Quantifying the gains of tax loss harvesting vs the costs

[ploldo]

I trying to quantify how much a fund must drop before it is worth it to tax loss harvest. In particular there are at least two costs to tax loss harvesting that I would like to quantify. Those costs are the bid/ask spread and time you are out of the market (usually 3 business days minimum on Vanguard).


Cost 1:
Assuming you buy a similar fund and hold for 31 days and then buy back your previous fund, this is 2 bid/ask costs. Since most ppl have international in taxable i'll look at those spreads. VWO, VEU, and VSS are .02%,.02% and .14% respectively from Vanguard.com. (Although yahoo finance seems to say much much higher spreads when taking (ask - bid)/ask - am I doing that wrong?)

So this is a .04 - .28% cost.


Cost 2:
When you are selling twice, you are out of the market for 6 days minimum. Assuming a 8% nominal return, this is 1.08 ^ (6/365.25) -1 = .1266%

Other costs:
Any transaction costs
time/effort to TLH
chance you miss out on a better TLH opportunity in this time period - I am not sure if this is a true cost or how to quantify it. Help?



Gains:

% loss * marginal income tax rate

If this number is greater than 3000, then there are additional gains of ?? (someone help me out here)



I haven't seen this analysis done anywhere before an I'm hoping we can work together to build a solid formula for knowing when to TLH. For example, VWO was down about .75% when I thought about this idea but I am not sure if this makes TLHing worth it.



Here is the equation I have so far:

Fundsize * (%loss * income tax rate - .1266% - bid/ask % spread * 2)


Example for me with VWO:

40000 * (.0075 * .25 - .1266% - .04%) = 75 - 34.64 = $40.36 - costs reduce this by almost 50% plus any other costs so waiting for a better opportunity may be better.

[livesoft]

Even with VBS, you are not out of the market 3 days or 6 days. You can buy as soon as you have sold. That is, you do not have to wait until the sale settles before you buy.

I have posted some TLH trades and some other trades on the forum with posted screen captures that I think show that one can do all this without commission and without getting hit by the bid/ask spread most of the time.
Example: viewtopic.php?p=742901#p742901

If you are at all concerned, then use mutual funds instead of ETFs.

My conclusion: the costs to TLH should be zero nowadays, but that doesn't mean one should TLH for small amounts.

[livesoft]

If one harvests more than $3000 in losses, then there are additional benefits. Let me give a big one: Suppose I have TLH'd $300,000 in losses and over the following 10 years I sell nothing else. Each year, I deduct $3,000 from my AGI so at the end of 10 years, I still have $270,000 in carryover losses. So I retire. Now over the next 10 years, I sell a little bit of my holdings each year at a gain. The return of capital is tax-free and the capital gains are offset by those carryover losses from 10 years ago.

The idea is that for the next 5 to 10 years,
(a) I have income to pay expenses, but
(b) I have no net capital gains and no taxable income, so I
(c) do conversions of my tradtional IRA and 401(k) assets to Roth IRAs every year to fill up my 0% tax bracket, so that
(d) when it comes time at age 70.5 to collect Social Security benefits I have only Roth IRAs left, so that I continue to pay
(e) zero taxes in retirement.

So that TLH many years ago is the gift that keeps on giving.

[Default User BR]

(Although yahoo finance seems to say much much higher spreads when taking (ask - bid)/ask - am I doing that wrong?)

The only ones that you should pay attention to are those when the market is open.


Brian

[MoonOrb]

I was thinking about this today, and here is the part I'm having trouble with:

Cost 2:
When you are selling twice, you are out of the market for 6 days minimum. Assuming a 8% nominal return, this is 1.08 ^ (6/365.25) -1 = .1266%

I think this assumption has a sample size problem. For instance, if you did thousands of these trades, taking the exact same amount of your investments of out market each time, then I'd agree you could assume something like an 8% nominal return. At the other extreme, if you only did one of these trades, it would be unlikely that the particular return for the few days you'd be out of the market would be exactly 8%. It would be some other amount, and given a sufficient number of trades, would eventually approach the 8% mean assumed nominal return.

The reason this troubles me is that in any given year in the market, so many of the gains occur in just a few days or weeks. If you miss a year's best week, you could miss that year's entire gain. Now, not every year is like this, and the flip side is also true--you could miss that year's entire loss if you miss a particularly bad week. But the solution to this problem has always been to ensure you're in the market at all times. Tax harvesting pulls some of your investment in and out of the market, so I think there's some risk component here that your formula doesn't take into account, since you're (presumably) not doing this kind of transaction so often that, over time, the times you pull money out of the market and miss out on gains are offset by the times you pull money out of the market and miss out on losses.

I'm not sure if there's ever been any discussion or analysis on this question, as it only occurred to me this morning as I was walking to work. But it sounds like the type of thing that someone a lot smarter than me already has given some thought.

