How can I reduce tax exposure?

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Topic Author
ZZ66
Posts: 2
Joined: Mon Sep 30, 2019 6:56 am

How can I reduce tax exposure?

Post by ZZ66 » Mon Sep 30, 2019 7:19 am

I am a recent military retiree with a pension of 72K/yr and healthcare from Tricare. I started a new job which pays 375K/yr. Last year our portfolio generated 59K dividends (40K qualified) and 42K long term capital gains (largely from Wellington and Star funds). Between pension, salary, and portfolio income I am projecting about 550 K in income next year. I plan to work 5 more years and retire completely at 55. I feel very fortunate to be in the position I am financially and did not expect to have this level of income. I didn't really have an overall investment plan until a few years ago and if I were to start over and build the portfolio from scratch I would try to make it more tax efficient. At this point it seems like whatever I do would create more tax liability in the short term.

Emergency funds: 20,000

Debt: None

Tax Filing Status: (Married Filing Jointly) 2 kids under 17, spouse is no longer working outside the home.

Tax Rate: 35% Federal,

State of Residence: FL

Age:50

Desired Asset allocation: 80% stocks / 20% bonds
Desired International allocation: 20% of stocks
Low to mid 7 figure portfolio

Current retirement assets

Taxable
1.25 % cash
27.11% Total Stock Index VTSAX (.05)
2.03 % Mid Cap Index VIMAX (.10)
2.68% Extended Index VEXAX (.14)
8.44% STAR fund VGSTX (.34)
14.97% Wellington VWEMX (.17)
4.26% Wellesley VWIAX (.16)
15.14 % Total Int Stock Index VTIAX (.16)
0.78 % TD Ameritrade LULU Lululemon stock
0.30 % Vanguard Brokerage Vanguard energy ETF EDU

His 401k
15.45 % TSP Military (.025) C 8% S 22% I 12% G 50% F8%
0.20 % New employer (.05) 500 index fund

His Roth IRA at Vanguard
4.39% REIT Index VGSLX (.10)

Her Roth IRA at Vanguard
1.5 % Total Int Stock Index VTIAX (.16)

Her Traditional IRA at Vanguard
1.5 % Mid Cap Index VIMAX (.10


Contributions:

New annual Contributions
$25000 his 401k plus 15000 employer match
$7000 his Roth IRA backdoor
100K in taxable account



Questions:

1. Should I do anything now or just stick it out and pay the taxes each year until retirement in 5 years and reassess then?

2. The Capital gains from Wellington and STAR fund are variable each year and create difficulty with tax planning since they come at the end of the year. Any suggestions to address this?

straws46
Posts: 214
Joined: Fri Jul 03, 2015 11:12 am

Re: How can I reduce tax exposure?

Post by straws46 » Mon Sep 30, 2019 8:35 am

I would say thank you for your support. Formerly in the military and now as a taxpayer. At least you live in Florida.

terran
Posts: 1018
Joined: Sat Jan 10, 2015 10:50 pm

Re: How can I reduce tax exposure?

Post by terran » Mon Sep 30, 2019 9:13 am

It sounds like you're already maxing out your retirement accounts to the extent you can. If your wife didn't have an existing traditional IRA I would mention that she could also contribute to a backdoor Roth based on your income.

Wellington and Wellesley aren't the most tax efficient thing to have in a taxable account given that they have a large amount of bonds, and have to rebalance causing them to realize capital gains. You'll have to decide if paying the capital gains to get out of them is worthwhile though. https://www.bogleheads.org/wiki/Tax-eff ... _placement might be worth a look.

If you're charitably inclined you might consider making large contributions to a donor advised fund while you're still working, and in a higher tax bracket. Possibly enough to sustain your charitable giving throughout retirement when you'll be in a lower tax bracket.

HomeStretch
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Joined: Thu Dec 27, 2018 3:06 pm

Re: How can I reduce tax exposure?

Post by HomeStretch » Mon Sep 30, 2019 10:23 am

Welcome!

For your Taxable account:
1. Buy US and International equities with your $100k per year contributions.
2. Star/Wellesley/Wellington/LULU/EDU - these are either not tax efficient (due to bonds) or not diversified enough. Turn off dividend and capital gain reinvestment so you don’t buy more. Sell any tax lots with losses or minimal long-term gain. Sell any other lots with taxable gains as you can - low income year, large market dip, etc.
3. Consider buying I-Bonds which are tax deferred (the state/local tax exemption doesn’t matter to you in FL). You and spouse can each buy $10k per year plus you can buy more with tax refund, in the name of a trust, etc.

