Life Strategy Funds: Tax hit

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mortfree
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Life Strategy Funds: Tax hit

Post by mortfree » Sat Mar 03, 2018 2:34 am

Break out your calculators.

Although it is not efficient I may want to invest in a Life Strategy fund (80:20 or 60:40) in a Taxable account.

I am in the 22% tax bracket and a PA resident.

What would the tax hit be if I invested 5k or 10k? Is there a foreign tax hit? I believe these hold international.

Finally, Is there a dollar amount where it is just too inefficient in a taxable account?

With my current investments in taxable I get $600 in qualified dividends

Let me know if you need more info. This is not the traditional asking for portfolio advice.
Last edited by mortfree on Sat Mar 03, 2018 4:01 am, edited 1 time in total.

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whodidntante
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Re: Life Strategy Funds: Tax hit

Post by whodidntante » Sat Mar 03, 2018 2:43 am

You can determine this yourself. Find the distributions last year and their composition. Cap gains LT/ST, dividends qualified/non-qualified, foreign tax withheld. And then it's a simple matter of arithmetic to determine the tax impact.

Also note that it's going to get worse over time if bond yields continue to increase as they have been doing so far this year. Bond yields are not qualified dividends.

I suggest you then compare it to VOO or whatever baseline you want to use so you can see how much of a difference it makes. An S&P 500 index ETF is going to be very tax efficient to buy and hold, because it's unlikely to distribute capital gains, and the dividends are going to be 100% qualified most of the time.

rkhusky
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Re: Life Strategy Funds: Tax hit

Post by rkhusky » Sat Mar 03, 2018 8:23 am

The qualified dividend percentage for LS Growth was 63% and for LS Mod Growth was 47%. You'll pay 15% tax on the QD and 22% tax on the non-QD. The 2017 dividend yield was about 2.2% for both, but that may go up in the future given that Total Bond yields are rising.

There is foreign tax, for which you can claim a credit on your tax return.

For comparison, Total Stock typically has a 2% dividend with 95% qualified and Total Int'l typically has a 3% dividend with 70% qualified, but you get the foreign tax credit on the latter.

Only you can say whether the simplicity of an LS fund is worth the extra tax cost versus a different strategy such as (Total Stock, Total Int'l and Int. Tax Exempt) or (Total Stock, Total Int'l in taxable and Total Bond in tax-advantaged).

The 22% bracket is marginal for using a tax-exempt bond fund vs. a taxable bond fund, because the taxable bond fund may produce more then 22% more dividends, which might make the after-tax return better. But you need to figure your marginal rate, because sometimes adding more taxable income reduces credits or causes other income to be taxed, which wasn't before.

Lafder
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Re: Life Strategy Funds: Tax hit

Post by Lafder » Sat Mar 03, 2018 10:21 am

Just remember if you have to pay tax, it is because you made money!

Life Strategy funds are convenient all in one funds with low fees .

If you hold the individual funds you can have a higher % bonds in retirement accounts, and lower tax generating options in your taxable accounts.

Overall, bogleheads obsess on saving taxes and fees that most people do not worry about.

It is hard to have holdings in taxable accounts that you never pay taxes on. Vanguard has some tax managed accounts that will sell at a loss to cancel gains to minimize taxes for you. But that means they are managed accounts, not index accounts and they have to choose what to buy and sell to minimize tax effects. See tax managed capital appreciation fund.

lafder

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goingup
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Re: Life Strategy Funds: Tax hit

Post by goingup » Sat Mar 03, 2018 12:47 pm

mortfree wrote:
Sat Mar 03, 2018 2:34 am
What would the tax hit be if I invested 5k or 10k?
I didn't break out my calculator and don't even do our own taxes. :twisted: However, I wouldn't worry a bit about taxes for that if it's the fund you want to hold in the short term. If you're looking for a "forever' fund and think you'll ever be in top-tier tax brackets, with a 6 figure fund balance, a broad market index fund would be a smarter choice.

mortfree
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Re: Life Strategy Funds: Tax hit

Post by mortfree » Sat Mar 03, 2018 3:01 pm

Thanks for the replies thus far.

I am not really a purist boglehead when it comes to investing.

I do hold a few shares of SPY (from 2004) and VTI (2017). SPY is S&P 500. VTI is total stock ETF (for the acronym haters)

My overall portfolio across all accounts is 75:25.

When I put money in my taxable account it “feels” like I am doing 100% equities so my thinking was to mix it up a little with the life strategy or maybe balanced fund to avoid the international (have some in 401k).

Thinking this bucket could be used for future college expenses if needed (13-17 years from now)

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grabiner
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Re: Life Strategy Funds: Tax hit

Post by grabiner » Sat Mar 03, 2018 8:07 pm

The LifeStrategy funds are just as tax-efficient as the funds they hold. The stock indexes are ideal for a taxable account, and Total Bond Market is OK in a taxable account in a moderate bracket, although you may prefer to hold bonds in your 401(k).

The problem occurs when you want to change your allocation. If you have $160K in stock and $40K in bonds, and you want to change to 60% stock, you need to sell $40K of stock. If you have $200K in LifeStrategy Growth and want to change to LifeStrategy Moderate Growth, you need to sell the whole fund, which requires selling $160K of stock for a much larger capital gain.

Therefore, if you want to hold a balanced fund in a taxable account, it makes more sense to use the Target Retirement funds, which will become more conservative over time. You still have to deal with capital gains if you want to change your allocation for other reasons, such as holding fewer bonds, or bonds in a different account (because your 401(k) has better bond than stock options) or a different type of bonds (NY munis if you move to NY).
Wiki David Grabiner

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