[ploldo]

Great replies livesoft, thanks.



MoonOrb,

Right, its just assuming average returns and there is risk. Looks like livesoft says you can negate most or all of this risk

[livesoft]

If one is doing TLH, then by definition the market is down from where you purchased it. If you follow my advice given elsewhere to try to do TLH on so-called ReallyBadDays (RBDs), then I believe the chance that you are near an intermediate market low is increased. Thus, I would not want to be out of the market if I TLH'd on an RBD since I believe the probability of being higher within a couple of weeks is better than 50:50 (and really better than 80:20).

[jsl11]

If you use Vanguard mutual funds in a Vanguard account, you can just exchange one fund for another. No expenses, and no time out of the market.
Jeff

[ploldo]

I have a VBS account and all my taxable funds are ETFs in here. But I don't see how to exchange funds to avoid the 3 day period. I only see the option to buy, sell, or trade but for all of them my funds available is essentially 0 (from my money market).

[kevinpet]

Other costs:
Any transaction costs
time/effort to TLH
chance you miss out on a better TLH opportunity in this time period - I am not sure if this is a true cost or how to quantify it. Help?

For that last one, you can use the volatility of the asset class. Just to make up some numbers, if BND is down 1% from where you bought it, maybe that's worth harvesting, but if VWO is down 2% that's just typical day to day variation and it's better to wait for something more significant.

[livesoft]

I have a VBS account and all my taxable funds are ETFs in here. But I don't see how to exchange funds to avoid the 3 day period. I only see the option to buy, sell, or trade but for all of them my funds available is essentially 0 (from my money market).

Then it's time to experiment. Tomorrow morning, sell 1 share of one of your ETFs, maybe the one with highest share price. Then immediately after selling, buy one share of another ETF with a lower share price. Can you do this in less than 5 seconds? That will certainly be less than 3 days if you can.

However, I will guess that Vanguard will not let you sell the share that you bought tomorrow for another 3 days, but try that experiment as well.

[Wagnerjb]

Cost 2:
When you are selling twice, you are out of the market for 6 days minimum. Assuming a 8% nominal return, this is 1.08 ^ (6/365.25) -1 = .1266%

Why do you need to be out of the market for 6 days? Don't you have an emergency fund sitting in the money market account? If so, just use those funds to execute a buy at the same time as you TLH.

Best wishes.

[hoppy08520]

If one harvests more than $3000 in losses, then there are additional benefits. Let me give a big one: Suppose I have TLH'd $300,000 in losses and over the following 10 years I sell nothing else. Each year, I deduct $3,000 from my AGI so at the end of 10 years, I still have $270,000 in carryover losses. So I retire. Now over the next 10 years, I sell a little bit of my holdings each year at a gain. The return of capital is tax-free and the capital gains are offset by those carryover losses from 10 years ago.

The idea is that for the next 5 to 10 years,
(a) I have income to pay expenses, but
(b) I have no net capital gains and no taxable income, so I
(c) do conversions of my tradtional IRA and 401(k) assets to Roth IRAs every year to fill up my 0% tax bracket, so that
(d) when it comes time at age 70.5 to collect Social Security benefits I have only Roth IRAs left, so that I continue to pay
(e) zero taxes in retirement.

So that TLH many years ago is the gift that keeps on giving.

This is pretty amazing livesoft, and it's a great summary. I don't have any taxable investment yet (hopefully some day) but when I do, I'll need to make sure I understand and practice TLH.

I am hoping that I'll have some years before age 70.5 to do some Traditional-to-Roth conversions at low/no tax, and I can see how doing TLH can lower my ordinary income by $3,000 annually (with carryover losses) and allow for even more room for Roth conversions.

[RobG]

If one harvests more than $3000 in losses, then there are additional benefits. Let me give a big one: Suppose I have TLH'd $300,000 in losses and over the following 10 years I sell nothing else. Each year, I deduct $3,000 from my AGI so at the end of 10 years, I still have $270,000 in carryover losses. So I retire. Now over the next 10 years, I sell a little bit of my holdings each year at a gain. The return of capital is tax-free and the capital gains are offset by those carryover losses from 10 years ago.

The idea is that for the next 5 to 10 years,
(a) I have income to pay expenses, but
(b) I have no net capital gains and no taxable income, so I
(c) do conversions of my tradtional IRA and 401(k) assets to Roth IRAs every year to fill up my 0% tax bracket, so that
(d) when it comes time at age 70.5 to collect Social Security benefits I have only Roth IRAs left, so that I continue to pay
(e) zero taxes in retirement.

So that TLH many years ago is the gift that keeps on giving.

