Tax efficient investment [becoming more tax efficient]

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Tommy
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Tax efficient investment [becoming more tax efficient]

Post by Tommy » Tue Mar 08, 2016 12:07 am

Hi All,

I'm new to this forum and would like to get some help and advise.. BTW, English is my second language, so please forgive grammar..
Emergency fund - 1 year
Debt - 4 more years to pay off mortgage
TAX bracket - probably 25%, no state tax
Here my investments:

401K - Fidelity
LifePath® Index 2020 Fund L - 13%
PIMCO TOTAL RETURN - 7%
VANG RUS 1000 GR TR- -2%
VANG S&P 500 IDX TR - - 2%
VANG RUS 1000 VAL TR - -2%
RUSSELL INTL VALUE - - 1,5%
RUSSELL INTL GROWTH - -1.5%
ARTISAN MID CAP - -1,5%

Roth IRA

SPARTAN 500 INDEX FD ADVANTAGE CLASS - - 1.5%
FIDELITY TOTAL BOND - - 1%

Vanguard investment
Vanguard 500 Index Fund Admiral Shares -1.75%
Vanguard Inflation-Protected Securities Fund Investor Shares -0.4%
Vanguard REIT Index Fund Investor Shares - 0.8%
Vanguard STAR Fund -6.5
Vanguard Target Retirement 2025 Fund - 7.5%
Vanguard Total Bond Market Index Fund Admiral Shares -2%
Vanguard Wellesley Income Fund Admiral Shares -7.5%
Vanguard Wellington Fund Admiral Shares - -7.7%

Wife's IRA
Vanguard LifeStrategy Moderate Growth Fund Investor Shares -13%
Vanguard Target Retirement 2030 Fund Investor Shares -11%

529 - 4.25%
Company stock -4.6%

Please note that those investments have been built during about 17 years, in different financial institutions and lately I'm trying to consolidate and have them in order.
So, I need help:
This year I was hit with big tax, even got AMT. So, I understand that my investments are not really tax efficient. What can be done to make them more tax efficient?
Thanks in advance

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dratkinson
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Re: Tax efficient investment [becoming more tax efficient]

Post by dratkinson » Tue Mar 08, 2016 7:18 pm

Recommended long-term retirement investing choices.
See: https://www.bogleheads.org/wiki/Three-fund_portfolio
See: https://www.bogleheads.org/wiki/Princip ... _placement

However you get to an age-appropriate 3-fund portfolio is fine: individual funds/ETFs, or an all-in-one fund. The 3-fund portfolio is recommended for all account types: employer tax-advantaged (401k,...), personal tax-advantaged (IRA,...), and personal taxable. It can be replicated in each account, or spread across all, guided by your investment options’ availability/costs. Your choice.

For taxable accounts and if in the 25+% fed tax bracket, substitute an intermediate-term national municipal bond fund for the 3-fund's recommended TBM.

If you move to a state with an income tax, then research "death spiral states" before investing in a single-state muni. Then if you go this route, restrict your single-state muni investment to be half of your total bonds in your taxable account.



Advice as it applies to your accounts.

Assuming Vanguard investment is a taxable account, the only recommended fund is the S&P500 index fund. All the other funds use/include tax-inefficient taxable bonds, tax-inefficient stocks, or use active management with the potential to generate capital gains.

Vanguard 500 Index Fund Admiral Shares -1.75%
Vanguard Inflation-Protected Securities Fund Investor Shares -0.4% taxable bonds
Vanguard REIT Index Fund Investor Shares - 0.8% tax-inefficient stocks
Vanguard STAR Fund -6.5 include taxable bonds
Vanguard Target Retirement 2025 Fund - 7.5% include taxable bonds
Vanguard Total Bond Market Index Fund Admiral Shares -2% taxable bonds
Vanguard Wellesley Income Fund Admiral Shares -7.5% include taxable bonds, active management
Vanguard Wellington Fund Admiral Shares - -7.7% include taxable bonds, active management

Recommended tax-efficient holding for (taxable) Vanguard investment
--Total stock market index fund (VTSMX).
--FTSE ex-US index fund (VFWAX), or Total Stock Market index fund (VGTSX). Both are similar: good long-term or as tax-loss harvest partners.
--Intermediate-term national muni bond fund (VWITX). I prefer long-term national muni bond fund (VWLTX). Or shorter term if you prefer.

