Close taxable account?

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Topic Author
Clipsadi
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Joined: Wed Mar 22, 2017 9:37 pm

Close taxable account?

Post by Clipsadi »

Hi all,

My wife and I think it's a good idea to sell our holdings in a taxable account (100% MSFRX) and reinvest the money in IRAs, preferably ROTHs. We only have the taxable account b/c it was a gift anyway. How do I estimate the taxes generated by the MSFRX sale? I think we are exempt from capital gains tax (income<50k), but I'm not certain. This is especially confusing b/c we'll be moving from FL to IL in August of this year.

more info on Taxable account in question: MSFRX, cost basis = $1K, market value = $8K

Emergency funds: 3 months
Debt: $0
Tax Filing Status: Married Filing Jointly
Marginal Tax Rate: 15% Federal, 0% FL State
State of Residence: FL, but moving to IL in august 2016
Age: 36 and 38
Desired Asset allocation: 90% stocks / 10% bonds

Current portfolio

total value: 36K
Asset Allocation: 10% bonds, 5% cash, 85% stocks

Current portfolio assets

Taxable
23% Charles Schwab MSFRX

His 401k
12% VTIVX, expense ratio = 0.16
Company match = NO

Her 401ks
12% FRS U.S. Stock Market Index Fund (120), expense ratio = 0.02
15% FCNTX, expense ratio = 0.70
Company match = NO

His Roth IRA at Vanguard
25% VOO ETF, expense ratio = 0.05

Her Roth IRA at Vanguard
13% VOO ETF, expense ratio = 0.05

weighted expense ratio = 0.3

Thanks so much!

Tim
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CAsage
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Re: Close taxable account?

Post by CAsage »

Essentially, you would sell all of the taxable account and then add the capital gains (which you estimated at $7000 (current value less initial cost AND all subsequent taxable dividends or reinvestment)) to your taxable income for this year. The capital gains tax rate is lower than normal income, and might be zero for your family. The closest way to check this would be to fill out a "pretend" tax return for 2017; do one with and one without the extra income.

The important number to learn here is your current tax bracket. A taxable income below $75,000 for Married filing jointly is 15%. So, there isn't a huge advantage to moving that money into an IRA since you don't save that much on taxes. A bigger question would be, can you afford to tie that money up until retirement? Do you anticipate having higher income in the future, which would be taxed at a higher rate, so moving to IRA better?
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MotoTrojan
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Re: Close taxable account?

Post by MotoTrojan »

CAsage wrote:Essentially, you would sell all of the taxable account and then add the capital gains (which you estimated at $7000 (current value less initial cost AND all subsequent taxable dividends or reinvestment)) to your taxable income for this year. The capital gains tax rate is lower than normal income, and might be zero for your family. The closest way to check this would be to fill out a "pretend" tax return for 2017; do one with and one without the extra income.

The important number to learn here is your current tax bracket. A taxable income below $75,000 for Married filing jointly is 15%. So, there isn't a huge advantage to moving that money into an IRA since you don't save that much on taxes. A bigger question would be, can you afford to tie that money up until retirement? Do you anticipate having higher income in the future, which would be taxed at a higher rate, so moving to IRA better?
IRA may not make sense but they mentioned Roth, which would seem like a no-brainer; No taxes on gains.

Main takeaway here is to see what your taxable income will be INCLUDING these gains, as in theory it could bump you up into the next tax bracket.

If that isn't the case, I would put them into a Roth. I like VTI but if you want to keep adding to your VOO, go for it :).
livesoft
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Re: Close taxable account?

Post by livesoft »

If you have been reinvesting the distributions, then some of the shares were purchased in the past year, so they will be deemed "short-term" and their gains will be taxed as ordinary income just like interest on a savings account.

MSFRX is a balanced fund and pays a dividend every month of about 3 cents a share and had a December capital gains distribution.

I would certainly unload this fund and use the money for IRAs.
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aristotelian
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Re: Close taxable account?

Post by aristotelian »

You can only contribute $5,500 each to the IRA's so you would not be able to dump all the funds into the IRA's at once.

Ideally you could contribute to the IRA's and keep the taxable...but if you can't, after you sell you will get a tax form at the end of the year that has your capital gains (profit) from the increase in value. It is a great idea to sell while you do not have to pay capital gain tax, although keep in mind that the capital gains are considered income and could put you into a higher bracket depending on how much they are. Then I believe you would have to pay 15% on all the gains.

If you contribute to an IRA, Roth makes sense. Pay taxes now while your rate is low, then get tax free growth from the IRA.

You could sell everything, contribute $5,500 each to the Roth, then re-buy with whatever is left over. The effect would be to "step up" your cost basis. That is, you would pay no tax on the gains while you are in the lower bracket, and then you would reset the basis for future sales, i.e. the profit would be determined from today's value rather than when originally purchased, and you would owe much less tax in the future.
livesoft
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Re: Close taxable account?