We've been through this before livesoft... Under most circumstances if you just use the losses to offset the gains you haven't accomplished anything. You need to invest the tax savings from the $3000 deduction for there to be any real advantage. This requires an increase in savings over and above what you would normally save and I don't think most people plan their savings that precisely.

An exception would be if you have enough losses to offset all future gains, which appears to be your example. However, planning on losing more than you gain isn't a very good strategy IMO.

rg

[hoppy08520]

...

[livesoft]

We've been through this before livesoft...

Until folks learn that unrealized cap gains are not taxed, return of capital is not taxed, and long-term capital gains are taxed at a rate as low as 0%, we will have to keep reminding folks. The idea of making sure to invest the tax savings is a nice addition, but is really secondary to the idea of paying zero taxes.

One does need to have substantial taxable investments and low enough expenses to keep one in the low long-term cap gains tax brackets.

[RobG]

We've been through this before livesoft...

Until folks learn that unrealized cap gains are not taxed, return of capital is not taxed, and long-term capital gains are taxed at a rate as low as 0%, we will have to keep reminding folks. The idea of making sure to invest the tax savings is a nice addition, but is really secondary to the idea of paying zero taxes.

One does need to have substantial taxable investments and low enough expenses to keep one in the low long-term cap gains tax brackets.

Good to know you haven't lost your touch livesoft. Perhaps you could tell me how you are going to not realize those capital gains without dieing with a bunch of unsold stock? This is fine if you want to pass them onto your heirs, but I think most of us are more worried that we will run out of money in retirement.

[livesoft]

I'm gonna use your suggestion and die beforehand. Before then, I will be living off of SS and Roth IRA assets. And before that, I will be using up carryover losses.

Example: I need $100,000 a year for expenses, but have $270,000 in carryover losses. I sell $100,000 of ETF shares with a basis of $70,000. How much tax do I owe? First, I would use up $30,000 of carryover losses to leave me with $240,000 of carryover losses for the future. I would have realized capital gains, but I would have not incurred any tax or indeed any Adjustable Gross Income. Rinse and repeat for 10 years. But don't forget to do conversions to Roth, too.

[Easy Rhino]

If you're light on cash, will a margin account at VBS let you buy new stocks without waiting 3 days for settlement?

I have margin on my taxable brokerage accounts (not at VBS). I don't actually carry a margin balance, but it sure makes trading easier. I know some are worried about the bogeyman of the brokerage going out of busines... but man, it sure makes the trades easier.

[RobG]

If you're light on cash, will a margin account at VBS let you buy new stocks without waiting 3 days for settlement?

I have margin on my taxable brokerage accounts (not at VBS). I don't actually carry a margin balance, but it sure makes trading easier. I know some are worried about the bogeyman of the brokerage going out of busines... but man, it sure makes the trades easier.

I'll agree with Livesoft's earlier comment, the money is available immediately so you don't need to wait 3 days. I was just rebalancing my VBS account today.

[RobG]

I'm gonna use your suggestion and die beforehand. Before then, I will be living off of SS and Roth IRA assets. And before that, I will be using up carryover losses.

I prefer a financial plan whose success doesn't require that the participant die Your scenarios aren't very realistic for most people who are eventually going to have to realize those gains or dip into their 401(k) and pay even higher tax rates. Realistically, in order to come out ahead with TLH you need to invest the tax savings - there is no free lunch.

For those that aren't following along let me give an example (for simplicity assume tax rate of 10% and ignore wash rule). Suppose you buy $100k in stock. Some time later it drops to $50k. Finally, in retirement you sell the whole lot at $200k (i.e. it doubled in price).

Case 1, you did NOT TLH so your gain is $100k. You pay 10% on your gain so you net $190k

Case 2, you did TLH when stock was $50k. In that case your gains are $150k. You pay 10% on your gain so you net $185k.

In case 2 you did get to write off $50k, but unless you invested the taxes saved from your write off the TLH actually made you lose $5000. Just remember that it is pretty hard to come out ahead without investing the tax savings.

rg

[livesoft]

Scenario 3: You decide to sell $140,000 in one year and $60,000 the next year. So one year you have $90K in long-term cap gains and no other income. For a couple that $90,000 is taxed at 0% according to Taxcaster. The next year, your $60,000 long-term cap gains is also taxed at 0%.

So with $200K of income over 2 years, the couple paid no income tax.

Without TLH and withdrawing $100K a year over 2 years, Taxcaster says the tax will be $1470 a year or $2940 for the 2-years. Tax-loss harvesting saved them $2940 in taxes.

Or if they sold $90K in year 1, no taxes, but $110K in year 2, Taxcaster says the tax will be $2970.

ETA: Darn it. I left out the cost basis, but you get the idea: The tax is NOT 10%.

[RobG]

Can you rerun that with the correct numbers?

