variable annuity as I hate the fees and want to get it close. ALL new 401K goes to the TSM but new contributions are now trivial elative to the total portfolio. So that's the quandary -- deferred accounts are now nearly fully in TSM and taxable accounts in muni funds with a bunch of cash around now seeking a home. My only way out of this is to just stop working which is under consideration but I never seem to do this and always defer stopping another year.