Low Income Investor (Tax Concerns)

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LouisJxn
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Low Income Investor (Tax Concerns)

Post by LouisJxn »

I have saved up about $20,000 in my bank account over a long period of time. I am currently a graduate student and work two part-time jobs. My annual income is about $8-10,000 per year, and I get a tax refund every year as a result. I am wanting to take $10,000 out of my bank account and invest in admiral shares of Vanguard S&P 500 (VFIAX).

My main concern right now is with how this investment might affect my taxes. Until I complete school and get a full-time career position, I would like to continue getting the refund and avoid any potential tax mistakes when investing. Does anyone know how an investment like this might affect someone in my position?

Thanks for any advice with this. - Louis
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Re: Low Income Investor (Tax Concerns)

Post by placeholder »

You should be looking at an IRA of some sort probably a Roth as your income is so low so put up to 5500 in there and invest where it will grow tax free from then on and the otherwise if you have more to invest buy funds in a taxable account and invest where there should be no taxes on dividends currently.
livesoft
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Re: Low Income Investor (Tax Concerns)

Post by livesoft »

Why are you getting a refund at all? Presumably, you are not having any income tax withheld from your paychecks (file W-4's to make sure that's true). Are you benefitting from a saver's credit (cannot be a full-time student)? Are you contributing to an IRA?

Rather than the S&P500 index fund, may I suggest instead the Total Stock Market Index fund or better yet a LifeStrategy or Target Retirement fund?

The S&P500 index fund will pay dividends a few times a year. Those dividends will be tax-free for someone with your current income.
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Topic Author
LouisJxn
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Re: Low Income Investor (Tax Concerns)

Post by LouisJxn »

Thanks for the advice on this. I have federal taxes taken out of my paycheck each year. There is no income tax in my state. When I file my return, I usually get a little bit more than I paid because of the earned income tax credit. I currently have no investments and have just put as much as possible into savings account. I am an absolute beginner at investing and since a family accountant does my taxes each year, I have little knowledge of what type of investments could affect what I might have to pay the gov't. My main concern was just getting an unexpected tax liability from investing a relatively large sum of money for someone with my lower income.

Thanks again. - Louis
JD
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Re: Low Income Investor (Tax Concerns)

Post by JD »

LouisJxn wrote:I have saved up about $20,000 in my bank account over a long period of time. I am currently a graduate student and work two part-time jobs. My annual income is about $8-10,000 per year, and I get a tax refund every year as a result. I am wanting to take $10,000 out of my bank account and invest in admiral shares of Vanguard S&P 500 (VFIAX).

My main concern right now is with how this investment might affect my taxes. Until I complete school and get a full-time career position, I would like to continue getting the refund and avoid any potential tax mistakes when investing. Does anyone know how an investment like this might affect someone in my position?

Thanks for any advice with this. - Louis
As your income is low, this should not affect your tax refund if you invest in the index that you mentioned. If you have $10,000 and want to use Vanguard S&P 500; You can invest all the amount or if you want to open a ROTH IRA, you would be able to place $5,500 in IRA and the rest in taxable account for the same fund.
tj
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Re: Low Income Investor (Tax Concerns)

Post by tj »

Investment Income must be $3300 or less for Earned income credit. This shouldn't be an issue for you.
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LouisJxn
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Re: Low Income Investor (Tax Concerns)

Post by LouisJxn »

I'm really not worried much about not getting the earned income tax credit, or even of getting no refund at all. I'm just worried about the theoretical scenario where I start investing a lot of money and end up having to pay taxes while I'm making so little. I would gladly give up my tax refund in order to begin improving my financial outlook through sound investments.
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22twain
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Re: Low Income Investor (Tax Concerns)

Post by 22twain »

JD wrote:if you want to open a ROTH IRA, you would be able to place $5,500 in IRA and the rest in taxable account for the same fund.
Or put $5500 in the IRA now, and then after the beginning of next year, another $4500, or even $5500 if you're feeling flush by then.
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Re: Low Income Investor (Tax Concerns)