Where do you live where you can realize $90k in gains (wrong amount btw) at 0% tax? Anyway, if the TLH didn't take place you would have even less gains so TLH didn't help.

I did make a mistake in forgetting you were carrying this over into retirement. In that case the $3000/yr deduction against your ordinary income helps.

[RobG]

Can you rerun that with the correct numbers?

Where do you live where you can realize $90k in gains (wrong amount btw) at 0% tax? Anyway, if the TLH didn't take place you would have even less gains so TLH didn't help.

I did make a mistake in forgetting you were carrying this over into retirement. In that case the $3000/yr deduction against your ordinary income helps.

Livesoft, I just realized if you are just plugging numbers into a tax calculator using this year's tax rules your results are really going to be misleading. The capital gains tax rate is zero for gains made in 2012 (and 2011) for incomes up to about $70k. This is certainly not what we can expect in the future.

[livesoft]

Actually, the Fiscal Cliff tax bill says differently. The 0% rate still applies. And there is a difference between income, adjusted gross income, taxable income, etc.

[RobG]

Actually, the Fiscal Cliff tax bill says differently. The 0% rate still applies. And there is a difference between income, adjusted gross income, taxable income, etc.

I think assuming a 0% capital gains tax to make your financial plan successful is less likely to work than requiring the early death of the investor, but it isn't my money so go for it. [edit, sorry for being so snarky, late night...]

[ploldo]

I learned a lot here, thanks. And I did get the near instant trading to work with VBS.

I realized I was missing one big thing though. I thought I could TLH based upon YEARLY losses of a fund, not the cost basis since initial purchase. So while VWO is down slightly this year, its still up since middle of last year when I acquired it.

it appears that TLHing is mostly going to happen on recently purchased funds right? Because say, after holding something for 10 years, its very unlucky to dip below the amount you purchased at.

I am in a situation where I will rarely be buying non tax deferred funds but still have 135k sitting in taxable. Last year was my first time TLHing. For simplicity sake, assuming this was an all time low for my fund, I can never tax loss harvest again unless I buy more, right?




What i was confusing was how the benefits of being tax deferred work. I was thinking taxable accounts pay taxes every year on any gains (so I thought that TLH was sorta of "reset" each year to a new cost basis), but in fact its only when you sell. My thinking was clouded here because I know I paid taxes last year on funds i didnt sell but this must be because of dividends. (Although after googling taxable vs tax deferred calculator they make it seem like gains are taxed every year so now im even more confused)

[House Blend]

The idea is that for the next 5 to 10 years,
(a) I have income to pay expenses, but
(b) I have no net capital gains and no taxable income, so I
(c) do conversions of my tradtional IRA and 401(k) assets to Roth IRAs every year to fill up my 0% tax bracket, so that
(d) when it comes time at age 70.5 to collect Social Security benefits I have only Roth IRAs left, so that I continue to pay
(e) zero taxes in retirement.

I too plan to use a taxable account for living expenses in early retirement while filling lower (ordinary income) brackets with Roth conversions.

But I think step (d) is a bit rosy. Just how big do you expect your 0% bracket to be? Maybe you are planning to move to a high income tax state, or pay lots of mortgage interest, or have high medical expenses.

In any case, 2 exemptions plus an MFJ standard deduction is about $20K. (A bit more after age 65.) Add another $3K from your annual capital loss deduction. Let's also be generous and assume that this massive taxable portfolio that is paying for your living expenses is distributing 100% qualified and/or tax-exempt dividends. That still affords only about $230K worth of no-tax Roth conversions over 10 years, plus whatever deductions you have beyond the standard deduction.

Methinks you have a bit more than that in tax-deferred accounts.

[Wagnerjb]

We've been through this before livesoft... Under most circumstances if you just use the losses to offset the gains you haven't accomplished anything. You need to invest the tax savings from the $3000 deduction for there to be any real advantage. This requires an increase in savings over and above what you would normally save and I don't think most people plan their savings that precisely.

Rob: Livesoft has documented the tremendous benefit that TLH can bring. In your first objection, you suggest that a person's budgeting habits may result in no real advantage. I disagree, even if you assume the guy saves a fixed dollar amount each year, and spends everything else. His $3,000 deduction is against ordinary income which might be taxed at 33%. When he realizes a $3000 capital gain (later), he only pays 15%. He has more wealth by using TLH, as he has paid less in tax. Thus, he has more money to spend and that makes his better off under any scenario. You might be tempted to suggest the guy in a very low tax bracket might somehow come out worse....but if this is true, that guy should simply not TLH.