Post by livesoft »

As we learned in another thread, the Roth vs traditional IRA for lowish income folks is not a no-brainer because of refundable tax credits that low income taxpayers may be eligible for. It is best to model taxes both ways to see which would be better.
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Kevin M
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Re: Close taxable account?

Post by Kevin M »

Makes sense, especially if you can do it in FL with no state income tax. Google tells me that IL income tax rate is only 3.75%, so even if you have to prorate the gain for state tax purposes, I'd say it probably makes sense from a long-term perspective.

Although you aren't paying federal income tax on qualified dividends, I see that MSFRX also holds bonds, so you are paying income tax on the bond portion of the distributions. Paying no tax in a Roth is always better than paying any tax in taxable.

With the Roth you can withdraw contributions (but not earnings) at any time penalty-free and tax-free, so you're not giving up much liquidity by moving it into a Roth. However, a traditional IRA may be advantageous for other reasons.

Kevin
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Topic Author
Clipsadi
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Joined: Wed Mar 22, 2017 9:37 pm

Re: Close taxable account?

Post by Clipsadi »

MotoTrojan wrote:
CAsage wrote:Essentially, you would sell all of the taxable account and then add the capital gains (which you estimated at $7000 (current value less initial cost AND all subsequent taxable dividends or reinvestment)) to your taxable income for this year. The capital gains tax rate is lower than normal income, and might be zero for your family. The closest way to check this would be to fill out a "pretend" tax return for 2017; do one with and one without the extra income.

The important number to learn here is your current tax bracket. A taxable income below $75,000 for Married filing jointly is 15%. So, there isn't a huge advantage to moving that money into an IRA since you don't save that much on taxes. A bigger question would be, can you afford to tie that money up until retirement? Do you anticipate having higher income in the future, which would be taxed at a higher rate, so moving to IRA better?
IRA may not make sense but they mentioned Roth, which would seem like a no-brainer; No taxes on gains.

Main takeaway here is to see what your taxable income will be INCLUDING these gains, as in theory it could bump you up into the next tax bracket.

If that isn't the case, I would put them into a Roth. I like VTI but if you want to keep adding to your VOO, go for it :).
Thanks for the insights! We do expect our income to increase into capital gains tax realm in < 3 years. This is the biggest reason I'd like to invest the 7k of gains in the ROTHs, as MotoTrojan pointed out, we'll be protecting those 7k from federal taxes forever! Although, it seems like I'll have to pay IL state tax on the capital gains since we'll be filing an IL state return next year. Is it too late for me to sell this year and claim the gains for 2016?
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Kevin M
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Re: Close taxable account?

Post by Kevin M »

Clipsadi wrote:Although, it seems like I'll have to pay IL state tax on the capital gains since we'll be filing an IL state return next year. Is it too late for me to sell this year and claim the gains for 2016?
I believe if you sell while still a FL resident you will pay no tax on the gain--at least that's what I find with a quick Google that led me to a TurboTax Q&A. The instructions for your state tax returns should clarify. At any rate, probably best to sell it before you move.

You cannot sell the fund in 2017 and claim the gain for 2016. If you sell in 2017, you will receive a 1099-B showing the sale for 2017.

Kevin
If I make a calculation error, #Cruncher probably will let me know.
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CAsage
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Re: Close taxable account?

Post by CAsage »

Yes, too late to sell for 2016 (sales must actually happen in that year). You can probably determine exactly how much capital gains you have by checking your online account - at least for Vanguard, it's easy to view. And you could split the money between your and your spouse Roth IRA, which also has the advantage of being available as an emergency fund... Lots of considerations, good inputs!
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livesoft
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Re: Close taxable account?

Post by livesoft »

It seems like you will be a part-year resident of each state. Sales while a resident of Florida should not have to pay IL income tax.
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Kevin M
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Re: Close taxable account?

Post by Kevin M »

livesoft wrote:As we learned in another thread, the Roth vs traditional IRA for lowish income folks is not a no-brainer because of refundable tax credits that low income taxpayers may be eligible for. It is best to model taxes both ways to see which would be better.
I think what you're saying is that if a tIRA contribution lowers your adjusted gross income (AGI) to the next lower income range, a larger percentage could be applied in calculating your savers credit. Looking at OP's numbers, here are a few considerations.

Stated income is <$50K, but we don't know what is meant by income. What matters for the savers credit is AGI. If $50K is AGI, then the max savers credit is 10% of contributions to IRAs (traditional and Roth) plus 401k plans (and other plans not applicable to OP) or $2,000, whichever is less. So assuming 401k contributions already are more than $2K, the savers credit is $200 unless AGI is lowered. Retirement Savings Contributions Credit (Saver’s Credit).