Post by kaneohe »

LouisJxn wrote: I'm just worried about the theoretical scenario where I start investing a lot of money and end up having to pay taxes while I'm making so little. .
Careful w/ your thought process tho................you pay taxes because you made income and you only pay a fraction of your income as taxes (fraction < 1.0).
Suppose you won the lottery and won $1M and had to pay 0.5M in taxes. Would you forfeit the winnings because you would have to pay 0.5M in taxes? I know
folks who owned rental properties who didn't want to have more rental income because they would have to pay more taxes so it may not be an uncommon thought.

..........so rather than just thinking about the taxes you would pay, perhaps it might be better to consider what your net income would be after taxes. Occasionally you might be in a situation where earning a little bit more might make you worse off (where credits are involved) so you'd have to consider your specific circumstances to be sure.
hyla
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Re: Low Income Investor (Tax Concerns)

Post by hyla »

I'm also a grad student, with similar income.

You should be fine, even if the money is in a taxable account. At your low income, even with a little additional money from investments, your income would still probably be low enough that your long term capital gains tax rate is 0%.
http://www.bogleheads.org/wiki/Capital_ ... stribution

That being said, I would suggest putting at least some money in a roth IRA. The savers credit gives a tax credit of 50% of money invested, up to certain limits, in an IRA at your income level (assuming you're not a full time student, my grad school qualifies me as half-time). Last year, saver's credit reduced my tax liability to nothing - I got all my withheld taxes back, and all because I'd put money in a retirement account which was already tax-advantaged! I looked through all the education deductions too, and saver's credit was better (for me) than all of them.
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BL
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Re: Low Income Investor (Tax Concerns)

Post by BL »

It doesn't sound like you do your own taxes. If that is true, I would like to suggest you do a tax return now without sending it. Usually you can do it online without cost (just don't submit it!) You can learn so much about taxes by doing "what-if" calculations. Even better is to look at Pub 17 at the IRS.gov site and read about the subject areas you are interested in, and even working out the forms by hand using the instructions and forms available there.

The Wiki here has a page on tax-efficient investing. Total Stock Market and Total International are very tax efficient. There is rarely any capital gains until you sell them (and that would be 0% through the 15% tax bracket) and the dividends are mostly qualified so they also have the 0% advantage. The S&P is a part of TSM and would also fit here, but the TSM is more complete so is recommended when available, but the S&P is often the closest you can get in many 401ks.

As suggested, fill your Roth this year and in January for 2015 before you do taxable. When you start a regular job, find low-cost index funds and start investing in 401ks, as well as continuing with Roths.
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Ged
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Re: Low Income Investor (Tax Concerns)

Post by Ged »

Generally investing money you have already paid income taxes on won't make you liable for taxes on the money you invest, only on income that you earn on the investment, either in the form of capital gains or dividends. Dividends are an ongoing earnings stream, capital gains are incurred only when you sell an equity. For someone in a low income bracket you may or may not be taxed on these depending on the details of the transaction.

Like others here have suggested, investing in a Roth account will likely be beneficial for you as it will allow your gains to be protected from taxes as well. You can contribute up to $5500 a year into a Roth account. Roth investing is very attractive for people whose tax rates are likely to go up in the future.

Do read the Wiki on tax efficient investing.
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BL
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Re: Low Income Investor (Tax Concerns)

Post by BL »

I suggest you read Getting Started in the Wiki, and read a recommended book such as Boglehead's Guide to Investing. Also recommend the new booklet by William Bernstein for beginners, If You Can:
https://dl.dropboxusercontent.com/u/290 ... %20Can.pdf
or on Amazon.com.
kaneohe
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Re: Low Income Investor (Tax Concerns)

Post by kaneohe »

This, from the wiki on timing of buying funds, may be useful so you don't pay unnecessary taxes
http://www.bogleheads.org/wiki/Timing_o ... duce_taxes
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Re: Low Income Investor (Tax Concerns)

Post by grabiner »

kaneohe wrote:This, from the wiki on timing of buying funds, may be useful so you don't pay unnecessary taxes
http://www.bogleheads.org/wiki/Timing_o ... duce_taxes
It's not relevant to the OP, who is in the 15% tax bracket and will pay no taxes on any qualified dividends he receives in September.