Your second point is that you are just offsetting carryforward losses with gains realized in the future. Ok, let's ignore the annual $3000 deduction for a minute. The benefit of having carryforward tax losses accrues to the retiree, especially the guy between retirement and the drawing of SS or the IRA RMD's. Let's say the guy wants to spend $100,000 per year. With tax losses you can - for example - withdraw $70,000 from your IRA and sell $30,000 worth of equities in your taxable account. This would allow you to stay in the lower tax brackets for many years. The second "layer" of tax free sales of stock allow you to avoid breaking into the next tax bracket. For the guy with a lot of built in capital gains (and no loss carryovers), the process is a lot sloppier.

Thus, having two streams of retirement cash flow can be an excellent tax management strategy if one stream (IRA) is pure taxable funds, while the other stream (TLH stocks or Roth) is pure tax-free funds. Livesoft has laid out the strategy well, and I agree with his strategy. Our numbers may be different, but the tax management principles are identical.

(Having tax loss carryovers also allows the taxable investor to rebalance without tax costs).

Best wishes.

[RobG]

Rob: Livesoft has documented the tremendous benefit that TLH can bring. In your first objection, you suggest that a person's budgeting habits may result in no real advantage. I disagree, even if you assume the guy saves a fixed dollar amount each year, and spends everything else. His $3,000 deduction is against ordinary income which might be taxed at 33%. When he realizes a $3000 capital gain (later), he only pays 15%. He has more wealth by using TLH, as he has paid less in tax. Thus, he has more money to spend and that makes his better off under any scenario. You might be tempted to suggest the guy in a very low tax bracket might somehow come out worse....but if this is true, that guy should simply not TLH.

Andy - I know you have a lot of skill in this area but I disagree. Please look at my example. In a nutshell what happens is the TLH gives yourself a $1000/year raise, but it also increases the amount of taxes you will pay in the future. If you spend the $1000 all you have done is increase the amount of taxes you owe in the future. You could achieve the same effect by simply saving less (and living better), and that wouldn't be a good saving strategy, right?

Your second point is that you are just offsetting carryforward losses with gains realized in the future. Ok, let's ignore the annual $3000 deduction for a minute. The benefit of having carryforward tax losses accrues to the retiree, especially the guy between retirement and the drawing of SS or the IRA RMD's. Let's say the guy wants to spend $100,000 per year. With tax losses you can - for example - withdraw $70,000 from your IRA and sell $30,000 worth of equities in your taxable account. This would allow you to stay in the lower tax brackets for many years. The second "layer" of tax free sales of stock allow you to avoid breaking into the next tax bracket. For the guy with a lot of built in capital gains (and no loss carryovers), the process is a lot sloppier.

Thus, having two streams of retirement cash flow can be an excellent tax management strategy if one stream (IRA) is pure taxable funds, while the other stream (TLH stocks or Roth) is pure tax-free funds. Livesoft has laid out the strategy well, and I agree with his strategy. Our numbers may be different, but the tax management principles are identical.

(Having tax loss carryovers also allows the taxable investor to rebalance without tax costs).

Best wishes.

I did make the mistake of not seeing the loss was being carried over into retirement because that didn't seem to be what the OP was considering nor did ($300k) seem achievable for most of us. If you can carry the loss into retirement I'd say it *probably* is a no-brainer to TLH, but I'm not positive you can achieve benefits beyond the $3000/yr deduction. The reason is that you can also do that by selling the stocks with the high basis first, and by TLH you lower the basis. The benefits are at least partially cancelled. In addition, if you just spent the $1000/yr previous to retirement that would take away from the benefit.

Bottom line, if you save the $1000/yr raise TLH is certainly beneficial. If not, be careful.

I have a date with my boy on a ski hill so have a good day

rg

[letsgobobby]

Rob - your posts have been helpful and I thank you for them. I am not persuaded by your argument, especially for the reasons others have pointed out (most Bogleheads will save/invest that extra $1000 per year; many will carry losses into retirement to offset recognized gains; many will leave taxable assets to heirs who receive a stepped up basis so that no taxes are ever paid). One other question - since the capital loss limit appears not to be indexed to inflation (it's been $3000 for as long as I can remember, which isn't that long), isn't a $3000 loss now worth more than a $3000 loss in 30 years?

[RobG]

Rob - your posts have been helpful and I thank you for them. I am not persuaded by your argument, especially for the reasons others have pointed out (most Bogleheads will save/invest that extra $1000 per year; many will carry losses into retirement to offset recognized gains; many will leave taxable assets to heirs who receive a stepped up basis so that no taxes are ever paid). One other question - since the capital loss limit appears not to be indexed to inflation (it's been $3000 for as long as I can remember, which isn't that long), isn't a $3000 loss now worth more than a $3000 loss in 30 years?

Thanks, based on my conversations here I think most people just TLH and think they get a benefit. I think it helps to point out that you need to invest the ~$1000 in tax savings or you will likely come out behind. I also need to remember that some people are able to carry their losses into retirement, but that is still 20 years out for me.