AGI can be lowered by either more 401k contributions or traditional IRA contributions. OP, are you maxing your 401k contributions ($18K each, so $36K total)? If not, this raises another possible option, which is to contribute more to 401k plans and use proceeds from taxable fund sale to compensate for covering living expenses. Not saying this is a better option, but it is another option to consider. Unless you are getting an employer match on additional contributions, a traditional IRA might be better than more 401k contributions to get access to a broader range of low-cost funds.

If 2017 AGI is expected to be >$40K and you can lower it below $40K with additional IRA or 401k contributions, then you increase your savers credit to 20% of the lesser of contributions or 2,000, so probably $400. If you can lower it below $37K, you can increase savers credit to $1,000 (50% of $2,000).

Looking at the 401k plans raises a question: why are you using a fund with an ER of 0.7% in a 401k when you have much lower costs options? Instead, you could stick with the low-cost funds in the 401k's, and pick up other desired asset classes in the IRAs (whether Roth or traditional).

Kevin
If I make a calculation error, #Cruncher probably will let me know.
Topic Author
Clipsadi
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Joined: Wed Mar 22, 2017 9:37 pm

Re: Close taxable account?

Post by Clipsadi »

Kevin M wrote:
livesoft wrote:As we learned in another thread, the Roth vs traditional IRA for lowish income folks is not a no-brainer because of refundable tax credits that low income taxpayers may be eligible for. It is best to model taxes both ways to see which would be better.
I think what you're saying is that if a tIRA contribution lowers your adjusted gross income (AGI) to the next lower income range, a larger percentage could be applied in calculating your savers credit. Looking at OP's numbers, here are a few considerations.

Stated income is <$50K, but we don't know what is meant by income. What matters for the savers credit is AGI. If $50K is AGI, then the max savers credit is 10% of contributions to IRAs (traditional and Roth) plus 401k plans (and other plans not applicable to OP) or $2,000, whichever is less. So assuming 401k contributions already are more than $2K, the savers credit is $200 unless AGI is lowered. Retirement Savings Contributions Credit (Saver’s Credit).

AGI can be lowered by either more 401k contributions or traditional IRA contributions. OP, are you maxing your 401k contributions ($18K each, so $36K total)? If not, this raises another possible option, which is to contribute more to 401k plans and use proceeds from taxable fund sale to compensate for covering living expenses. Not saying this is a better option, but it is another option to consider. Unless you are getting an employer match on additional contributions, a traditional IRA might be better than more 401k contributions to get access to a broader range of low-cost funds.

If 2017 AGI is expected to be >$40K and you can lower it below $40K with additional IRA or 401k contributions, then you increase your savers credit to 20% of the lesser of contributions or 2,000, so probably $400. If you can lower it below $37K, you can increase savers credit to $1,000 (50% of $2,000).

Looking at the 401k plans raises a question: why are you using a fund with an ER of 0.7% in a 401k when you have much lower costs options? Instead, you could stick with the low-cost funds in the 401k's, and pick up other desired asset classes in the IRAs (whether Roth or traditional).

Kevin
Thanks again for all input! Very informative, I clearly have a lot to learn. Kevin, Here's a little more info on our situation.

1. Expected AGI for 2017 = 48k
2. There is no match in our 401ks
3. Allocation to FCNTX (expense ratio 0.7) in her 401k is best available option for now, we plan to roll the balance over to tIRA when we move to IL.
4. Expected $ available in 2017 to allocate to 401k or IRAs = 15k (~7k from income, ~8k from sale of MSFRX)
5. My wife will likely be a full-time student in 2017, which I believe eliminates her ability to receive a savers credit.

I like your suggestion of increasing contributions to 401K plans, I had not considered that. It would certainly be beneficial in the short run to receive a larger savers credit! I'll have to take livesoft's advice and estimate taxes for a bunch of different solutions. I suppose Ideally I should model after tax expected returns for all the various options and see which solution is most favorable in the long run. Unfortunately I have less than infinite time to learn appropriate modeling techniques and apply them :annoyed

I think the most important thing here is recognizing that the taxable account has got to go!

Tim
livesoft
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Re: Close taxable account?

Post by livesoft »

You will be able to convert traditional IRA to Roth IRA in the future. Your 401(k) could also be converted after you leave your current employer. I'm not saying you should do conversions, but conversions are in play.
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oldcomputerguy
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Re: Close taxable account?