For your TSP/401k and her tIRA - hold as much of your 20% bond allocation as you can here and direct new contributions to bonds. There are no tax consequences to changing the allocation of your balances.

Your portfolio is low-to-mid 7-figures. You are projecting annual $132k savings on $550k in income for the next 5 years. Your annual after-tax spending is likely $250-$275k. Have you run any retirement projections to see if your pension + SS(?) + reasonable portfolio withdrawals in 5 years will support that spend level + income taxes in retirement?

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BolderBoy
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Location: Colorado

Re: How can I reduce tax exposure?

Post by BolderBoy » Mon Sep 30, 2019 10:48 am

ZZ66 wrote:
Mon Sep 30, 2019 7:19 am
Taxable
1.25 % cash
27.11% Total Stock Index VTSAX (.05)
2.03 % Mid Cap Index VIMAX (.10)
2.68% Extended Index VEXAX (.14)
8.44% STAR fund VGSTX (.34)
14.97% Wellington VWEMX (.17)
4.26% Wellesley VWIAX (.16)
15.14 % Total Int Stock Index VTIAX (.16)
0.78 % TD Ameritrade LULU Lululemon stock
0.30 % Vanguard Brokerage Vanguard energy ETF EDU
This is overly complex and partially tax-inefficient.

Objective: 80/20 AA. Easily accomplished with a 3-4 fund portfolio covering the entire market.

Method: try to keep the 20% bond allocation inside tax-deferred retirement plans (tIRA, t401k). If you cannot get the whole 20% inside tax-deferred retirement plans, then use a tax-exempt bond fund in taxable for the rest. Next, focus on changing your taxable account to hold only stock index funds (such as the VTSAX & VTIAX), so sell everything else and buy more of those; you may take a tax hit doing this and may need to spread out the sells/buys over a few years. Also keep whatever amount of cash you may need in taxable.

Stop all reinvestments of divs & CGs in your non-retirement accounts.

The sooner you simplify your portfolio the easier it will be to manage the taxes.
"Never underestimate one's capacity to overestimate one's abilities" - The Dunning-Kruger Effect

jtdavid
Posts: 111
Joined: Thu Mar 01, 2007 12:21 pm

Re: How can I reduce tax exposure?

Post by jtdavid » Mon Sep 30, 2019 10:52 am

If you make any significant charitable donations, you would benefit from donating the appreciated tax-inefficient funds (wellington, wellesley, star) and rebuying tax efficient funds in taxable.

cherijoh
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Location: Charlotte NC

Re: How can I reduce tax exposure?

Post by cherijoh » Mon Sep 30, 2019 11:32 am

HomeStretch wrote:
Mon Sep 30, 2019 10:23 am
For your Taxable account:
1. Buy US and International equities with your $100k per year contributions.
2. Star/Wellesley/Wellington/LULU/EDU - these are either not tax efficient (due to bonds) or not diversified enough. Turn off dividend and capital gain reinvestment so you don’t buy more. Sell any tax lots with losses or minimal long-term gain. Sell any other lots with taxable gains as you can - low income year, large market dip, etc.
3. Consider buying I-Bonds which are tax deferred (the state/local tax exemption doesn’t matter to you in FL). You and spouse can each buy $10k per year plus you can buy more with tax refund, in the name of a trust, etc.

For your TSP/401k and her tIRA - hold as much of your 20% bond allocation as you can here and direct new contributions to bonds. There are no tax consequences to changing the allocation of your balances.
Good advice - especially about turning off dividend and cap gains reinvestments. Direct that money to tax-efficient funds or ETFs. Before becoming a Boglehead I invested in actively managed mutual funds. I had stopped reinvesting cap gains & dividends, but didn't want the tax hit from selling the shares. When stocks tanked during the Great Recession, I sold all those shares and invested in either TSM or International index funds depending on the focus of that fund. (I still had some capital gains but not nearly as much if I had sold a few years earlier). When the market recovered, my investments did too. In your case when you sell STAR, Welleseley, or Wellington, I'd buy TSM in taxable and sell sufficient TSM in your 401k to buy bonds to maintain your desired AA.

