Fire Wife's Advisor and Incur Tax Hit or Stay The Course?

Have a question about your personal investments? No matter how simple or complex, you can ask it here.
Post Reply
Topic Author
andy8921
Posts: 19
Joined: Fri Dec 26, 2014 1:02 am

Fire Wife's Advisor and Incur Tax Hit or Stay The Course?

Post by andy8921 » Sun Jan 18, 2015 5:55 pm

My wife of 13 years has a mid 6 figure taxable managed investment account dating from before we were married. For the last 9 years, she has used an advisor with one of the large brokerage firms. He has constructed a fairly well-diversified portfolio, with roughly 2/3 in equities and 1/3 in fixed income and his returns over the last nine years have been good, but not spectacular. However, most of the investments in her portfolio are high expense ratio (over 1%) actively managed stock and bond funds and her advisor charges approximately 1% annually to manage the account.

I first broached the idea of moving the account to Vanguard and self managing five years ago and after extensive discussions about the compounding effect of fees and expenses, my wife is now comfortable with the idea. We self manage the rest of our assets, including three rollover IRA's, my 401K and Roth IRA's for both of us primarily with a three fund portfolio and our returns have been good and our expenses are very low. I think we both feel we are now capable of managing the taxable account ourselves and saving a substantial amount each year in expenses and fees. The problem is my wife's taxable account has approximately $100,000 in unrealized, long term capital gains and roughly 2/3 of the gains are in proprietary funds not eligible for in kind transfers to Vanguard. We will therefore incur a substantial tax hit if we liquidate the portions of the portfolio ineligible for an in kind transfer.

What are Bogleheads opinions about situations such as these where changing to a passively managed, low cost approach will result in a substantial tax liability? I am concerned that liquidating the funds ineligible for transfer to Vanguard or another low cost provider, taking the tax hit and self managing might wind up offsetting the savings in fees and expenses that we would surely enjoy by making the switch, at least in the short term. I should point out that this account is our only taxable account and we have few options as far as tax loss harvesting is concerned, as there are no sizable losses in the taxable account at the present time. Would you Bogleheads recommend we rip off the band aid, incur the tax hit and self manage, thereby saving thousands of dollars a year in expenses and fees or would you stay the course and remain with this advisor and continue to pay the high fees and expense ratios associated with active management and hope his good track record to date continues?

Thanks again in advance for you thoughts on this issue.

Andrew

livesoft
Posts: 69620
Joined: Thu Mar 01, 2007 8:00 pm

Re: Fire Wife's Advisor and Incur Tax Hit or Stay The Course

Post by livesoft » Sun Jan 18, 2015 5:58 pm

Here is a wiki article on the subject:
http://www.bogleheads.org/wiki/Paying_a ... itch_funds

I would switch.
Wiki This signature message sponsored by sscritic: Learn to fish.

dbr
Posts: 31328
Joined: Sun Mar 04, 2007 9:50 am

Re: Fire Wife's Advisor and Incur Tax Hit or Stay The Course

Post by dbr » Sun Jan 18, 2015 6:01 pm

Why not compare the tax cost to the investment cost. If the cap gains are 50% of the asset value and the tax is 15%, then the cost is 7.5% of assets. If the funds are costing you 2% a year in excess costs, then the breakeven time is 3.5 years to be ahead. Actually if the funds invested are actively managed funds 2% is not the extent of the costs. One item that may be significant is internal costs for trading inside those funds. For stocks that can be 1% for every 100% in turnover. There are also tax costs for capital gains distributions.

livesoft
Posts: 69620
Joined: Thu Mar 01, 2007 8:00 pm

Re: Fire Wife's Advisor and Incur Tax Hit or Stay The Course

Post by livesoft » Sun Jan 18, 2015 6:02 pm

If the funds are actively-managed and you have been paying taxes on the realized gains all along (see your past Schedule B and Schedule D), then you may be surprised at how little the tax cost to switch might be. Frankly, I would not trust what the advisor stated was the cost basis either.
Wiki This signature message sponsored by sscritic: Learn to fish.

User avatar
magellan
Posts: 3471
Joined: Fri Mar 09, 2007 4:12 pm

Re: Fire Wife's Advisor and Incur Tax Hit or Stay The Course

Post by magellan » Sun Jan 18, 2015 6:41 pm

If you can benefit from a large one-time charitable deduction and you plan to give to charities in future years, setting up a Donor Advised Charitable Gift Fund might be a good option for some of the funds, especially those with the highest unrealized gains.

You can fund the charitable account with appreciated shares and get a one-time immediate deduction of the market value of the shares. You never pay taxes on the unrealized gains. Then you draw down the account by making gifts to charities of your choice of the next several years or decades.