(It's also not relevant since the investment would be better in a Roth IRA, where there will be no taxes.)
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Peter Foley
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Re: Low Income Investor (Tax Concerns)

Post by Peter Foley »

When one owns a stock mutual fund like the S&P 500, that person receives dividends and perhaps some capital gains each year. (Unless you sell the fund - then there are capital gains, but that doesn't seem to be your scenario.) If a single person earns less than $36,900* in taxable income, qualified dividends and long term taxable gains are not taxed. (Yes this is grossly oversimplified, but does address the OP's situation.)

Therefore at your current income level owning a broad based equity fund like the S&P 500 or Total Stock Market, will have a minimal, if any, affect on your taxes.


*Figure roughly $40,000 in gross income.
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Re: Low Income Investor (Tax Concerns)

Post by denovo »

LouisJxn wrote:Thanks for the advice on this. I have federal taxes taken out of my paycheck each year.

Thanks again. - Louis
Reduce your withholding.
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Topic Author
LouisJxn
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Re: Low Income Investor (Tax Concerns)

Post by LouisJxn »

Thanks for all of the advice. I've already learned a lot in just my first post here. Would it be better to put $5,500 in Roth IRA vs. $10,000 in admiral shares of the VFIAX fund? I wasn't sure if it would be worth getting the lower expense fee with admiral shares.. or the tax benefits of the IRA right niw. Given the info I have been given here, I feel much better about the tax situation regardless of which one I choose. I would like to pick the best option of the two, though.
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Re: Low Income Investor (Tax Concerns)

Post by KyleAAA »

LouisJxn wrote:Thanks for all of the advice. I've already learned a lot in just my first post here. Would it be better to put $5,500 in Roth IRA vs. $10,000 in admiral shares of the VFIAX fund? I wasn't sure if it would be worth getting the lower expense fee with admiral shares.. or the tax benefits of the IRA right niw. Given the info I have been given here, I feel much better about the tax situation regardless of which one I choose. I would like to pick the best option of the two, though.
Without question, Roth IRA is better. You can always withdraw your contributions in the future without penalty if you need it. But if you don't think you'll need this money for the next 40 years, put it in an IRA. No contest.
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Re: Low Income Investor (Tax Concerns)

Post by grabiner »

LouisJxn wrote:Thanks for all of the advice. I've already learned a lot in just my first post here. Would it be better to put $5,500 in Roth IRA vs. $10,000 in admiral shares of the VFIAX fund? I wasn't sure if it would be worth getting the lower expense fee with admiral shares.. or the tax benefits of the IRA right niw.
If you use this fund, you will get Admiral shares and their lower expenses in the Roth IRA next year, when you can contribute another $5500. And whatever you put in the Roth IRA, you will get the long-term benefit of tax-free growth.

You might also use a Target Retirement fund in the Roth IRA, which is better diversified, as it includes small-company stocks, foreign stocks, and bonds as well as the large-company stocks in the S&P 500.
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Re: Low Income Investor (Tax Concerns)

Post by White Coat Investor »

I wouldn't expect much of an effect on your taxes. The yield is 2%. 2% of $10K is $200. And in your tax bracket, the rate on capital gains and qualified dividends is 0%.
1) Invest you must 2) Time is your friend 3) Impulse is your enemy | 4) Basic arithmetic works 5) Stick to simplicity 6) Stay the course
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BL
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Re: Low Income Investor (Tax Concerns)

