Producing Income in Taxable Account (Not Retired)

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tryinghard
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Producing Income in Taxable Account (Not Retired)

Post by tryinghard » Sat Jun 17, 2017 10:21 am

Bogleheads,
Looking to invest 100K in a taxable account to produce some current income. I need about $400/month and plan on just withdrawing it from the overall balance each month by selling the fund (auto withdrawal). I understand there will be times that I am taking out the original principal to get the $400/month but I am ok with that (I understand the risk the funds could go down). I want to make sure I am not missing anything related to taxes and need some expert advice!

1. Does it matter if the funds are tax efficient if I am needing current income? Should I do a munipcal bonds / dividend fund portfolio to only get hit at 15%? Or go to something like wellsley income fund or target retirement income with higher taxed bonds? Does it matter if I am trying to maximize my income of the 100k?

2. In terms of tax strategy, does it matter if I set a $400/ month withdraw (auto reinvest of div and cap gains) or should I only try and pull out capital gains and/or dividends when they come available (not doing auto reinvest of div and cap gains)?
Is there a tax advantage of either?

3. Any ideas on some good funds for my scenario? Index or actively managed? I am thinking muni bond fund / dividend appreciation fund or just all in a wellsley income fund.

dbr
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Re: Producing Income in Taxable Account (Not Retired)

Post by dbr » Sat Jun 17, 2017 10:58 am

You should take rather than reinvest any distributions of dividends and taxable gain. These are taxed no matter what you do.

If you have multiple tax lots you can sell bits of the one's with the highest basis and least capital gain using specific ID.

You still want the most tax efficient funds. Do not confuse yield with withdrawals and be sure to account for the value of your investment by tracking only total return. High yield funds do not generate free money but they do generate taxes.

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TD2626
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Re: Producing Income in Taxable Account (Not Retired)

Post by TD2626 » Sat Jun 17, 2017 11:14 am

$400 a month is $4800 a year, which is a 4.8% per year.

A 4% withdrawal rate is often quoted as a rough guide. Many people on the forum use lower rates (say 3% or 3.5%).

If you believe 4.8% is possible, carefully consider whether:
1. Your expectations are too high
2. Your planned investments are taking on too much risk.

Just a caution.

delamer
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Re: Producing Income in Taxable Account (Not Retired)

Post by delamer » Sat Jun 17, 2017 11:29 am

As dbr said, it doesn't matter whether you have dividends/capital gains/interest for a mutual fund reinvested or deposited into your checking account. The tax treatment for those earnings is the same.

It is easier if you avoid small purchases using reinvested earnings, for tracking purposes when you sell shares. Lots of little transactions with different cost bases can be a pain to deal with. If, on the other hand, you want more control of your taxes by selling specific lots then reinvesting would allow for that. It doesn't seem worth it given the amount involved.

You didn't say in your post how long you want this $400/per month withdrawal. If you timeline is forever, that would suggest a different type of investment than if it is 10 years.

dbr
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Re: Producing Income in Taxable Account (Not Retired)

Post by dbr » Sat Jun 17, 2017 11:34 am

TD2626 wrote:$400 a month is $4800 a year, which is a 4.8% per year.

A 4% withdrawal rate is often quoted as a rough guide. Many people on the forum use lower rates (say 3% or 3.5%).

If you believe 4.8% is possible, carefully consider whether:
1. Your expectations are too high
2. Your planned investments are taking on too much risk.

Just a caution.
We need to know the long term intent. Usually when someone uses the word "for income" that is a tip off they expect to grow the investment while also getting free money handed out to them. The expectation is typically unrealistic. But the OP doesn't really read that way. There is nothing wrong with having some money and deciding to spend it over time understanding that the account might go down or might go up. It always make sense to not take losses to taxes. So maybe we could hear more about what is intended?

avalpert
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Re: Producing Income in Taxable Account (Not Retired)