Both Vanguard and Fidelity offer these accounts and they allow you to make grants as low as $50-100. The grants can be to any legitimate charity including the John C. Bogle Center for Financial Literacy.

User avatar
Ged
Posts: 3839
Joined: Mon May 13, 2013 1:48 pm
Location: Roke

Re: Fire Wife's Advisor and Incur Tax Hit or Stay The Course

Post by Ged » Sun Jan 18, 2015 6:53 pm

So you have a mid six figure account with 100K in cap gains.

The taxes on that would be likely around 15K.

You are paying 2% at least of that 500K every year in fees. That's 10K per year.

The tax hit would be recovered in less than 2 years.

Seems to me that's a no-brainer.

stan1
Posts: 8046
Joined: Mon Oct 08, 2007 4:35 pm

Re: Fire Wife's Advisor and Incur Tax Hit or Stay The Course

Post by stan1 » Sun Jan 18, 2015 6:54 pm

magellan wrote:If you can benefit from a large one-time charitable deduction and you plan to give to charities in future years, setting up a Donor Advised Charitable Gift Fund might be a good option for some of the funds, especially those with the highest unrealized gains.

You can fund the charitable account with appreciated shares and get a one-time immediate deduction of the market value of the shares. You never pay taxes on the unrealized gains. Then you draw down the account by making gifts to charities of your choice of the next several years or decades.

Both Vanguard and Fidelity offer these accounts and they allow you to make grants as low as $50-100. The grants can be to any legitimate charity including the John C. Bogle Center for Financial Literacy.
Unfortunately Vanguard Charitable has much higher minimums than Fidelity Charitable:
Vanguard: $25K minimum initial contribution, minimum $500 grant
Fidelity: $5K minimum initial contribution, $50 minimum grant

Vanguard Charitable is too rich for my blood, so I use Fidelity Charitable. Schwab DAFs are competitive with Fidelity Charitable.

User avatar
magellan
Posts: 3471
Joined: Fri Mar 09, 2007 4:12 pm

Re: Fire Wife's Advisor and Incur Tax Hit or Stay The Course

Post by magellan » Sun Jan 18, 2015 6:58 pm

stan1 wrote:Unfortunately Vanguard Charitable has much higher minimums than Fidelity Charitable:
Vanguard: $25K minimum initial contribution, minimum $500 grant
Fidelity: $5K minimum initial contribution, $50 minimum grant
Thanks for the correction. As you might have guessed, we have Fidelity also.

User avatar
Toons
Posts: 13427
Joined: Fri Nov 21, 2008 10:20 am
Location: Hills of Tennessee

Re: Fire Wife's Advisor and Incur Tax Hit or Stay The Course

Post by Toons » Sun Jan 18, 2015 6:59 pm

Ged wrote:So you have a mid six figure account with 100K in cap gains.

The taxes on that would be likely around 15K.

You are paying 2% at least of that 500K every year in fees. That's 10K per year.

The tax hit would be recovered in less than 2 years.

Seems to me that's a no-brainer.


+1,That spells it out very well :happy
"One does not accumulate but eliminate. It is not daily increase but daily decrease. The height of cultivation always runs to simplicity" –Bruce Lee

OpenRoad
Posts: 95
Joined: Wed Aug 27, 2014 2:09 pm

Re: Fire Wife's Advisor and Incur Tax Hit or Stay The Course

Post by OpenRoad » Sun Jan 18, 2015 7:57 pm

Many good points/advice already given. I would switch if it was me, and I actually did it a while back.

Another option on how to switch is to ease into it. You could fire your advisor and immediately save 1%. Then over time sell funds and move to vanguard as appropriate, potentially tax loss harvesting along the way to reduce taxes.

User avatar
Watty
Posts: 18131
Joined: Wed Oct 10, 2007 3:55 pm

Re: Fire Wife's Advisor and Incur Tax Hit or Stay The Course

Post by Watty » Sun Jan 18, 2015 8:01 pm

I agree that you need to find out what the exact numbers are and to figure out just how long it would take to come out ahead. One thing to remember is that by keeping the funds there you are not avoiding taking the capital gains, just delaying it.

For example if you sell something now, pay the capital gains, then reinvest it, then you will have a higher cost basis which will help if you. When you are figuring out the break even point remember to take the taxes 20 years from now into account when it is eventually sold either way.
However, most of the investments in her portfolio are high expense ratio (over 1%) actively managed stock and bond funds and her advisor charges approximately 1% annually to manage the account.
The first thing to do would be to make sure that that dividends and capital gains distributions are not being automatically reinvested. There is a saying; "The first thing to do when you realize that you have dug yourself into a hole, is to stop digging."