With the market being down, maybe you can make your changes without too much additional capital gains tax.


401K. Simplicity is preferred. Can consolidate your multiple holdings into fewer using above guidelines. No tax cost to do so.


Your IRA. TSM preferred over S&P500, but your choices are okay.


Wife's IRA. Looks okay, but LS fund uses constant bond allocation, whereas TDR fund uses increasing bond allocation as you age. As approaches seem mutually exclusive, so can settle on one or the other. Either is fine if it fits your long-term goal. Together they are not bad. Bottom line: this is not a critical decision.


529. Company stocks are generally only recommended for a small (~5%) play money investing account. Why? So if you lose it (company bankruptcy), you don't care. Think GM, Enron, Worldcomm,....



Recommended Books.

The Only Investment Guide You’ll Ever Need, by Andrew Tobias. It covers a wide range of personal finance topics: life insurance, debt, credit cards, introductory investing,…. (I read it in the '70s and it’s updated periodically. A newer book by Quinn's on "making the most of your money" is also recommended.)

The Boglehead's Guide to Investing. It's a structured overview of the topic: selecting an asset allocation, account types, appropriate investments for each account type, and a little investing history to support the recommendations.

Get the books from local library, through inter-library loan, or buy them.

Begin reading in the Wiki (link: screen top right) while waiting for your books. Read the introductory material and all else that interests you.

Search the Wiki for recommended "books". Read several to round out your investor education. Read one on bonds. Why? So you will know which boring bonds to select to keep your investments stable during a market crisis.



Welcome.
d.r.a, not dr.a. | I'm a novice investor, you are forewarned.

livesoft
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Re: Tax efficient investment [becoming more tax efficient]

Post by livesoft » Tue Mar 08, 2016 7:39 pm

One thing you can do to improve tax-efficiency is look at your tax return. I always tell folks that their Schedule B should have less than $10 reported in the top half and the bottom half should have only qualified dividends and no non-qualified dividends. Also, their Schedule D should always have a net loss, so that -$3,000 get put on Form 1040 Line 13.

If that's not happening on your tax return, then get rid of the investments that cause that not to happen. Already mentioned were Wellesley and Wellington in your taxable account. Those are terribly tax-inefficient funds and should not be held in a taxable account by folks not in very very low tax brackets.

But this will not necessarily help your AMT problems. Those usually arise from too many deductions. But maybe your AMT was only $10?
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jjface
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Re: Tax efficient investment [becoming more tax efficient]

Post by jjface » Tue Mar 08, 2016 7:46 pm

Tommy wrote: Vanguard investment
Vanguard STAR Fund -6.5
Vanguard Wellesley Income Fund Admiral Shares -7.5%
Vanguard Wellington Fund Admiral Shares - -7.7%
These three are the biggest culprits. All of which distribute extra gains near the year end. I think each distributed nearly 6% in dividends, bond interest and gains in the year vs a total stock market fund which is only going to have about 2% in dividends. All of which as well contain tax inefficient bonds. I am a fan of these funds but I wouldn't keep them in a taxable account if I could help it.

Since they do distribute gains the tax hit to sell them might be reasonable at the moment.

