High ER funds with large cap gains - what to do ?

Have a question about your personal investments? No matter how simple or complex, you can ask it here.
Post Reply
curious george
Posts: 23
Joined: Sat Jul 27, 2013 11:24 pm

High ER funds with large cap gains - what to do ?

Post by curious george » Mon Feb 19, 2018 8:47 am

Hello

I was previously with an advisory service that invested in some mutual funds with lower costs but also some higher cost funds. As previously mentioned, we are no longer using their services.
These funds now have significant cap gains. We would be in the 20% cap gains bracket.
We are now in a quandary- what to do with these higher cost funds ? The ER is close to 1% for these funds.
I did already sell the funds with small dollar amounts and the highest expense ratios but am stuck with the rest.
Is there a formula that someone has used to help estimate how long it would take to make up for the taxes paid on gains vs lower fees ?
Can anyone share their own experience on how to handle this ?
All of our new investments are going into lower cost funds with Vanguard and I am torn as how best to handle this.

Thanks !

livesoft
Posts: 62294
Joined: Thu Mar 01, 2007 8:00 pm

Re: High ER funds with large cap gains - what to do ?

Post by livesoft » Mon Feb 19, 2018 8:58 am

Formula discussed in the wiki: https://www.bogleheads.org/wiki/Paying_ ... itch_funds

If reinvesting distributions, stop that.

Consider donating shares to your Donor Advised Fund.
Wiki This signature message sponsored by sscritic: Learn to fish.

User avatar
Watty
Posts: 13824
Joined: Wed Oct 10, 2007 3:55 pm

Re: High ER funds with large cap gains - what to do ?

Post by Watty » Mon Feb 19, 2018 9:38 am

If you have not done it already then one thing to do would be to change the mutual funds to not automatically reinvest dividends and capital gains distributions. This will prevent you from buying any more of them.

You also need to dig into the details of the funds to figure out if there are other costs associated with it like 12-b1 fees or lots of fees associated with them actively doing a lot of buying and selling of the stock that the fund owns. The total cost of them could be higher than the 1% ER you are seeing.

Somewhere in the prospectus or web site for the fund you may be able to find a performance chart that shows the fund 3,5, and ten year performance compared to a comparable index fund. The difference can help give you an idea of what the total of all the costs were but you have to take this with a grain of salt since an actively managed fund may have made a large bet on something like New Zealand stocks and that might be compared to generic international index fund. Just by random change New Zealand stock might have done a lot better or worse than the broad index fund. Comparing the funds performance to the 10(best) or 5 year performance of the index fund will give you the best idea of what the true expenses of the funds are.

I'm not any accounting guru but for the math but I would look at it this way.

1) Figure out the capital gains tax, including state taxes, as a percent of the entire value of the fund, not just the gains. (assume that you are in the 20% combined capital gains tax bracket)

For example of you have $1,000 in a fund with a $250 gain then 20% of that is $50 dollars so that is 5% of the total value of the fund. If the fund is charging you 1% too much then a back of the envelope calculation be that it would take about five years to break even.

This ignores the compounding and that the chance that the capital gains might trigger other things like the AMT or medicare surcharges. You could do a dummy tax return to help see the impact of anything like that. It sounds like the amounts are large so getting professional tax advice would likely be a good idea.

2) You also need to look to see if your tax situation will likely change and put you into a different capital gains tax bracket anytime soon. For example if you are 64 and retiring next year and your income will be a lot lower then it might make sense to wait a year.

3) If you will need to sell the funds in ten years and you expect to be in the same tax bracket then you would only be deferring the capital gains taxes not avoiding them.

4) You also need to check to make sure that there is not a back end load for the mutual fund.

5) If you support a charity or family member then you could give them shares in the mutual fund instead of cash. They can then sell it and pay lower or no capital gains taxes. You can also set up a donor advised fund to put a large amount into now and then distribute the money to a charity in the future.

There are a few "gotcha" things to keep in mind.

1) You could end up being widowed, divorced, or (re)married which could change your future tax bracket. You might also move to a different state.

2) Tax rates can change. Talking about politics or future law changes are not allowed here and I don't have a crystal ball but a reasonable case can be made for expecting higher taxes in the future.

3) Under current law if you hold the funds until you die then your estate gets them at a stepped up cost basis and the capital gains tax never has to be paid. The problem with this is that "current" is the key word. There has been periodic talk of changing this so if you are relatively young you cannot count on the law still working like this if you live to be 95.