Another minor adjustment would be to buy more international in taxable and swap out of it in tax-advantaged plans. You can only take advantage of the foreign tax credit if the funds are in your taxable account.

HomeStretch wrote:
Mon Sep 30, 2019 10:23 am
Your portfolio is low-to-mid 7-figures. You are projecting annual $132k savings on $550k in income for the next 5 years. Your annual after-tax spending is likely $250-$275k. Have you run any retirement projections to see if your pension + SS(?) + reasonable portfolio withdrawals in 5 years will support that spend level + income taxes in retirement?
I agree. OP may have been aggressively paying down a mortgage or socking money away for the kid's college funds, in which case he could still be in excellent shape. But if the retirement budget will continue to be that high, you are likely to fall short when you take taxes into account.

terran wrote:
Mon Sep 30, 2019 9:13 am
If you're charitably inclined you might consider making large contributions to a donor advised fund while you're still working, and in a higher tax bracket. Possibly enough to sustain your charitable giving throughout retirement when you'll be in a lower tax bracket.
Good advice, too.

In case you are not familiar with DAFs, you can donate appreciated shares and get the tax deduction for the entire amout of the contribution and totally avoid cap gains on the "sale". You can invest the money inside the DAF and make grants as you see fit. There is no need to distribute the entire amount in the same year you made the donation. If you donate appreciated shares, the donation is subject to a 30% cap based on AGI; any excess will be saved for the future. You can also donate cash (which would be subject to a 50% cap), but then you'd lose out on one of the biggest benefits.

Since LULU and EDU are such a small % of your total portfolio, I'd suggest them for the initial DAF funding if they are highly appreciated.

I retired in 2018, so I decided to set up a DAF at Fidelity Charitable in 2017 while I was still in a higher tax bracket. I donated the lots with the lowest cost basis (which would have generated the greatest capital gains) and sold shares with the highest cost basis to generate a cash stash to start my retirement. This turned out to be a very good thing due to the change in the tax laws. Last year I covered all my charitable giving from the DAF and used the itemized deduction for the first time in over 35 years. Since I have no mortgage interest deduction and did enough Roth conversions in 4Q 2018 that none of my medical expenses were deductible, I would have had to make at least $5K in charitable deductions before I broke even on standard vs. itemized deductions.
Last edited by cherijoh on Mon Sep 30, 2019 11:39 am, edited 1 time in total.

delamer
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Re: How can I reduce tax exposure?

Post by delamer » Mon Sep 30, 2019 11:35 am

Determine the cost basis for each investment in your taxable account. Hopefully that information is available on your brokerage statement.

Then you’ll know what the cost would be to sell any of your positions (cost basis times LTCG tax rate, unless you have any short-term gains).

That would be the start of developing a plan to gradually sell off your less-tax-efficient investments.

This might require a short term increase in taxes but would reduce them in the long run.

BruinBones
Posts: 37
Joined: Sun Apr 22, 2018 5:39 pm

Re: How can I reduce tax exposure?

Post by BruinBones » Mon Sep 30, 2019 1:40 pm

I was in a very similar situation as yours retiring from the military.
Good answers so far. Here is my advice based on my experience:
- converting all of your TSP to G-fund will get you close to your goal of 20% Bonds
- remainder of bond balance can be in your mixed funds if you choose to continue them, (not my recommendation), or Total Bond Market Index in 401(k) or traditional IRA, and/or Total Exempt Bond Index Fund in taxable.
- stop all dividend reinvestments in taxable
- convert Star/Wellesley/Wellington/LULU/EDU to Total Stock Market Index or 500 Index fund in taxable; may take several years to do this efficiently
- keep Total International Stock Index as is (I only allocate 10% overall to International)
- consider large donation to Donor Advised Fund to offset capital gains and taxes

Congratulation. With your pension and upcoming job for next few years, you have already won the game.
Welcome to Retired Military.

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FelixTheCat
Posts: 1670
Joined: Sat Sep 24, 2011 12:39 am

Re: How can I reduce tax exposure?

Post by FelixTheCat » Mon Sep 30, 2019 1:53 pm

Start reading Tax-efficient fund placement https://www.bogleheads.org/wiki/Tax-eff ... _placement
Felix is a wonderful, wonderful cat.

Topic Author
ZZ66
Posts: 2
Joined: Mon Sep 30, 2019 6:56 am

Re: How can I reduce tax exposure?

Post by ZZ66 » Tue Oct 01, 2019 4:09 am

Thanks everyone for the prompt response!!