They will likely not gladly offer it by there is a good chance that you could change the account not being managed by them which would at least stop the management fee. I am not 100% sure but I would think if you are dealing with Merrill Lynch you might be able to move them to a Merrill Edge account.

If they will not do that for you, then there may be other places than Vanguard that do not charge a fee that will accept the funds.

User avatar
Watty
Posts: 18131
Joined: Wed Oct 10, 2007 3:55 pm

Re: Fire Wife's Advisor and Incur Tax Hit or Stay The Course

Post by Watty » Sun Jan 18, 2015 8:05 pm

One other thing. If you user ID is based on your real name you can send a message to a moderator to ask them to change it to something more anonymous.

User avatar
neutics
Posts: 93
Joined: Sun Jun 21, 2009 9:53 pm
Location: Austin, TX

Re: Fire Wife's Advisor and Incur Tax Hit or Stay The Course

Post by neutics » Sun Jan 18, 2015 8:10 pm

Agree with OpenRoad's thought process...

Depending who her advisor uses as a custodian you could ask them to immediately 'de-link' the account, thereby stopping his 1% draw on the account (should be pro-rated). If the custodian is Schwab, TDAmeritrade etc. you should have the whole universe available. Then take your time to sell/move, possibly even delaying until you need to start drawing from taxable accounts 1st in retirement.

Let us know what happens!

Topic Author
andy8921
Posts: 19
Joined: Fri Dec 26, 2014 1:02 am

Re: Fire Wife's Advisor and Incur Tax Hit or Stay The Course

Post by andy8921 » Sun Jan 18, 2015 9:00 pm

Thanks to everyone for all the helpful responses. I was pretty confident most of you would recommend making the switch, but it helps to actually see the feedback when making this kind of decision. As some of you suggested, we could simply fire the advisor and save the 1% right off the bat, but I would prefer to make a clean break and start fresh with all low cost funds. We can hold the majority of the portfolio with Vanguard, just not the funds with the largest unrealized gains, so we will likely initially only sell those funds that cannot be transferred in kind and sell the rest over the coming months/years. I will discuss the tax implications with my tax professional friend and let you know the outcome, but I anticipate we will make the switch in the next month or so. Thanks again for all your help.

Andrew

heyyou
Posts: 3597
Joined: Tue Feb 20, 2007 4:58 pm

Re: Fire Wife's Advisor and Incur Tax Hit or Stay The Course

Post by heyyou » Mon Jan 19, 2015 4:45 pm

A "clean break" is preferred but that costs more in cap gains taxes. Ask your tax pro to calculate your cap gains tax, before you sell off all in one year.

This is a good idea.
Another option on how to switch is to ease into it. You could fire your advisor and immediately save 1%. Then over time sell funds and move to vanguard as appropriate, potentially tax loss harvesting along the way to reduce taxes.
To motivate you, research the account closing fee. It is their last chance to get money from you, and they do.

VG may accept some proprietary funds. If not, see if Schwab or TDAmeritrade do, and transfer the shares to one of them, then liquidate over time to buffer the tax hit.

This post was written by someone who is converting about 5% of my tIRA to Roth IRA each year. Patience is fullness.

Don46
Posts: 196
Joined: Sun Feb 24, 2013 6:53 pm

Re: Fire Wife's Advisor and Incur Tax Hit or Stay The Course

Post by Don46 » Mon Jan 19, 2015 5:38 pm

I pulled out of a managed account that had over 300k in capital gains more than a year ago. I sold some off, took some losses on others, and will sell others off in due time.
No one really likes paying taxes, but capital gains taxes are still low and now you have a stepped up tax basis for the next sale.
The adviser had me in some good stocks and limited partnerships (oil and gas) and they made money for me. But at my age (68) and with my nest egg, I did not need to take the risk he was exposing me to. I was paying about 18k in fees annually and though it was under 1 percent, that was a huge bite out of our annual expenses.
My wife and I are going to Europe for a month this summer and I will toast my late adviser in Paris and Rome because the money I'm saving by doing it myself will easily pay for our trip. :sharebeer
Good luck on your new path. You are moving in the right direction.

Boats day
Posts: 59
Joined: Thu Mar 06, 2014 11:39 am

Re: Fire Wife's Advisor and Incur Tax Hit or Stay The Course

Post by Boats day » Mon Jan 19, 2015 5:55 pm

I am a male and in a 2nd marriage with my wife. She has a substantial portfolio and has done quite well on her own with higher fee advisors. Most women do a lot better at investing than men do and I pretty much stay out of her business.
If I were you I would back way off and let her make the changes. Since she rejected your advice 5 years ago I think you may be wearing her down and perhaps trying to bully her. ....(strong words I know but think about it take a deep breath and be thankfully for a wife who has managed to accumulate a substantial portfolio.).

gwrvmd
Posts: 817
Joined: Wed Dec 02, 2009 8:34 pm
Location: Calabash NC

Re: Fire Wife's Advisor and Incur Tax Hit or Stay The Course

Post by gwrvmd » Mon Jan 19, 2015 6:10 pm

Livesoft is right, if you have been paying your taxes every year you have no untaxed capital gains this year except what have occurred since Jan 1 2015, which for most of us is zero.
When an interest payment or capital gain appears on a 1099, you pay taxes on it. It makes no difference if interest and capital gains were reinvested or not, you paid taxes on them and your cost basis for that investment goes up.