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BL
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Re: Tax efficient investment [becoming more tax efficient]

Post by BL » Tue Mar 08, 2016 8:17 pm

It looks like these are your taxable funds which are the ones giving you tax problems (if any are not retirement funds please specify):
Vanguard investment
Vanguard 500 Index Fund Admiral Shares -1.75%
Vanguard Inflation-Protected Securities Fund Investor Shares -0.4%
Vanguard REIT Index Fund Investor Shares - 0.8%
Vanguard STAR Fund -6.5
Vanguard Target Retirement 2025 Fund - 7.5%
Vanguard Total Bond Market Index Fund Admiral Shares -2%
Vanguard Wellesley Income Fund Admiral Shares -7.5%
Vanguard Wellington Fund Admiral Shares - -7.7%
They are all decent funds, but you certainly don't need them all, as they overlap quite a bit.

Inflation-protected funds and REIT are not considered tax-efficient funds and should be elsewhere if you insist on having them. Perhaps the Total Bond market and Wellesley would be next on the selling list, if not too much Capital Gains. I believe the 500 index is considered tax-efficent. Total international stock market and total US stock market are also considered tax-efficient.

Anyway, you want to check cost basis to find out what kind of capital gains/losses each fund has, so you would know the cost trade-off if you sell. Perhaps you can set them all to Specific Id for your cost basis, so that you could sell off the parts that have losses and leave the parts that have too much in gains. This should work fine if you haven't sold any of these funds earlier.

Be sure to stop dividend reinvestment so you can buy tax-efficient stocks with that.

Tommy
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Re: Tax efficient investment [becoming more tax efficient]

Post by Tommy » Tue Mar 08, 2016 9:12 pm

Thanks everyone who replied. AMT was $850. Funny thing is that I'm not deducting anything, my mortgage interest and property tax too low to be deducted. Well, this year I was deducting sales taxes for 2 new cars (one got total, another was 17 years old), not sure if it caused it. I was going for some time to get rid of Star but last 3 years it performed very decently...
There is some overlap in portfolio of course, and I need to simplify, in the same time I noticed that Star and TR behave differently, although they are similar in terms of stock/bonds allocation and international exposure, they have different sector structure. They kinda balance each other. I'm trying to keep 60/40 AA in general, but since my wife 8 years younger, her part is more aggressive and mine less

livesoft
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Re: Tax efficient investment [becoming more tax efficient]

Post by livesoft » Tue Mar 08, 2016 9:21 pm

Tommy wrote:Funny thing is that I'm not deducting anything, my mortgage interest and property tax too low to be deducted. Well, this year I was deducting sales taxes for 2 new cars …
I thought sales tax was deducted on Schedule A, so that would mean one would put ANY and ALL mortgage interest and property tax on Schedule A as well. So I don't understand the sentence from you that I quoted. If you took the standard deduction, then you didn't deduct sales tax, right?
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Tommy
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Re: Tax efficient investment [becoming more tax efficient]

Post by Tommy » Wed Mar 09, 2016 1:06 am

Quite honestly I'm using turbo tax and what it put on which schedule I have no idea. What I meant that for last 3 or 4 years I couldn't deduct anything, and used standard deduction. This year after I put sales tax I was able to use itemized deduction, although difference was quite small, but came AMT

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BL
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Re: Tax efficient investment [becoming more tax efficient]

Post by BL » Wed Mar 09, 2016 2:12 am

You don't have to itemize your deductions. If it is cheaper to use standard deduction, use that.

EDIT
Look at your 1099s from Vanguard. Subtract the Qualified Dividends from Ordinary Dividends. You pay tax on that difference at your regular rate, plus you pay tax on the Q D + Capital Gains at the 15% rate on any amount in the 25% tax bracket. (See below.)

If you were in tax-efficient funds you would pay little or no 1099 tax at 25% because almost all of the dividends should be qualified dividends. There would be perhaps ~2% dividends overall if you had no taxable bonds in there. There would probably be no Capital Gains if you had the two stock funds in the 3-fund portfolio.

Also look at page 2 of your 1040 tax form, line 43, taxable income.
Compare to these numbers:
$74,900 is the top Taxable Income within the 15% tax bracket for married filing jointly.
$151,200 is the top of the 25% tax bracket for MFJ.