Post by BL »

LouisJxn wrote:Thanks for all of the advice. I've already learned a lot in just my first post here. Would it be better to put $5,500 in Roth IRA vs. $10,000 in admiral shares of the VFIAX fund? I wasn't sure if it would be worth getting the lower expense fee with admiral shares.. or the tax benefits of the IRA right niw. Given the info I have been given here, I feel much better about the tax situation regardless of which one I choose. I would like to pick the best option of the two, though.
If you put $5500 into Roth this year and the same for next year in January, you will then have enough for admiral status if you have at least 10k in a single fund. It will automatically change after a bit or you can do the exchange from investor to Admiral shares yourself when you have that much in the fund. (You could even wait until January and buy $11,000 worth of an Admiral fund for 2014 and 2015.) Not sure why you want S&P 500 rather than the more complete Total Stock market, but it is not bad, and a Vanguard Roth can exchange funds at no cost later, so is isn't set in stone. (Most of the portfolios recommended here use Total Stock market.) You could always use a Target Retirement fund for an aggressive but better balanced fund until you have enough saved for a couple admiral funds. The ERs are still very reasonable and the dollar amount differences would not amount to much.
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Re: Low Income Investor (Tax Concerns)

Post by Big Brother »

I think we've covered the lack of tax implications of investing now and I would say that is a wise choice. I would recommend maxing your ROTH IRA contributions for this year ($5,500) and holding the rest in savings until next year when you can make the 2015 ROTH contributions. I would shoot for the total stock market fund as well. Also, If I was you, I would make sure my emergency fund is fully funded for my transition out of grad school. Once you invest in the ROTH, it's out of reach (with a few exceptions) until your 59.5.
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Re: Low Income Investor (Tax Concerns)

Post by Bob's not my name »

LouisJxn wrote:the tax benefits of the IRA right now.
What tax benefits? You're in the 0% federal bracket and have no state income tax. If you were in another state the answer might be different:
Bob's not my name wrote:MD: Marginal rate on top $1,000 of $10,999 is 80%, which can be avoided with 401k, 403b, or 529 contributions made in the calendar year but not by TIRA contributions.
VA: Marginal rate on top $1,000 of $12,949 is 47%, which can be avoided with 401k, 403b, or TIRA contributions but not by 529 contributions.
NJ: Marginal rate on top $1,000 of $11,000 is 24%, which can be avoided only with 401k contributions.

Also, all of these states have beaches, so another mitigation option is working less. This makes particular sense when your marginal rate including payroll taxes exceeds 100%. The surfin' safari income ranges, in which you will make more money at the beach than in the office, are:
MD: $10,000 - $10,840
VA: $11,950 - $12,360
NJ: $10,001 - $10,156
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Re: Low Income Investor (Tax Concerns)

Post by Bob's not my name »

Big Brother wrote:Once you invest in the ROTH, it's out of reach (with a few exceptions) until you're 59.5.
And by "out of reach" we mean that you can withdraw your contributions at any time, at any age, and for any reason, penalty-free. Also, William Roth requests (from the grave) that everyone stop yelling his name :D
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Re: Low Income Investor (Tax Concerns)

Post by BeaverFood »

Big Brother wrote:Also, If I was you, I would make sure my emergency fund is fully funded for my transition out of grad school.
I wanted to echo this advice: I know it's tempting to invest all of the funds and start getting returns on your investments, but I would suggest keeping at least 6 months of living expenses in an emergency fund to help cover your transition from grad school to your career. Whatever you have on hand beyond that amount, I'd most definitely put in a Roth and continue to fund a Roth each year going forward.
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LouisJxn
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Re: Low Income Investor (Tax Concerns)

Post by LouisJxn »