Post by oldcomputerguy »

Clipsadi wrote:Hi all,

My wife and I think it's a good idea to sell our holdings in a taxable account (100% MSFRX) and reinvest the money in IRAs, preferably ROTHs. We only have the taxable account b/c it was a gift anyway. How do I estimate the taxes generated by the MSFRX sale? I think we are exempt from capital gains tax (income<50k), but I'm not certain. This is especially confusing b/c we'll be moving from FL to IL in August of this year.

more info on Taxable account in question: MSFRX, cost basis = $1K, market value = $8K
How long have you held the MSFRX? If it's one year or less (short-term), and you sell, then the capital gain will be taxed at your normal marginal income tax rate. If more than one year (long-term), it'll be taxed at long-term capital gain rates, which in the 15% marginal tax bracket would be 0%. Beware that the $7,000 capital gain doesn't kick you up into the 25% bracket, it gets more complicated at that point.
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Kevin M
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Re: Close taxable account?

Post by Kevin M »

Clipsadi wrote: 1. Expected AGI for 2017 = 48k
Is this after the expected $15K 401k (and possible tIRA) contributions? If so, then your savers credit is $200 for each spouse who makes IRA/401k contributions of $2,000 or more in 2017. So max of $400 for both spouses (I overlooked that it's for each spouse, since the only return I do that gets this credit is for a single person, and I was looking form 8880 in her return to figure this out).

401k contributions come off the top, so your 2016 401k contributions will be reflected (not included) in your 2016 AGI.

Assuming AGI of $48K, you would need to make $8K of additional 401k or traditional IRA contributions to increase your savers credit to $400 for each spouse who contributed $2K or more to retirement accounts. If no can do, this is not a factor in whether to do traditional or Roth contributions.
2. There is no match in our 401ks
OK, then this is not a reason to prefer 401k over traditional IRA.
3. Allocation to FCNTX (expense ratio 0.7) in her 401k is best available option for now, we plan to roll the balance over to tIRA when we move to IL.
I was confused by the inclusion of the lower cost fund in "her 401ks", but now I see the "s", so I assume the lower cost fund is in a 401k for a previous employer, and that the higher cost fund is in 401k for current employer.

It appears that your wife plans to stop working (at a job) when you move in August, which is why you plan to roll over to an IRA instead of a new 401k. That probably makes sense. The main caveat for this is if income were to increase significantly in future years, so that you were no longer eligible for deductible IRA contributions or direct Roth contributions, in which case the tIRA would present problems for doing tax-free backdoor Roth contributions, unless you/wife could roll any tIRAs into 401k plans. This may not be a big consideration for you.
4. Expected $ available in 2017 to allocate to 401k or IRAs = 15k (~7k from income, ~8k from sale of MSFRX)
5. My wife will likely be a full-time student in 2017, which I believe eliminates her ability to receive a savers credit.
Not an expert in this, but in looking at the tax forms, I don't see that this is so. If your wife is working now, you could bump up her 401k contributions to ensure that she gets the max savers credit. Or if she has at least $2K of earned income (after 401k contributions) in 2017, she can make an IRA contribution up to $5,500 or earned income, whichever is less, at any time in 2017.
I like your suggestion of increasing contributions to 401K plans, I had not considered that. It would certainly be beneficial in the short run to receive a larger savers credit!
Assuming you already will contribute $2K or more each, it will only make a difference if you can reduce AGI below $40K, in which case either additional 401k or tIRA contributions will accomplish the same thing.
I'll have to take livesoft's advice and estimate taxes for a bunch of different solutions. I suppose Ideally I should model after tax expected returns for all the various options and see which solution is most favorable in the long run. Unfortunately I have less than infinite time to learn appropriate modeling techniques and apply them :annoyed
A common approach is to get some "tax diversification" by contributing some to traditional and some to Roth accounts.

You want to have enough income in retirement, including distributions from traditional retirement accounts, to at least fill up the 0% tax bracket (from deductions and exemptions) and the 10% tax bracket, and any tax bracket that is lower than what you are or will be in while working. Of course all of this assumes no changes in tax law, but this uncertainty is another reason for some tax diversification.

I have family members who have quite a nice income from Social Security, RMDs, and taxable investments, and who have paid no tax in some years and very little tax in other years. So most of the tIRA contributions they made while in the 25% tax bracket are being taxed at 0% upon distribution. Best of both worlds--a deduction going in and no tax coming out--a super Roth!

However, having some in a Roth gives you some diversification against future tax law changes, unexpectedly high income in the future, and other tax-related uncertainties. You may be able to do Roth conversions in the future at an even lower tax rate than your current tax rate, but then you may not.

I tend to go with the bird in the hand, and do (or recommend to family members) deductible contributions when possible, but I admit this isn't necessarily optimal. A compromise might be to go with 2/3 traditional and 1/3 Roth, which in your situation would be close to 2/3 to 401k plans and 1/3 to Roth IRAs.

Of course Roth IRAs have other benefits like being able to withdraw contributions penalty-free and tax-free, so can serve as an emergency fund, and no RMD requirements.

Kevin
If I make a calculation error, #Cruncher probably will let me know.
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