Post by avalpert » Sat Jun 17, 2017 11:37 am

tryinghard wrote: 1. Does it matter if the funds are tax efficient if I am needing current income? Should I do a munipcal bonds / dividend fund portfolio to only get hit at 15%? Or go to something like wellsley income fund or target retirement income with higher taxed bonds? Does it matter if I am trying to maximize my income of the 100k?
Of course it matters - the more taxes generated the more you actually need to withdraw to hit your $400/month post-tax income target. What that means you should do requires much more context than you provide here.
2. In terms of tax strategy, does it matter if I set a $400/ month withdraw (auto reinvest of div and cap gains) or should I only try and pull out capital gains and/or dividends when they come available (not doing auto reinvest of div and cap gains)?
Is there a tax advantage of either?
You should not reinvest dividends but use them as part of the withdrawal amount (if they are substantially higher than the withdrawal amount you can reinvest the difference - but you might want to think in terms aligning withdrawal periods with dividend periods)
3. Any ideas on some good funds for my scenario? Index or actively managed? I am thinking muni bond fund / dividend appreciation fund or just all in a wellsley income fund.
You provide no context as to your need/ability for risk here - any recommendation provided would be imprudent without that.
Bogleheads,
Looking to invest 100K in a taxable account to produce some current income. I need about $400/month and plan on just withdrawing it from the overall balance each month by selling the fund (auto withdrawal). I understand there will be times that I am taking out the original principal to get the $400/month but I am ok with that (I understand the risk the funds could go down). I want to make sure I am not missing anything related to taxes and need some expert advice!
Now, you are talking about a 4.8% withdrawal rate overall. What is your real goal here - do you need the $400/month for some set length of time to hit minimum payments? Without more detail this looks like a poorly thought out idea overall.

retiredjg
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Re: Producing Income in Taxable Account (Not Retired)

Post by retiredjg » Sat Jun 17, 2017 12:33 pm

Remember that any shares sold that have short term cap gains will be taxed at your ordinary rate, not the LTCG rate of 15%.

Maybe you should keep out 9 months to 1 year's worth of cash, invest the rest and wait a year before using any of that money (other than the dividends).

tryinghard
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Re: Producing Income in Taxable Account (Not Retired)

Post by tryinghard » Sat Jun 17, 2017 12:58 pm

Thanks for all the replies....
The income would be used to "help" pay a mortgage...but please dont panic...if times got tough I have other sources to continue to pay every month without a hiccup...I just want to allocate this 100k to the mortgage itself without giving it to the bank upfront. Basically, I dont want to put any more than 20% down on a new mortgage...would rather keep the cash but use it's proceeds to pay my 30/yr mortgage every month. So in theory I am looking at a 30 yr timeline.
I'm open to any ideas?

tryinghard
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Re: Producing Income in Taxable Account (Not Retired)

Post by tryinghard » Sat Jun 17, 2017 1:06 pm

Side note to help ease the 4.8 percent withdrawal rate....
I would be fine with 3-4 percent withdrawal rate. I'm guessing a mixture of municipal bonds and the vanguard dividend appreciation fund (taking out dividends only every year) might be my best bet? (Getting taxed at only 15% on the dividends in current tax bracket)

dbr
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Re: Producing Income in Taxable Account (Not Retired)

Post by dbr » Sat Jun 17, 2017 1:14 pm

tryinghard wrote:Side note to help ease the 4.8 percent withdrawal rate....
I would be fine with 3-4 percent withdrawal rate. I'm guessing a mixture of municipal bonds and the vanguard dividend appreciation fund (taking out dividends only every year) might be my best bet? (Getting taxed at only 15% on the dividends in current tax bracket)
This isn't about withdrawal rate. The actual question is does it make sense to borrow money to invest in a taxable account and if so what should I invest in. A condition on borrow is that the actual instrument is a mortgage. You could also ask if it makes sense to hold a negative allocation to bonds in order to have an asset allocation that is more than 100% stocks, assuming your investment is made in stocks. I think you can see borrowing money to buy a house and then investing in bonds that yield less than the rate on your mortgage makes no sense and that an investment that earns risk free more than you pay on your mortgage would be a no-brainer, after tax computations of course. An investment that returns more than the rate you pay on your mortgage but is risky, I am not sure how to answer in general.

It is an observation that most young wage earners take out mortgages to buy houses and also contribute to the max in 401k's or IRA's. It is perfectly legitimate to consider a debt to be a negative bond as an asset allocation.

avalpert
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Re: Producing Income in Taxable Account (Not Retired)