By the way, your English is excellent.
Last edited by BL on Wed Mar 09, 2016 9:39 am, edited 3 times in total.

livesoft
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Re: Tax efficient investment [becoming more tax efficient]

Post by livesoft » Wed Mar 09, 2016 6:16 am

I would not be surprised if you had entered something incorrectly in TurboTax. I think everyone should always look at the tax forms produced by software and understand where the numbers are coming from. That might mean reading the instructions from the IRS for the forms, too.
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Tommy
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Re: Tax efficient investment [becoming more tax efficient]

Post by Tommy » Wed Mar 09, 2016 11:51 am

Thanks for reply and suggestions. Will follow your suggestions and try to implement.
One more question, not really related to taxes.
My 401K doesn't have much options, but interesting that all options are not mutual funds, despite their names. For example:
Vanguard S&P 500 Index Trust - it looks like mutual fund but it doesn't. What it says:
This collective trust is managed by Vanguard Fiduciary Trust Company, a subsidiary of The Vanguard Group, Inc. and is not a mutual fund.
Exp Ratio (Gross) 0.0113%
PIMCO Total Return Account
Exp Ratio (Gross) 0.27%
The investment option is a managed separate account. It is managed by PIMCO. This investment option is not a mutual fund.
Artisan Mid Cap Account - 0.5033%
The investment option is a managed separate account. It is managed by Artisan. This investment option is not a mutual fund.
LifePath® Index 2020 Fund L - 0.09%
The investment option is a collective investment trust. It is managed by BlackRock. This investment option is not a mutual fund.
Russell International Value Account - 0.5728% .This SMA is managed by Russell Investment Management Company.This investment option is not a mutual fund.
Russell International Growth Account - 0.5734% .This investment option is not a mutual fund.
Vanguard Russell 1000 Growth Index Trust -0.0216% -This collective trust is managed by Vanguard Fiduciary Trust Company, a subsidiary of The Vanguard Group, Inc. and is not a mutual fund
Vanguard Russell 1000 Value Index Trust -0.0202% - This collective trust is managed by Vanguard Fiduciary Trust Company, a subsidiary of The Vanguard Group, Inc. and is not a mutual fund.
If they are not mutual funds, what they are? Any recommendations to simplify from cost perspective?

livesoft
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Re: Tax efficient investment [becoming more tax efficient]

Post by livesoft » Wed Mar 09, 2016 12:02 pm

They are: https://www.bogleheads.org/wiki/Collect ... ent_Trusts and better for you than mutual funds. You are lucky to have a 401(k) with them available.

To simplify, start by making your taxable account 50% total US stock market index fund and 50% total international stock market index fund.
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Miriam2
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Re: Tax efficient investment [becoming more tax efficient]

Post by Miriam2 » Wed Mar 09, 2016 12:13 pm

Tommy wrote:Quite honestly I'm using turbo tax and what it put on which schedule I have no idea. What I meant that for last 3 or 4 years I couldn't deduct anything, and used standard deduction. This year after I put sales tax I was able to use itemized deduction, although difference was quite small, but came AMT
livesoft wrote:I would not be surprised if you had entered something incorrectly in TurboTax. I think everyone should always look at the tax forms produced by software and understand where the numbers are coming from. That might mean reading the instructions from the IRS for the forms, too.
I agree. I have done our taxes pencil to paper with a calculator for45 years and I know exactly where sales tax, mortgage interest and property taxes and all that other stuff fit into the grand scheme of the 1040 tax form. And after doing them by hand and reading the IRS directions, I even have an idea why they are where they are. It's kind of logical :shock:

But last year I tried Turbo Tax to double check what I did, as our taxes had become more complicated. I was appalled at how simple Turbo Tax was at just asking questions, asking for numbers, then auto-calculating - and none of it was in the same order as the line-by-line 1040 form. The line-by-line is critical in understanding how the 1040 tax structure is set up. Turbo Tax taught nothing and it was very easy to miss putting something in, which would then change the calculations.

If OP does not know what Schedule he put something on, I agree going back to square one with the paper forms or perhaps seeing a tax preparer for a year would be important.

