International better in taxable account?

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Gaston
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International better in taxable account?

Post by Gaston »

I've read it can be better to hold international funds in a taxable account. I don't fully understand this, but the rationale has something to do with the ability to obtain a tax credit on foreign dividends withheld at source. Thoughts on this?
Da5id
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Re: International better in taxable account?

Post by Da5id »

Gaston wrote: Mon Jun 14, 2021 7:16 pm I've read it can be better to hold international funds in a taxable account. I don't fully understand this, but the rationale has something to do with the ability to obtain a tax credit on foreign dividends withheld at source. Thoughts on this?
https://www.bogleheads.org/wiki/Tax-eff ... le_account has some explanation of this. But you'd have to work out for your individual situation how to balance:

1) the tax credit (favors taxable)
2) the (generally) higher dividends that international throws off (favors not in taxable)
3) the lower percentage of qualified dividends that international has (favors not in taxable)

So there are tradeoffs...
retiredjg
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Re: International better in taxable account?

Post by retiredjg »

This is not about "international being better in taxable".

But, if you can fill your plan at work and an IRA and if you have more money to save for retirement, the next place to put money for retirement is a taxable account.

If you are able to save that much, some people like to put international into taxable for a number of reasons. One of those reasons is being able to claim the foreign tax credit. It is not a big credit, but it does help make some international index funds pretty tax-efficient (i.e.taxable can be a good location for international to be).

If you are not saving that much, don't be concerned. Your international allocation can go anywhere. The location often depends on where you can find it with low expense ratios. For example, some 401k plans do not offer low cost international funds. In a case like that, an IRA (traditional or Roth) can be a good place for it to live.
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JoMoney
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Re: International better in taxable account?

Post by JoMoney »

FWIW, here's a chart of the growth of $10,000 if it could be invested in the "MSCI All-Country World Index excluding USA"-Net Return (which is the index after tax withholding that an index fund like iShares ACWX tracks) relative to the -Gross Return index (which tracks the index return if there was no foreign tax withholding).

Image
LINK

It appears that over the past 20 years the foreign withholding of taxes had an impact equivalent to about -0.43% annualized.
If you hold the 'international' in a taxable account you may be eligible for a credit on your U.S. taxes for those foreign taxes paid, if you hold in a retirement account you don't get anything for that :(
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Da5id
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Re: International better in taxable account?

Post by Da5id »

JoMoney wrote: Mon Jun 14, 2021 7:54 pm It appears that over the past 20 years the foreign withholding of taxes had an impact equivalent to about -0.43% annualized.
If you hold the 'international' in a taxable account you may be eligible for a credit on your U.S. taxes for those foreign taxes paid, if you hold in a retirement account you don't get anything for that :(
Is there similar plot that takes into account the higher dividend rate and the lower percentage of qualified dividends that international stocks have (and an assumed marginal tax rate)? The tax credit is one factor, those are a counter-balancing factor. I'm not sure that it is always correct to put international in taxable?
ruud
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Re: International better in taxable account?

Post by ruud »

If you're in a high federal and state tax bracket, the foreign tax credit does not overcome the additional tax drag from the higher yield and lower qualified dividend rate on international stock funds. So "international goes in taxable" is not a universal recommendation.
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lazynovice
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Re: International better in taxable account?

Post by lazynovice »

ruud wrote: Mon Jun 14, 2021 8:14 pm If you're in a high federal and state tax bracket, the foreign tax credit does not overcome the additional tax drag from the higher yield and lower qualified dividend rate on international stock funds. So "international goes in taxable" is not a universal recommendation.
I cannot seem to find it but somewhere above the 28% bracket is where the benefits of FTC start to break down.
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Da5id
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Re: International better in taxable account?

Post by Da5id »

lazynovice wrote: Mon Jun 14, 2021 8:31 pm
ruud wrote: Mon Jun 14, 2021 8:14 pm If you're in a high federal and state tax bracket, the foreign tax credit does not overcome the additional tax drag from the higher yield and lower qualified dividend rate on international stock funds. So "international goes in taxable" is not a universal recommendation.
I cannot seem to find it but somewhere above the 28% bracket is where the benefits of FTC start to break down.
I'd have thought you'd need multiple inputs and this would be fund specific. Particularly if doing a trade-off of US stocks in taxable vs international in taxable, you'd have to compare the tax credit vs qualified/unqualified dividends for the actual funds involved. And there are further issues if for example trying to manage income for phase-outs or ACA MAGI.
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JonnyDVM
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Re: International better in taxable account?

Post by JonnyDVM »

I favor international in taxable not just for the foreign tax credit, but also because I only have so much tax free space. Tax free space is better used for assets with a heavier tax drag.
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JoMoney
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Re: International better in taxable account?

Post by JoMoney »

Da5id wrote: Mon Jun 14, 2021 8:13 pm
JoMoney wrote: Mon Jun 14, 2021 7:54 pm It appears that over the past 20 years the foreign withholding of taxes had an impact equivalent to about -0.43% annualized.
If you hold the 'international' in a taxable account you may be eligible for a credit on your U.S. taxes for those foreign taxes paid, if you hold in a retirement account you don't get anything for that :(
Is there similar plot that takes into account the higher dividend rate and the lower percentage of qualified dividends that international stocks have (and an assumed marginal tax rate)? The tax credit is one factor, those are a counter-balancing factor. I'm not sure that it is always correct to put international in taxable?
I don't know of one... But, yeah, I'd wager it's definitely not "always" correct to put international in taxable. There are lots of factors individuals need to consider for their individual situation.
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lazynovice
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Re: International better in taxable account?