Post by avalpert » Sat Jun 17, 2017 4:36 pm

tryinghard wrote:Thanks for all the replies....
The income would be used to "help" pay a mortgage...but please dont panic...if times got tough I have other sources to continue to pay every month without a hiccup...
What are those other sources? Are they your earned income from a job? Is there some mental accounting here trying to segregate 'income' from different sources in a way that is going to lead you to poor cash management decisions (particularly increased taxes and suboptimal asset allocation?).
I just want to allocate this 100k to the mortgage itself without giving it to the bank upfront.
What is the interest rate on the mortgage? It doesn't sound like cash flow for payments is the issue - so the real question is why are you borrowing the extra money? Is it for liquidity - then capital safety may be worth the cost. Is it to invest on margin - then you may need to take more risk to try to have it payoff.
Basically, I dont want to put any more than 20% down on a new mortgage...would rather keep the cash but use it's proceeds to pay my 30/yr mortgage every month.
Why? What are you trying to accomplish here?

kappy
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Re: Producing Income in Taxable Account (Not Retired)

Post by kappy » Sat Jun 17, 2017 5:14 pm

I agree with the others that ask why invest it when dividends are less than the interest rate of your loan? If you want to invest, do it in a TSM or S&P 500, take dividends and put them towards the mortgage, then use your other income sources to make up the difference. At least then, you have a tax efficient investment that should beat your mortgage rate over 20+ years.

tryinghard
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Re: Producing Income in Taxable Account (Not Retired)

Post by tryinghard » Sat Jun 17, 2017 10:53 pm

Thanks again for all of the insight....
As mentioned earlier by someone who clarified it for me.."Does it make sense to borrow money for a 30 yr mortgage in order to invest in a taxable account?" That IS my question. Figure a mortgage rate (after my tax deduction) right at 2.55%.
My thought process is that I can beat this over a 20-30 year period by investing in munis and TSM index funds?
Like "Kappy" suggested..I would rely on the dividends to help pay and would leave capital gains and the funds to grow over 30 yrs.
I am willing to take that risk in believing I would be able to beat a 2.55% rate and I would remain liquid with my money.
Thoughts?

avalpert
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Re: Producing Income in Taxable Account (Not Retired)

Post by avalpert » Sat Jun 17, 2017 11:43 pm

tryinghard wrote:Thanks again for all of the insight....
As mentioned earlier by someone who clarified it for me.."Does it make sense to borrow money for a 30 yr mortgage in order to invest in a taxable account?" That IS my question. Figure a mortgage rate (after my tax deduction) right at 2.55%.
My thought process is that I can beat this over a 20-30 year period by investing in munis and TSM index funds?
Like "Kappy" suggested..I would rely on the dividends to help pay and would leave capital gains and the funds to grow over 30 yrs.
I am willing to take that risk in believing I would be able to beat a 2.55% rate and I would remain liquid with my money.
Thoughts?
If you have the income coming through other avenues to pay the mortgage then forget about 'income' generated from this particular pot - in fact, don't think of this pot as any different from the rest of your asset allocation at all. I do get a sense from your other posts that you have a tendency to think of dividends and capital gains as distinct kinds of returns - now is as good a time as any to rid yourself of that belief and focus on total returns.

What is your asset allocation?

If you did have a 2.55% post-tax rate, unless your asset allocation is very risk averse, I would probably invest rather than pay towards the mortgage - my post-tax rate is ~1.9% and I have no intention of paying it down any faster than they require.

ofckrupke
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Re: Producing Income in Taxable Account (Not Retired)

Post by ofckrupke » Sat Jun 17, 2017 11:44 pm

tryinghard wrote:Thoughts?
If you can beat the breakeven rate then you don't want an amortizing/decumulating investment pool, right?
And if an amortizing pool is necessary to make the payments then your investment pool has an exposure to sequence of returns risk that is not in the conventional calculus, so at the very least a higher "expected beat margin" is required, relative to an accumulating pool model. You're not telling us everything, but I think it indicates that there is probably not enough margin of safety in the plan.

Additionally, it may be possible to get a lower interest rate with the lower LTV associated with a higher than 20% down payment.
It should be obvious to you that the effect should not be to lower the breakeven rate for the investment pool alternative, so you should probably spend some time figuring out how to quantify the expected increase in required breakeven rate if such a lower rate is available.

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TD2626
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Re: Producing Income in Taxable Account (Not Retired)

Post by TD2626 » Sat Jun 17, 2017 11:53 pm

It's very risky in my opinion. A mortgage is basically a levered investment in real estate. The OP is considering intentionally taking on leverage to invest in stocks. The stock market is risky enough as it is without risking your house.