Tommy
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Re: Tax efficient investment [becoming more tax efficient]

Post by Tommy » Wed Mar 09, 2016 12:55 pm

I'd agree with you but my taxes are absolutely straightforward. I'm not entering anything, except donations ,sales tax, mortgage interest and property tax . Turbo tax imports W2, imports tax forms from financial institutions. I did verify that it import them correctly but this is it. I have no additional income, rental property, business, alimony, etc. As software engineer I understand how Turbo Tax works and know where it can go wrong. In some complex cases I wouldn't trust it, but as I said my case absolutely straightforward.

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Re: Tax efficient investment [becoming more tax efficient]

Post by livesoft » Wed Mar 09, 2016 1:09 pm

Excellent! Please tell me why you had AMT of $850 then. I am very curious what caused that because of your stated marginal income tax bracket.
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Tommy
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Re: Tax efficient investment [becoming more tax efficient]

Post by Tommy » Wed Mar 09, 2016 2:08 pm

this is what I'm trying to understand myself :) Turbo Tax said that AMT because of large capital gains or too much deductions. Since I don't have any additional deductions this year I'd assume it is because of capital gains. BTW, what is "marginal income tax bracket"?

livesoft
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Re: Tax efficient investment [becoming more tax efficient]

Post by livesoft » Wed Mar 09, 2016 2:20 pm

The internet finds some AMT information:
http://fairmark.com/general-taxation/al ... liability/
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Tommy
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Re: Tax efficient investment [becoming more tax efficient]

Post by Tommy » Wed Mar 09, 2016 3:35 pm

thanks. Same thing
State and local taxes. If you itemize, there’s a good chance you claim a deduction for state and local tax, including income tax or sales tax and, if you own a home, property tax. These deductions are not allowed under the AMT.
Long-term capital gains: it’s possible to be stuck with AMT liability because of a large capital gain.
OK, hopefully market will go more down, I will be able to re-balance to more tax efficient investment

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dratkinson
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Re: Tax efficient investment [becoming more tax efficient]

Post by dratkinson » Thu Mar 10, 2016 11:40 am

livesoft wrote:One thing you can do to improve tax-efficiency is look at your tax return. I always tell folks that their Schedule B should have less than $10 reported in the top half and the bottom half should have only qualified dividends and no non-qualified dividends. Also, their Schedule D should always have a net loss, so that -$3,000 get put on Form 1040 Line 13.

If that's not happening on your tax return, then get rid of the investments that cause that not to happen. ...
That's a gem worth including in my off-line notes, with suggested edits.
  • Fund tax-efficiency improvement opportunities from review of tax return, if/when tax efficient to change.
    --Top of Sch B should list <$10.
    --Bottom of Sch B should list only: QDI income, tax-exempt dividends, and ordinary dividends from funds with offsetting FTC.
    --Sch D should list $3K annual loss.


Edit.
Also forgot to add tax-exempt dividends.
Last edited by dratkinson on Tue Jan 16, 2018 12:15 pm, edited 5 times in total.
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livesoft
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Re: Tax efficient investment [becoming more tax efficient]

Post by livesoft » Thu Mar 10, 2016 12:00 pm

Well maybe add "If possible" to that gem.
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grabiner
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Re: Tax efficient investment [becoming more tax efficient]

Post by grabiner » Thu Mar 10, 2016 8:59 pm

livesoft wrote:One thing you can do to improve tax-efficiency is look at your tax return. I always tell folks that their Schedule B should have less than $10 reported in the top half and the bottom half should have only qualified dividends and no non-qualified dividends. Also, their Schedule D should always have a net loss, so that -$3,000 get put on Form 1040 Line 13.
One exception: foreign-stock funds, which may give you as much back on Form 1116 as you lose in non-qualified dividends. This does apply to me; in my 28% tax bracket, the extra 13% tax on the non-qualified dividends is less than the foreign tax credit which is about 6% of the dividend yield.
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