I'm not sure how the $3000 loss now vs later factors in. If you don't invest the savings it won't make a difference in how much money you have in retirement.

[Wagnerjb]

I'm not sure how the $3000 loss now vs later factors in. If you don't invest the savings it won't make a difference in how much money you have in retirement.

Rob: with all due respect, you are ignoring two aspects that are very important or most people here. First is the time value of money and second is tax arbitrage (deducting at one rate, paying at a lower rate).

You seem to be discounting the fact that a typical Boglehead will pay less in overall tax, and therefore be better off. You also seem to be discounting the time value of money by constructing a naive and undisciplined individual to show that he won't benefit. The guy you are describing is the same guy who says, "Gee, I like my employer to overwhithhold my income taxes during the year, because I like the refund in April". This guy doesn't understand the time value of money, and does not have the discipline to plan and budget. For this guy, maybe our advice would be not to TLH. But for most Bogleheads I firmly believe it adds value...both time value of money and lower overall tax payments.

Best wishes.

[RobG]

I'm not sure how the $3000 loss now vs later factors in. If you don't invest the savings it won't make a difference in how much money you have in retirement.

Rob: with all due respect, you are ignoring two aspects that are very important or most people here. First is the time value of money and second is tax arbitrage (deducting at one rate, paying at a lower rate).

You seem to be discounting the fact that a typical Boglehead will pay less in overall tax, and therefore be better off. You also seem to be discounting the time value of money by constructing a naive and undisciplined individual to show that he won't benefit. The guy you are describing is the same guy who says, "Gee, I like my employer to overwhithhold my income taxes during the year, because I like the refund in April". This guy doesn't understand the time value of money, and does not have the discipline to plan and budget. For this guy, maybe our advice would be not to TLH. But for most Bogleheads I firmly believe it adds value...both time value of money and lower overall tax payments.

Best wishes.

Andy, if you aren't investing the extra $1000 saved you ARE NOT doing tax arbitrage. You are just spending $1000 and then increasing the amount of capital gains taxes you'll eventually pay because you lowered the basis.

Based on the conversations I have had here I'd say most people didn't realize that you have to invest that tax savings or TLH could hurt you in the end. Your previous post said they didn't need to change their savings habit so you appear to have it wrong too, with all due respect. Sure, the oversight doesn't matter to the wealthy who are just passing on their stock to their kids, but it will hurt the people who will eventually deplete their taxable accounts and they need the money the most.

Now if you have been able to carry over the loss to retirement you can deduct the $3k off your income and play a little arbitrage game so you maybe are paying 15% instead of 25% on that $3000 and you save $300/year. That isn't exactly huge, but I will grant you that it is "free" money. (In reality you will save a bit more because the basis isn't zero and there is some value in pushing out when you pay those taxes.) I can think of other advantages of having those losses in retirement to help with tax planning, so if can carry the loss into retirement then it is a good idea if you know how to tax plan.

[Wagnerjb]

Andy, if you aren't investing the extra $1000 saved you ARE NOT doing tax arbitrage. You are just spending $1000 and then increasing the amount of capital gains taxes you'll eventually pay because you lowered the basis.

Based on the conversations I have had here I'd say most people didn't realize that you have to invest that tax savings or TLH could hurt you in the end. Your previous post said they didn't need to change their savings habit

If you TLH in the 30% rate and pay capital gains (later) in the 15% rate, here is what happens. You don't change your savings rate, as that is based on your salary and long-term projections. OK, so this year you have an extra $1000 to spend. So you splurge. In 10 years, you have to pay an extra $500 in taxes (when you sell the asset). So you spend $500 less that year. What is wrong with that? If your budget is so tight that it cannot absorb a reduction of $500 you probably aren't a candidate for TLH anyway. But for those of us who can easily absorb a $500 reduction (and not feel it), you are up $500. Some may fritter it away, while some may save it. Either way, you have $500 more to buy toys or invest....that you didn't have before you harvested.

Best wishes.

[RobG]

Andy, if you aren't investing the extra $1000 saved you ARE NOT doing tax arbitrage. You are just spending $1000 and then increasing the amount of capital gains taxes you'll eventually pay because you lowered the basis.

Based on the conversations I have had here I'd say most people didn't realize that you have to invest that tax savings or TLH could hurt you in the end. Your previous post said they didn't need to change their savings habit

If you TLH in the 30% rate and pay capital gains (later) in the 15% rate, here is what happens. You don't change your savings rate, as that is based on your salary and long-term projections. OK, so this year you have an extra $1000 to spend. So you splurge. In 10 years, you have to pay an extra $500 in taxes (when you sell the asset). So you spend $500 less that year. What is wrong with that? If your budget is so tight that it cannot absorb a reduction of $500 you probably aren't a candidate for TLH anyway. But for those of us who can easily absorb a $500 reduction (and not feel it), you are up $500. Some may fritter it away, while some may save it. Either way, you have $500 more to buy toys or invest....that you didn't have before you harvested.