Say one has a net worth of $500k. They buy a $500k house with a $400k morgage. They invest the $400k in stocks and have $100k in home equity. There's a massive downturn in the markets. Real estate declines by 50% and stocks decline by 70%. The $500k home is now worth $250k. The $400k in stocks is worth $120k. Net worth is now negative $30,000. Yes, net worth went from +500k to -30k. In the Great Depression, stocks lost 90% - so this estimate is not even a worst case scenario.

Over 30 years, there is a very high probability of hitting a large market downturn. Can the payments be kept up in these conditions?

This sort of thing is something that is discussed a lot in a slightly different (but effectively equivalent) way - in "should I pay off my mortgage or invest" type threads. Consider looking at some of those. People do sometimes keep a mortgage instead of paying it off early and invest instead - but often to maximize tax-advantaged account contributions.

tryinghard
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Re: Producing Income in Taxable Account (Not Retired)

Post by tryinghard » Sun Jun 18, 2017 12:39 am

Everything makes sense on what you all are posting...
How about if I didn't need the income generated by the invested money to pay the mortgage and I just let it grow? Would this change things?
Same scearnio but let's say I can pay my mortgage outright with a very secure job...I have a lot of money to put down but choose to instead just put 20% down bc I want to invest the money in a taxable account. Is this wrong?
Do most of you all still advocate putting as much cash down on a mortgage (besides leaving a savings account, emergency fund and money for tax deferred accounts?)

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grabiner
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Re: Producing Income in Taxable Account (Not Retired)

Post by grabiner » Sun Jun 18, 2017 2:27 pm

tryinghard wrote:1. Does it matter if the funds are tax efficient if I am needing current income? Should I do a munipcal bonds / dividend fund portfolio to only get hit at 15%? Or go to something like wellsley income fund or target retirement income with higher taxed bonds? Does it matter if I am trying to maximize my income of the 100k?
Tax efficiency still matters. If you are in a 25% tax bracket and withdraw $10,000 from your account:

You can spend $7500 if this is bond income (and if you use munis instead, you will probably only get $7500 in income from munis of the same risk).
You can spend $8500 if this is qualified dividends, or long-term capital gains distributed by a mutual fund.
You can spend $9250 if you sell $10,000 in stock for which you had paid $5000, paying tax only on the $5000 gain.
You can spend $10,000 if you sell $10,000 in bonds with little or no capital gain.

Thus it is best to hold tax-efficient stock funds even if you are withdrawing the money; you can spend more of the money you withdraw. And if you do hold bond funds in your taxable account, it is better to sell the bond funds in preference to selling stock funds witch capital gains. (But your asset allocation comes first; if you have too much stock for your risk tolerance, you should sell stock even if you pay a capital-gains tax.)
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grabiner
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Re: Producing Income in Taxable Account (Not Retired)

Post by grabiner » Sun Jun 18, 2017 2:29 pm

tryinghard wrote:Everything makes sense on what you all are posting...
How about if I didn't need the income generated by the invested money to pay the mortgage and I just let it grow? Would this change things?
Same scearnio but let's say I can pay my mortgage outright with a very secure job...I have a lot of money to put down but choose to instead just put 20% down bc I want to invest the money in a taxable account. Is this wrong?
Do most of you all still advocate putting as much cash down on a mortgage (besides leaving a savings account, emergency fund and money for tax deferred accounts?)
See Paying down loans versus investing on the wiki.

Investing in stock rather than paying down a mortgage increases your risk, which may or may not be worth the higher expected return. But you can increase your risk without paying down the mortgage, by selling bonds and buying stocks. Therefore, it makes sense to use bond returns as a fair comparison; can you earn more on low-risk bonds with the same duration as the payments you would be making?
David Grabiner

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BuyAndHoldOn
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Re: Producing Income in Taxable Account (Not Retired)

Post by BuyAndHoldOn » Sun Jun 18, 2017 3:02 pm

retiredjg wrote:Remember that any shares sold that have short term cap gains will be taxed at your ordinary rate, not the LTCG rate of 15%.

Maybe you should keep out 9 months to 1 year's worth of cash, invest the rest and wait a year before using any of that money (other than the dividends).

I like a strategy *like this*. You could do a bond/CD ladder (look into such things, if the terms are unfamiliar) for 9-18 months, and leave the rest invested in something that could grow before you looked at needing the money again. And you could have some assets in bonds/longer CDs for after that 9-18 month period that wouldn't fluctuate as much.

I think asset allocation is a better strategy than producing income. And I used to invest for dividends, if that counts for anything.

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