Lots of good advice. I will start with switching off dividend and CG reinvestment in the tax inefficient accounts and directing to my index funds. Then I'll look at whether it's worth it to sell some of my Wellington, Wellesley and Star funds.

I didn't plan to work full time after leaving the military. I had hoped to work some temp jobs and travel in between. We did an extended 5 month trip with the kids last Summer and we had a great time. I did a temp job over the winter and we had planned to continue our travels but my wife and I decided that we needed to maintain some stability for the kids since they are in middle and high school. The current job opportunity came up and we decided that it was a great opportunity and the money was very good even if we didn't really need it. I think it was a good decision although I do miss the freedom that we had last year.

The kids will be done with HS in 5 years so I figure that will be our new retirement goal. I didn't list it with the other investments, but there is money from us as well as grandparents set aside for their college that will be adequate to cover expected expenses.

I have tracked our yearly spending over the last 10 years and we spend between 100 to 120 K per year. I figure that between the military pension and 3% withdrawal from our portfolio (currently worth 3.5 M ) we can generate about 177K per year which will cover expenses and taxes once I am no longer working. Of course I hope the portfolio is worth more that that in 5 years.

I appreciate any additional input...

knightrider
Posts: 600
Joined: Fri Jun 06, 2014 11:20 am

Re: How can I reduce tax exposure?

Post by knightrider » Tue Oct 01, 2019 8:31 am

BolderBoy wrote:
Mon Sep 30, 2019 10:48 am
Stop all reinvestments of divs & CGs in your non-retirement accounts.
I never knew this was a bad thing. Can anyone explain in a nutshell why it is not recommended?

terran
Posts: 1018
Joined: Sat Jan 10, 2015 10:50 pm

Re: How can I reduce tax exposure?

Post by terran » Tue Oct 01, 2019 8:36 am

knightrider wrote:
Tue Oct 01, 2019 8:31 am
BolderBoy wrote:
Mon Sep 30, 2019 10:48 am
Stop all reinvestments of divs & CGs in your non-retirement accounts.
I never knew this was a bad thing. Can anyone explain in a nutshell why it is not recommended?
It's not necessarily a bad thing, but the OP has some suboptimal investments for a taxable account, so by reinvesting dividends he's continuing to add to those investments. By stopping he'll be able to invest the proceeds into investments that are better suited to a taxable account.

It can also be good not to automatically reinvest dividends if you like to tax loss harvest in your taxable account as an automatically reinvested dividend can cause a wash sale. In this case, remember to also turn off dividend reinvestment in tax advantaged accounts of investments you also hold in your taxable account.

HomeStretch
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Re: How can I reduce tax exposure?

Post by HomeStretch » Tue Oct 01, 2019 11:17 am

HomeStretch wrote:
Mon Sep 30, 2019 10:23 am
Your portfolio is low-to-mid 7-figures. You are projecting annual $132k savings on $550k in income for the next 5 years. Your annual after-tax spending is likely $250-$275k. Have you run any retirement projections to see if your pension + SS(?) + reasonable portfolio withdrawals in 5 years will support that spend level + income taxes in retirement?
ZZ66 wrote:
Tue Oct 01, 2019 4:09 am
I have tracked our yearly spending over the last 10 years and we spend between 100 to 120 K per year.
With an income of $550k, your payroll and income taxes are likely $145-$150k. If your spend on all expenses (except payroll and income taxes) is $100 - $120k per year, your savings rate should be closer to $280k (= $550k - $150k - $120k) versus the $132k contributions you posted above.

At that savings rate, you might be able to retire permanently in under 5 years!

Consider running a payroll and income tax projection to double-check the overall numbers. Income = Savings + Taxes + Spend.

3Fund4Life
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Re: How can I reduce tax exposure?

Post by 3Fund4Life » Tue Oct 01, 2019 12:33 pm

In order to decrease the tax drag of dividends in our taxable, we did the following:

1. Moved 50% of our bond allocation to taxable - used VG national munis (perfect for you living in FL).

2. Moved 100% of our VG international index to tax deferred. VTIAX has a 3% yield - roughly 70% of that is qualified. The other 30% is not (taxed at marginal rate). This also made sense because VTIAX did not appreciate much at all over the past few years for us in taxable. We were able to buy it back in our tax deferred at a cheaper institutional class level (.07 vs .11 ER).
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