Understanding tax efficient help

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EvelynTroy
Posts: 293
Joined: Sat Jun 07, 2008 8:35 am

Understanding tax efficient help

Post by EvelynTroy » Wed Feb 14, 2018 1:38 pm

Considering purchasing Vanguard Wellesley Income Admiral Shares fund (VWIAX) - its been noted that this fund is not tax efficient and best held in a tax advantaged account. I have other index ETF's and couple of funds - that are placed in the proper tax protected or taxable accounts.

I never really did understand exactly what is meant by tax efficient - if someone could explain this I would be appreciative. And what exactly the disasadvantage of placing this in a taxable account would be.
Thanks in advance.
Evelyn

MotoTrojan
Posts: 1378
Joined: Wed Feb 01, 2017 8:39 pm

Re: Understanding tax efficient help

Post by MotoTrojan » Wed Feb 14, 2018 1:43 pm

EvelynTroy wrote:
Wed Feb 14, 2018 1:38 pm
Considering purchasing Vanguard Wellesley Income Admiral Shares fund (VWIAX) - its been noted that this fund is not tax efficient and best held in a tax advantaged account. I have other index ETF's and couple of funds - that are placed in the proper tax protected or taxable accounts.

I never really did understand exactly what is meant by tax efficient - if someone could explain this I would be appreciative. And what exactly the disasadvantage of placing this in a taxable account would be.
Thanks in advance.
Evelyn
A fund can be tax-efficient or inefficient based on a number of things. A higher dividend yield for example will put a tax-drag on the growth of your fund, assuming you reinvest dividends. Furthermore, some funds have a lower percentage of qualified dividends, which are taxed at a lower rate. Active funds or less broad index funds will have higher turnover, which results in any capital gains taxes being passed on to you. In Roth, none of this is taxed. In tax-deferred, none of this matters and you just get taxed on withdrawal amount(s).

Wellesley has a high percentage in bonds which pay most return in dividends. Not sure on % of those that are qualified but perhaps it is low. And it will have a higher turnover on the equity side than a Total US or S&P500 fund, which rarely have companies move in/out (requiring buying/selling).

To put it bluntly, your tax-bill will be higher with Wellesley in taxable. If you have tax-efficient assets such as Total US, Large-Cap US, S&P500, or Total International in your tax-protected accounts, I would consider swapping those with Wellesley, and then rebuying them in taxable. No harm done there.

onourway
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Re: Understanding tax efficient help

Post by onourway » Wed Feb 14, 2018 2:06 pm

The disadvantage of Wellesley in taxable is twofold. One, with ~60% of the fund's assets in bonds, most of the return it generates is paid out as dividend payments that are taxable at your full marginal tax rate. The other problem is that it distributes significant yearly long-term as well as short-term capital gains, again, taxable to you. You can see these distributions yourself at https://personal.vanguard.com/us/funds/ ... true#tab=4 and calculate what your approximate yearly tax bill would have been in the past.

Say you invested $10k in Wellesley in January 2017. At an approximate share price of $25.50 that would have bought you 392.16 shares. (For simplicity dividends will not be reinvested). The first dividend paid was 3/27 at 0.17/share for $66.67 in dividends for you. In June you would have been paid $74.51 in dividends, and $76.08 in September. Finally in December you'd be paid $84.12 in dividends, $9.65 in short-term capital gains, and $111.53 in long-term capital gains.

In sum:
$301.38 in dividends
$9.65 STCG
$111.53 LTCG

Assume a marginal tax rate of 25%. The tax paid would be:
$75.35 from Dividends
$2.41 from short gains
$16.73 from long gains

for $94.49 in total tax.

This gives a tax cost ratio of 0.94 or $94/$10,000.

Holding say Total Stock market at a tax cost of .33 or $33/$10,000 is 3x as efficient. So Wellesley has an additional tax drag of 0.61% annually.

Obviously investing in Wellesley is very different than investing in Total Stock Market, and so some people choose to hold it in spite of this additional cost.

EvelynTroy
Posts: 293
Joined: Sat Jun 07, 2008 8:35 am

Re: Understanding tax efficient help

Post by EvelynTroy » Wed Feb 14, 2018 2:18 pm

I appreciate these two detailed explanations very much - I understand what you are explaining.

Moto said
If you have tax-efficient assets such as Total US, Large-Cap US, S&P500, or Total International in your tax-protected accounts, I would consider swapping those with Wellesley, and then rebuying them in taxable. No harm done there.
I do have Vanguard Total Stk Market ETF and Vanguard FTSE all-world ETF in my traditional IRA account.
I thought if I sold all or portions of these I would have to pay taxes because I took them out of the IRA - and didn't just roll them over into something else within the IRA? I'm retired and can't add new money to the traditional IRA.

I do have somewhat of a sizeable RMD to take in 2018 - I could take this from the Total Stk. Market or FTSE all-world and then reinvest into the taxable account.
Thanks.
Evelyn

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Duckie
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Re: Understanding tax efficient help

Post by Duckie » Wed Feb 14, 2018 6:04 pm

EvelynTroy wrote:I do have Vanguard Total Stk Market ETF and Vanguard FTSE all-world ETF in my traditional IRA account.
I thought if I sold all or portions of these I would have to pay taxes because I took them out of the IRA - and didn't just roll them over into something else within the IRA? I'm retired and can't add new money to the traditional IRA.
You sell some or all of the two ETFs inside the TIRA. You now have some cash still inside the TIRA. Then you buy Wellesley inside the TIRA. If you want you can then buy the two ETFs in your taxable account. Since you are not withdrawing from the TIRA, just buying and selling inside it, there are no taxes for this swap.

livesoft
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Re: Understanding tax efficient help

Post by livesoft » Wed Feb 14, 2018 7:03 pm

Here's the way I look at tax-efficiency: It is simply that I keep more on the annual return for a tax efficient fund, so my portfolio effectively has a lower overall effective expense ratio.

If Wellesley in a taxable account incurs an additional 1% of the total fund value as taxes, then that's like an additional 1% expense ratio added on. One won't see this easily because one has to fill out a tax return and also one usually doesn't remove the 1% from Wellesley to pay the additional taxes. If you learned that all the annual performance numbers for Wellesley were 1% lower or if you learned that Wellesley had a 1% larger expense ratio than it does, would you still want to buy it?
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EvelynTroy
Posts: 293
Joined: Sat Jun 07, 2008 8:35 am

Re: Understanding tax efficient help

Post by EvelynTroy » Thu Feb 15, 2018 8:06 am

Thanks again Duckie and Livesoft -
The analogy of thinking about it as an extra expense ratio makes good sense, and I'm going to make room for Wellesley in my TIRA.
These simple helpful suggestions - give me a better feeling of control over why I should or shouldn't make changes.
Evelyn

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