index fund convert seeks tax advice

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mrh
Posts: 2
Joined: Thu Jun 13, 2013 2:59 pm

index fund convert seeks tax advice

Post by mrh »

Hi,
I have a portfolio of equities (no funds) currently worth $1.2 mill managed for a 1% fee. Is there a way to minimize the tax bill in the transition to a 100% index fund position, and would you recommend transitioning to a 100% index fund? (If sold today the profit would be $330K (probably 30/70 short term vs long term capital gain but I'm guessing)

age: 55
marital status: single
occupation: social worker (salary: approx $30,000/yr) I just started contributing 100% of my salary to a 403b and will select a Vanguard index fund once there's an accumulation.
reside in: Yonkers, NY (in a rental)
debt: approx $16,000 left from a student loan
other assets: 1/5 share in a trust worth $4.3 mill and managed by PNC of Red Bank NJ; will dissolve when my uncle, 83, dies. 72/25/3 equities to fixed income to alternative investments; TIAA-CREF acct worth $87,000 68/17/15 equities to real estate to annuity; $60,000 in cash, 33oz gold bullion.

Any guidance you are willing to give me would be so appreciated!!
jimmy
Posts: 69
Joined: Sat Apr 27, 2013 1:29 am

Re: index fund convert seeks tax advice

Post by jimmy »

Any tax loss carryover's or unrealized losses? To minimize some taxes I would probably wait to sell the s/t gains until they become l/t gains. If you want to sell to index funds I don't see a reason not to sell the majority of your l/t gains to convert. You may want to spread the tax over 2 maybe 3 years but always check with your CPA on your particular situation to make sure it doesn't trigger any excess taxes.
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hansp
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Location: San Francisco, CA

Re: index fund convert seeks tax advice

Post by hansp »

mrh, a question:

Is the 1.2M on top of the money in your uncle's trust or is that your share of the trust? (1/5 of 4.3M doesn't equal 1.2M).

Assuming it is separate, taxable $$$, then I'd echo jimmy's advice.

First thing I'd do is transfer all of the stock "in-kind" to Vanguard or whatever place you are going to eventually buy your funds. That will save you the 1% management fee ($12K/year) right away. Note that once all your gains go long term, it would cost you at most $50K in taxes, or about 4 years of the management fee!

One possibility: sell everything that is at a loss and the small l/t gains until you hit break-even net gain. (this may be nothing if these are l/t holdings). Remember long term capital gains are 0% while you are still in the 15% tax bracket.

Then follow jimmy's advice on letting short term gains convert to long term and potentially breaking it up over a year or two. However, given the size of the gains you have, personally I'd just bite the bullet and sell it all at once and put all of the net earnings, minus estimated taxes and paying off the student loan, into index funds.

If you edit your original post and list the options available in your 403b & TIAA-CREF acct, along w/ your desired allocation, people will be happy to give you more specific advice on how to invest everything across all accounts.

Then once you are setup with this, whenever the trust $ comes to you, you can just push it into your existing allocation.
livesoft
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Re: index fund convert seeks tax advice

Post by livesoft »

If you have any automatic re-investment of dividends happening, turn that off. That will reduce the amount of short-term shares to deal with in the coming months.

You can donate shares to charity that have been held long-term and that have gains. You may wish to open your own donor-advised fund to accept shares and then donate smaller amounts to various charities from the DAF. While you won't pay any taxes on gains for such donations even if you do not itemize, you should work out how to itemize on your tax return to get more deductions. Perhaps bunching deductions will help, but maybe just your state+city income tax exceeds the standard deduction and you itemize anyways.

If your income is low enough, the long-term capital gains tax rate is 0%. So ... figure out how much LTCG you can have each year without paying CG tax and try to only sell up to that amount of gains.
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Bob's not my name
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Joined: Sun Nov 15, 2009 8:24 am

Re: index fund convert seeks tax advice

Post by Bob's not my name »

Selling it all at once would be a bad idea. Even the long term gains would be taxed at 27% at the margin* (15% LTCG tax + 3.8% ACA tax + 1% ATRA tax due to exemption phaseout + 6.85% NY + 0.7% Yonkers -- I didn't research the Yonkers tax thoroughly so double check me there). As livesoft suggests, you should be able to sell in yearly batches at lower tax rates. You ought to think about these categories/priorities:
  • It looks like you have way too much equity exposure for your age. You can begin to address this without tax implications by shifting all of your tax-advantaged accounts to bonds and by buying municipal bond funds with your cash.
  • Any large holdings of one individual stock?
  • Hold the short term gains until they're long term.
Understand your tax situation. It looks like you might have tens of thousands of dollars of taxable investment income each year on top of your $30,000 salary. As an illustration:

$70,000 gross income
- $23,000 403b contributions
- $2,000 pre-tax health, dental, and disability insurance premiums withheld from your pay (guess)
-----------
$45,000 AGI --> eligible for $5,500 deductible traditional IRA contribution (remember this is an illustration -- check your real numbers)
- $6,500 TIRA contribution**
- $3,900 personal exemption
- $6,100 standard deduction
-----------
$28,500 taxable income --> in the 15% bracket (0% long term capital gains rate) with less than $8,000 of headroom to realize gains at the 0% rate

Again, run this check with your real numbers, using your 2012 tax return as a guide. I suspect you don't have much, if any, room in the 15% bracket to realize long term gains at the 0% rate. Therefore the best LTCG rate you can get might be 15% federal + NY state + Yonkers, at least avoiding the new federal taxes introduced in 2013 on people like you. This rate won't change much as long as you keep your AGI below the $200,000 threshold at which the 3.8% ACA tax kicks in (the ATRA tax kicks in at $250,000 AGI). So if you actually have no headroom in the 15% federal bracket, you can probably sell everything in three tax years and pay about 22% tax. If you do have headroom, it may be wise to spread the sales over many years to milk that 0% federal rate.

*If you started making charitable donations as livesoft suggests and itemizing deductions, there would be an additional ATRA 1% effective marginal rate due to the itemized deduction phaseout, so your total marginal rate on LTCG and QD would be over 28%. I'm not saying donations are a bad idea, I'm just saying combining donations with selling everything else at once would result in a higher marginal rate on the gains.

**Large stock sales will probably make you ineligible for deductible TIRA contributions, which is a shame because the effective marginal tax rate on your earned income might be over 40%.
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grabiner
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Re: index fund convert seeks tax advice

Post by grabiner »

Welcome to the forum!
mrh wrote:I have a portfolio of equities (no funds) currently worth $1.2 mill managed for a 1% fee. Is there a way to minimize the tax bill in the transition to a 100% index fund position, and would you recommend transitioning to a 100% index fund? (If sold today the profit would be $330K (probably 30/70 short term vs long term capital gain but I'm guessing)
If you have a diversified portfolio of equities, you could just move them to a discount brokerage and leave them there, treating them as if they were a large-cap index fund. On average, 20 large-cap stocks should behave similarly to the S&P 500.

You still want to sell any single stock that is more than 5% of your portfolio, and enough stock to get to your target asset allocation; taxes should not be a reason to take extra risks.

And wait before taking any short-term gains. Whatever you do sell this year will be taxed at a much higher rate if the gains are short-term rather than long-term; the exact tax rate may depend on how much you sell.
Wiki David Grabiner
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