Best wishes.

Andy - My only point through this exchange is that if you "fritter it away" you are implementing a spending strategy, not an investing strategy. TLH is advertised as part of an investment strategy but it is easy to unwittingly turn it into a spending strategy.

If you just want more money now, and are willing to sacrifice your retirement fund, why don't you just spend more and save less? While fun, I would hope you would agree that isn't a very good investing strategy.

[Wagnerjb]

Andy - My only point through this exchange is that if you "fritter it away" you are implementing a spending strategy, not an investing strategy. TLH is advertised as part of an investment strategy but it is easy to unwittingly turn it into a spending strategy.

If you just want more money now, and are willing to sacrifice your retirement fund, why don't you just spend more and save less? While fun, I would hope you would agree that isn't a very good investing strategy.

Rob: it seems to boil down to how you view investing. If you can (for example) lower your ER by a few points, lower your investment taxes by a few percentages, and raise your returns - through more risk - then what do you do with those benefits? It appears you would save the extra, then maybe retire earlier. Others may keep their savings constant (after costs and taxes) and use the benefits for current consumption. I don't see anything wrong with using the investment related savings to increase today's pre-retirement standard of living. This is as long as you are disciplined in your planning...and I get your point that not everybody fits that bill.

Best wishes.

[RobG]

Andy, what is this pre-retirement enjoyment you speak of? This isn't the petrocelliheads, it's the bogleheads. We start celebratory threads when an expense ratio drops from 0.1% to 0.08%, saving us $500 per year (for every $2.5 million invested). If that isn't living it up, what is?

Seriously, I think we agree on everything now. Thanks for chiming in.

rg

[ploldo]

A like all the strategy here to minimize tax on a traditional IRA during retirement. Why wouldn't this work?

I plan to fully fund my 401k and roth every year and spend the rest leaving none in taxable. At retirement with 0 income can't I just convert my whole traditional to a roth at once and be paying 0% tax on this? It seems like there is a catch here but I don't see it.

Err nvm its taxed as regular income. So ill jsut convert the max for the min tax bracket I want.

[DSInvestor]

At retirement with 0 income can't I just convert my whole traditional to a roth at once and be paying 0% tax on this? It seems like there is a catch here but I don't see it.

If you were retired today at age 65 with ZERO income and a 1M Traditional IRA, a conversion of the whole $1M to Roth would add $1M of Adjusted Gross Income. The Fed Tax cost in 2012 for a single filer age 65 taking std deduction and 1 exemption would be $322K.

The tax cost may be lower if you had some assets in taxable accounts (invested tax efficiently) and making a series of smaller Roth conversions every year.

[swaption]

Rob,

Your point is simply not valid. Implicit in the discussion of any issue here is the assumption of "all else being equal" which one would assume includes spending. Your comment could just as easily be said about someone that spends 0.25% to lower their mortgage rate by 2.00% per annum. The use of the interest savings has no bearing on the validity of the strategy. And I'll go one further to say that spending all of the savings does not necessarily invalidate the strategy given that for most investment returns are typically headed for some form of consumption, either now or in the future. So maybe one could take that trip to Paris when they're 50 instead of 70, and perhaps even enjoy it a whole lot more.

[RobG]

Rob,

Your point is simply not valid. Implicit in the discussion of any issue here is the assumption of "all else being equal" which one would assume includes spending. Your comment could just as easily be said about someone that spends 0.25% to lower their mortgage rate by 2.00% per annum. The use of the interest savings has no bearing on the validity of the strategy. And I'll go one further to say that spending all of the savings does not necessarily invalidate the strategy given that for most investment returns are typically headed for some form of consumption, either now or in the future. So maybe one could take that trip to Paris when they're 50 instead of 70, and perhaps even enjoy it a whole lot more.

This is a dead horse, but I have to say that is a bizarre statement swaption. This is a board about investing for the future so if there is any implied assumption it would be that advice will increase, not decrease the value of your portfolio.

[swaption]

Rob,

Your point is simply not valid. Implicit in the discussion of any issue here is the assumption of "all else being equal" which one would assume includes spending. Your comment could just as easily be said about someone that spends 0.25% to lower their mortgage rate by 2.00% per annum. The use of the interest savings has no bearing on the validity of the strategy. And I'll go one further to say that spending all of the savings does not necessarily invalidate the strategy given that for most investment returns are typically headed for some form of consumption, either now or in the future. So maybe one could take that trip to Paris when they're 50 instead of 70, and perhaps even enjoy it a whole lot more.