Remember, when you bought a mutual fund 10 years ago and it declared a long term capital gain you paid taxes on that gain some of which occurred before you even owned the fund. When you sell someone else will pay capital gains on some of your gains. That's the way the system works.

I have been investing in mutual funds for 40 years, I have had some of my current funds for over 25 years. As long as I pay my taxes for 2014, I have no unpaid capital gains except those that occurred since Jan 1 2015. The cost basis for all funds I own in a taxable account is their value per share on Dec 31 2014

For tax deterred mutual fund accounts none of the above applies

The above applies to mutual funds, it may not apply to some other investment forms such as LLCs and REITS

With mutual funds most people have no unpaid capital gains, except for the current year, if they paid the taxes on the gains listed on the IRS 1099 forms we all receive....Gordon
Disciple of John Neff

Oliver
Posts: 217
Joined: Mon Sep 03, 2007 11:49 pm

Re: Fire Wife's Advisor and Incur Tax Hit or Stay The Course

Post by Oliver » Tue Jan 20, 2015 6:38 am

gwrvmd wrote:Livesoft is right, if you have been paying your taxes every year you have no untaxed capital gains this year except what have occurred since Jan 1 2015, which for most of us is zero.
When an interest payment or capital gain appears on a 1099, you pay taxes on it. It makes no difference if interest and capital gains were reinvested or not, you paid taxes on them and your cost basis for that investment goes up.

Remember, when you bought a mutual fund 10 years ago and it declared a long term capital gain you paid taxes on that gain some of which occurred before you even owned the fund. When you sell someone else will pay capital gains on some of your gains. That's the way the system works.

I have been investing in mutual funds for 40 years, I have had some of my current funds for over 25 years. As long as I pay my taxes for 2014, I have no unpaid capital gains except those that occurred since Jan 1 2015. The cost basis for all funds I own in a taxable account is their value per share on Dec 31 2014

For tax deterred mutual fund accounts none of the above applies

The above applies to mutual funds, it may not apply to some other investment forms such as LLCs and REITS

With mutual funds most people have no unpaid capital gains, except for the current year, if they paid the taxes on the gains listed on the IRS 1099 forms we all receive....Gordon
I hope I am misunderstanding you. Your tax basis is whatever price you paid for your mutual fund shares. The share price is different from what you paid due to unrealized gains within the fund.

dbr
Posts: 31328
Joined: Sun Mar 04, 2007 9:50 am

Re: Fire Wife's Advisor and Incur Tax Hit or Stay The Course

Post by dbr » Tue Jan 20, 2015 9:09 am

Oliver wrote:
gwrvmd wrote:Livesoft is right, if you have been paying your taxes every year you have no untaxed capital gains this year except what have occurred since Jan 1 2015, which for most of us is zero.
When an interest payment or capital gain appears on a 1099, you pay taxes on it. It makes no difference if interest and capital gains were reinvested or not, you paid taxes on them and your cost basis for that investment goes up.

Remember, when you bought a mutual fund 10 years ago and it declared a long term capital gain you paid taxes on that gain some of which occurred before you even owned the fund. When you sell someone else will pay capital gains on some of your gains. That's the way the system works.

I have been investing in mutual funds for 40 years, I have had some of my current funds for over 25 years. As long as I pay my taxes for 2014, I have no unpaid capital gains except those that occurred since Jan 1 2015. The cost basis for all funds I own in a taxable account is their value per share on Dec 31 2014

For tax deterred mutual fund accounts none of the above applies

The above applies to mutual funds, it may not apply to some other investment forms such as LLCs and REITS

With mutual funds most people have no unpaid capital gains, except for the current year, if they paid the taxes on the gains listed on the IRS 1099 forms we all receive....Gordon
I hope I am misunderstanding you. Your tax basis is whatever price you paid for your mutual fund shares. The share price is different from what you paid due to unrealized gains within the fund.
Indeed. While Livesoft is correct in pointing out that the basis may be higher than the investor imagines due to already taxed and reinvested dividends and capital gains distributions, the idea that no capital gain is ever realized and taxable income obtained when selling a mutual fund is just plain not so.

Post Reply