Thanks again, everyone. From what I have gathered in reading the replies, I need to a) consider starting with a Roth IRA right now, and 2) look at the S&P 500 vs. Total Stock Market index. I am pretty much sold now on starting with the Roth IRA, especially knowing that I can go up to Admiral Shares in a few months. And the little bit of research I have done indicates that these have very similar track records. IS the VTSMX what most people start with? Thanks again.
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Re: Low Income Investor (Tax Concerns)

Post by KyleAAA »

LouisJxn wrote:Thanks again, everyone. From what I have gathered in reading the replies, I need to a) consider starting with a Roth IRA right now, and 2) look at the S&P 500 vs. Total Stock Market index. I am pretty much sold now on starting with the Roth IRA, especially knowing that I can go up to Admiral Shares in a few months. And the little bit of research I have done indicates that these have very similar track records. IS the VTSMX what most people start with? Thanks again.
Read this page about the three-fund portfolio: http://www.bogleheads.org/wiki/Three-fund_portfolio

Feel free to start with VTSMX if you want, but I would diversify as quickly as possible into a three fund portfolio even before worrying about qualifying for Admiral shares.

Or even better, just invest in one of the Target Retirement or Lifestrategy funds.
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Re: Low Income Investor (Tax Concerns)

Post by RyeWhiskey »

LouisJxn wrote:Thanks again, everyone. From what I have gathered in reading the replies, I need to a) consider starting with a Roth IRA right now, and 2) look at the S&P 500 vs. Total Stock Market index. I am pretty much sold now on starting with the Roth IRA, especially knowing that I can go up to Admiral Shares in a few months. And the little bit of research I have done indicates that these have very similar track records. IS the VTSMX what most people start with? Thanks again.
Hello,
I'm a graduate student in the same tax bracket. Glad you are looking into the Roth IRA - I recommend you check out Vanguard for opening that account. The difference between the Total Stock Index and the SP500 Index is minimal but important philosophically. The SP500 Index is only 500 companies which the TSM Index is well over 3,000. Diversification matters. I highly recommend you explore Vanguard's LifeStrategy and/or Target Retirement Funds for an excellent, low-cost, extremely diversified, investment.

You may also desire to explore an HSA account if you have a high deductible health care plan. :sharebeer
This post was brought to you by Vanguard Total World Stock Index (VTWSX/VT).
Topic Author
LouisJxn
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Re: Low Income Investor (Tax Concerns)

Post by LouisJxn »

I appreciate everyone's help with this. I am definitely sold on starting with $5,500 in a Roth IRA. And another $5,500 next year to reach admiral shares.

Now I'm just trying to decide between three options :

1) S&P 500
2) Life Strategy Growth Fund
3) Total Market Index Fund

I have been doing some research on these three, but I still can't decide on which one would best suit my needs. The Life Strategy Growth Fund seems to stand out above the rest, but I definitely want to make sure it's the direction I need to go right now.
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Re: Low Income Investor (Tax Concerns)

Post by KyleAAA »

LouisJxn wrote:I appreciate everyone's help with this. I am definitely sold on starting with $5,500 in a Roth IRA. And another $5,500 next year to reach admiral shares.

Now I'm just trying to decide between three options :

1) S&P 500
2) Life Strategy Growth Fund
3) Total Market Index Fund

I have been doing some research on these three, but I still can't decide on which one would best suit my needs. The Life Strategy Growth Fund seems to stand out above the rest, but I definitely want to make sure it's the direction I need to go right now.
It really doesn't matter because there are absolutely no negative consequences if you change your mind later because it's in a Roth IRA. Just go ahead and buy the Lifestrategy fund. You can sell tomorrow with no consequences if you want.
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LouisJxn
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Re: Low Income Investor (Tax Concerns)

Post by LouisJxn »

All of the replies here really helped, so thanks to everyone for helping me with this. I just took the first step and submitted my application to open a Roth IRA and put $5,500 into the Life Strategy Growth Fund. I will plan to add another $5,500 in January of next year.
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