User avatar
Toons
Posts: 12931
Joined: Fri Nov 21, 2008 10:20 am
Location: Hills of Tennessee

Re: High ER funds with large cap gains - what to do ?

Post by Toons » Mon Feb 19, 2018 9:47 am

I have a fund that paid out five figures in cap gains this year.
It varies from year to year.
Some years negligible .
Some years large.
I take the divs and cap gains in cash and spend or invest elsewhere.
Taxes?
I pay what I owe.
I don't of time fretting over the taxes,
If my marginal rate changes,so be it
It is what it is.
Think about it,how many people in this country would like to have such a "problem",
If that is what one wants to call it.

:mrgreen:
"One does not accumulate but eliminate. It is not daily increase but daily decrease. The height of cultivation always runs to simplicity" –Bruce Lee

JW-Retired
Posts: 6880
Joined: Sun Dec 16, 2007 12:25 pm

Re: High ER funds with large cap gains - what to do ?

Post by JW-Retired » Mon Feb 19, 2018 9:57 am

curious george wrote:
Mon Feb 19, 2018 8:47 am
Can anyone share their own experience on how to handle this?
Gifted large cap gain stocks to the kids who could sell at zero tax, or at least much lower than my Fed + California tax cost.

It makes what to do their problem. :D
JW
Retired at Last

cas
Posts: 309
Joined: Wed Apr 26, 2017 8:41 am

Re: High ER funds with large cap gains - what to do ?

Post by cas » Mon Feb 19, 2018 10:07 am

Watty wrote:
Mon Feb 19, 2018 9:38 am


1) Figure out the capital gains tax, including state taxes, as a percent of the entire value of the fund, not just the gains. (assume that you are in the 20% combined capital gains tax bracket)

<skip>

This ignores the compounding and that the chance that the capital gains might trigger other things like the AMT or medicare surcharges. You could do a dummy tax return to help see the impact of anything like that. It sounds like the amounts are large so getting professional tax advice would likely be a good idea.
Another tax to consider: Net Investment Income Tax (NIIT). If your taxable income is high enough that you will be paying 20% federal capital gains tax, you will also be paying NIIT (3.8%) on the capital gains.

User avatar
grabiner
Advisory Board
Posts: 22529
Joined: Tue Feb 20, 2007 11:58 pm
Location: Columbia, MD

Re: High ER funds with large cap gains - what to do ?

Post by grabiner » Mon Feb 19, 2018 6:06 pm

Another way to get rid of funds that you don't want to hold is to donate to charity. You shouldn't do this just for the tax benefit, but if you are donating several thousand dollars to a charity, you might as well do it with those funds.
Wiki David Grabiner

Afty
Posts: 792
Joined: Sun Sep 07, 2014 5:31 pm

Re: High ER funds with large cap gains - what to do ?

Post by Afty » Mon Feb 19, 2018 6:58 pm

We have some similar funds from an old Merrill Lynch account. We have been donating them to our Donor Advised Fund.

larmewar
Posts: 359
Joined: Sat Mar 03, 2007 7:45 pm

Re: High ER funds with large cap gains - what to do ?

Post by larmewar » Tue Feb 20, 2018 5:08 pm

Check for shares that could be sold at a loss or small capital gain using specific share identification.

Lar

harmony
Posts: 493
Joined: Sun Nov 24, 2013 1:35 am

Re: High ER funds with large cap gains - what to do ?

Post by harmony » Tue Feb 20, 2018 7:40 pm

If you or your spouse are getting close to needing long term care and you don’t have good LTC insurance; then if these funds are withdrawn in the same year when you have big LTC expenses, the taxable income portion may be partially deducted on Schedule A.

aristotelian
Posts: 4594
Joined: Wed Jan 11, 2017 8:05 pm

Re: High ER funds with large cap gains - what to do ?

Post by aristotelian » Tue Feb 20, 2018 7:49 pm

I am still in the midst of liquidating high expense funds I have had for 20 years. Got rid of the most egregious ones over the last two years. You are going to have to take a tax hit but in the long run it will be worth it. Only exception would be if you are near retirement with low anticipated taxable income. In that case, you should wait and then clear the gains when you are in the 0% capital gains bracket.

Otherwise, don't do it all at once. Stay in the 15% capital gains bracket. Doing too much at once could cause problems for Roth/Traditional eligibility, child tax credit, Obamacare subsidies, etc. Keep all of these things in mind.

If you have any charitable interests, these shares are ideal for contributing to a Donor Advised Fund. Then you do not have to pay any capital gains tax at all.

Post Reply