Post by lazynovice »

Da5id wrote: Mon Jun 14, 2021 8:48 pm
lazynovice wrote: Mon Jun 14, 2021 8:31 pm
ruud wrote: Mon Jun 14, 2021 8:14 pm If you're in a high federal and state tax bracket, the foreign tax credit does not overcome the additional tax drag from the higher yield and lower qualified dividend rate on international stock funds. So "international goes in taxable" is not a universal recommendation.
I cannot seem to find it but somewhere above the 28% bracket is where the benefits of FTC start to break down.
I'd have thought you'd need multiple inputs and this would be fund specific. Particularly if doing a trade-off of US stocks in taxable vs international in taxable, you'd have to compare the tax credit vs qualified/unqualified dividends for the actual funds involved. And there are further issues if for example trying to manage income for phase-outs or ACA MAGI.
Well, clearly I am wrong about 28% as there is no 28% bracket anymore!

At the 32% bracket or $20,000 in qualified dividends, you have to start making adjustments to the credit, so I know that at 32% you start to lose some of the benefit. I just don’t know if you lose some of it below 32%.

During tax season there was some discussion here and a tax bracket was quoted likely using VXUS as the example. At the time,I considered moving all my Roth to international and offsetting in taxable but then I considered that I won’t be above the 32% bracket (currently in 37%) forever. I aspire to be in the 12% or 15% in a few years, so I have split the difference for now. My 401(k) is full of bonds, my Roth and taxable are split 75/25 US and International.
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grabiner
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Re: International better in taxable account?

Post by grabiner »

lazynovice wrote: Mon Jun 14, 2021 10:08 pm At the 32% bracket or $20,000 in qualified dividends, you have to start making adjustments to the credit, so I know that at 32% you start to lose some of the benefit. I just don’t know if you lose some of it below 32%.
You have to make an adjustment, but it doesn't usually limit your credit. You count your foreign qualified dividends at 15/37 or 20/37 of their value, depending on whether you pay 15% or 20% tax on them, and then determine what fraction of your taxable income is foreign. But foreign funds with mostly qualified dividends tend to have a foreign tax credit of about 8% of the dividend yield, so the limit isn't likely to come into play in the 32% bracket.

The $20,000 limit is more likely to affect investors if they hit that limit while still in a lower tax bracket. However, this is not common, because $20,000 in qualified dividends requires about $1M in foreign stock, and few investors in a low tax bracket have that much foreign stock in a taxable account.

What does reduce the benefit of international in a taxable account in high brackets is the higher dividend yield, and higher fraction of non-qualified dividends.
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lazynovice
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Re: International better in taxable account?

Post by lazynovice »

grabiner wrote: Mon Jun 14, 2021 11:38 pm
lazynovice wrote: Mon Jun 14, 2021 10:08 pm At the 32% bracket or $20,000 in qualified dividends, you have to start making adjustments to the credit, so I know that at 32% you start to lose some of the benefit. I just don’t know if you lose some of it below 32%.
You have to make an adjustment, but it doesn't usually limit your credit. You count your foreign qualified dividends at 15/37 or 20/37 of their value, depending on whether you pay 15% or 20% tax on them, and then determine what fraction of your taxable income is foreign. But foreign funds with mostly qualified dividends tend to have a foreign tax credit of about 8% of the dividend yield, so the limit isn't likely to come into play in the 32% bracket.

The $20,000 limit is more likely to affect investors if they hit that limit while still in a lower tax bracket. However, this is not common, because $20,000 in qualified dividends requires about $1M in foreign stock, and few investors in a low tax bracket have that much foreign stock in a taxable account.

What does reduce the benefit of international in a taxable account in high brackets is the higher dividend yield, and higher fraction of non-qualified dividends.
Thanks for your answer. If the credit is limited, do you get to carry that amount over into future years?
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grabiner
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Re: International better in taxable account?

Post by grabiner »

lazynovice wrote: Tue Jun 15, 2021 8:36 am
grabiner wrote: Mon Jun 14, 2021 11:38 pm
lazynovice wrote: Mon Jun 14, 2021 10:08 pm At the 32% bracket or $20,000 in qualified dividends, you have to start making adjustments to the credit, so I know that at 32% you start to lose some of the benefit. I just don’t know if you lose some of it below 32%.
You have to make an adjustment, but it doesn't usually limit your credit. You count your foreign qualified dividends at 15/37 or 20/37 of their value, depending on whether you pay 15% or 20% tax on them, and then determine what fraction of your taxable income is foreign. But foreign funds with mostly qualified dividends tend to have a foreign tax credit of about 8% of the dividend yield, so the limit isn't likely to come into play in the 32% bracket.

The $20,000 limit is more likely to affect investors if they hit that limit while still in a lower tax bracket. However, this is not common, because $20,000 in qualified dividends requires about $1M in foreign stock, and few investors in a low tax bracket have that much foreign stock in a taxable account.

What does reduce the benefit of international in a taxable account in high brackets is the higher dividend yield, and higher fraction of non-qualified dividends.
Thanks for your answer. If the credit is limited, do you get to carry that amount over into future years?
Yes. Form 1116 allows you to carry a foreign tax credit back one year and forward ten years. Thus, if a one-time change in income denies you the full credit, you will likely get it back. But if you find yourself regularly having the credit limited, you will lose some of the benefit permanently and may need to change your investments.
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