This is a dead horse, but I have to say that is a bizarre statement swaption. This is a board about investing for the future so if there is any implied assumption it would be that advice will increase, not decrease the value of your portfolio.

If you think my statement bizarre, then not a dead horse at all. If the requirement be that one's portfolio increase, then implicit in anything is the assumption of "all else being equal", in which case the portfolio would increase. To bring in what ifs like increased spending, just wastes time and risks diluting the original topic.

[RobG]

I'm not sure where you are going with this swaption, but in my experience a lot of people don't realize TLH by itself will reduce the value of your portfolio because it increases the amount of taxes you owe. It just isn't something that is immediately obvious so every few years I pop in and annoy livesoft and sometimes Andy just to keep ya'll on your toes.

Done under the right conditions, TLH is a good idea. (Especially if you can carry the losses over to retirement.)

[jbk]

Rob, you must have been the guy I was thinking of when I ran this poll here last year: viewtopic.php?f=2&t=96800&view=viewpoll

You might be happy to know that the overwhelming majority of the few who voted are hanging on to the tax savings from TLH.

[livesoft]

I'm not sure where you are going with this swaption, but in my experience a lot of people don't realize TLH by itself will reduce the value of your portfolio because it increases the amount of taxes you owe. It just isn't something that is immediately obvious so every few years I pop in and annoy livesoft and sometimes Andy just to keep ya'll on your toes.

I am annoyed because that's an interesting statement since LT cap gains tax rates are lower than marginal income tax rates for everybody (except folks who don't pay income taxes, then they are equal). But you mentioned "in my experience" and I am curious about that. Are you talking to people much about TLH? Is it related to your job?

[RobG]

Thanks jbk, that could have been me as most people here tell us to "TLH", not "TLH and save the difference." The results are kind of strange as they don't seem to match up with the comments. I guess it is believed if you don't change your spending habits you are investing - a conservation of money principle. Bogleheads are better than most with this, but most people's lifestyle gets more expensive as their income rises. Spending new money seems like that new word you just learned and suddenly you find it everywhere when you go looking, especially early on in a career.

Livesoft, mostly from posts here (see my first sentence above). It is true that there is a difference in tax rates, but the government has made it difficult to exploit this difference with their $3000/year limit on higher income stuff. On top of that when it comes time to cash in it is more cost effective to cash in stocks instead of your TIRA because of that same lower tax rate. When that happens the cap losses are put against the cap gains and you've accomplished nothing unless you invested the tax savings from the $3000 deduction. (Again, with TLH in retirement you do get the modest benefit of using that tax difference on the $3000 deduction).

I'm no dummy and this didn't occur to me at first because it wasn't mentioned here. Sorry if it is obvious to everyone else, but given the pushback when I bring it up I'd say most people didn't realize it either.

[livesoft]

I realize that if one pays the same LT cap gains taxes later on in life as the rate they pay when they do the TLH, then the win is the "loan" which then only works if the "loan" is invested and not spent. Plus the win is the differential between the marginal income tax and cap gains tax rate that one would pay on $3,000 annually over the life of the carryover loss.

However, I am all for TLHing losses before they become LT, but whether that makes any difference to most folks is debatable. For me, it allows me to spend some of my short-term taxable gains without taxes even while not retired. You may ask, "Why would you sell shares with ST gains instead of LT gains?" The answer is simple: The shares with ST gains are the ones with the highest basis and thus the least amount of gains and thus with my previous ST realized (and carryover) losses lead to no tax. Why sell at all? I need to pay for college expenses so I am living paycheck to paycheck.

Mostly though, for me the additional win is the differential between LT cap gains in retirement (most 0%) and rates while working.

The title of this thread is "Quantifying ....". I hope folks see that there are many apparent subtleties that they want to account for in their own particular situation. My situation is that I am near full retirement and see how to use the current tax laws in my favor for the next few years.

[RobG]

Livesoft , can't talk, going skiing again

[jbk]

Thanks jbk, that could have been me as most people here tell us to "TLH", not "TLH and save the difference." The results are kind of strange as they don't seem to match up with the comments. I guess it is believed if you don't change your spending habits you are investing - a conservation of money principle. Bogleheads are better than most with this, but most people's lifestyle gets more expensive as their income rises. Spending new money seems like that new word you just learned and suddenly you find it everywhere when you go looking, especially early on in a career.

I noticed that about the poll. Apparently, some voters didn't post and some posters didn't vote.

Count me in the general "conservation of money" category. I'm already maxing the 403(b) and the Roth and I'm not adding to taxable since I'm transferring taxable money to retirement money. Current cash flow is negative, but that should end when the last kid finishes daycare. While I track the budget monthly, I can't say I've invested the tax difference from TLH, but I'm reasonably sure I didn't raise expenses and blow it.

Of course everyone knows the market is only going up from here, making the discussion moot