Minimizing capital gains taxes when moving to low-cost funds?

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Tannhauser
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Minimizing capital gains taxes when moving to low-cost funds?

Post by Tannhauser » Thu Jul 13, 2017 1:02 pm

Hi everybody, thanks for reading this message.

I need to sell a bunch of high expense-ratio mutual funds (which my former financial advisor put me into) so that I can put that money into low-cost Vanguard funds. But I’m debating about when exactly I should sell, trying to understand the trade-offs between high ERs and capital gains taxes. I'm wondering what you would do in my situation.

Here’s a bit more info about that situation. I’m in the 25% income tax bracket now. I’m already FI, and expect to be retired in three years maximum. (I'm still working because my job is interesting.) When I retire, I expect to be in the 0% tax bracket for long-term capital gains.

I’ve provided below the list of funds I need to sell, their amounts, ERs, and unrealized capital gains. Do you think it makes more sense to sell sooner rather than later and pay the higher capital gains tax in order to get away from these high ERs? Or should I wait a couple years, put up with the high ERs, and sell when I won’t pay long-term capital gains?

Thanks very much for thinking about this. Any advice appreciated!


Fund ER Amount Unrealized cap gains
SGENX 1.10 $216k $65k
SGOVX 1.14 $90k $18k
FKINX .61 $18k $3k
HFCSX 1.50 $59k $11k

cap396
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Re: Minimizing capital gains taxes when moving to low-cost funds?

Post by cap396 » Thu Jul 13, 2017 2:00 pm

I'm no expert, but if you pay 15% tax on your unrealized gains, that would be $14,550. Your expenses for three years keeping your funds as-is would be $13,190. The two numbers are close, but (if my math is right), it would be slightly better to wait three years and then switch to the low-cost funds. Plus, if you make the switch now, the taxes you pay come out of the market sooner (and lose the potential to grow). The ER is spread out over three years, so at least some of that expense still have the potential to grow over the next three years (however if it does grow, then you're also paying more $$ in expenses).

Again, I'm no expert, but I think it wouldn't make a tremendous difference either way, with maybe a slight advantage to waiting until your tax bracket means paying 0% in capital gains.

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Re: Minimizing capital gains taxes when moving to low-cost funds?

Post by rkhusky » Thu Jul 13, 2017 2:37 pm

Or just sell the funds where the 3 year expense cost is clearly more than the CG cost. HFCSX and maybe SGOVX and maybe FKINX, just to simplify things.

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grabiner
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Re: Minimizing capital gains taxes when moving to low-cost funds?

Post by grabiner » Thu Jul 13, 2017 9:01 pm

rkhusky wrote:Or just sell the funds where the 3 year expense cost is clearly more than the CG cost. HFCSX and maybe SGOVX and maybe FKINX, just to simplify things.
If you bought the funds over a period of time, you can sell those shares with lower capital gains; you can get more money out of high-expense funds this way.
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Re: Minimizing capital gains taxes when moving to low-cost funds?

Post by LadyGeek » Thu Jul 13, 2017 9:17 pm

This thread is now in the Investing - Help with Personal Investments forum (portfolio help).
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Re: Minimizing capital gains taxes when moving to low-cost funds?

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Re: Minimizing capital gains taxes when moving to low-cost funds?

Post by ChicagoJon » Thu Jul 13, 2017 11:00 pm

My apologies if I should have assumed this outright, but are all these funds held in a taxable account? It's not explicitly stated in your post. I concur with Grabiner to sell off lots with minimal capital gains first. If taxable holdings use a cost basis other than Specific ID, then you have additional considerations to evaluate.

When I shifted my parent's portfolio over to Vanguard a few years back, I coupled capital losses in select lots with comparable gains in other funds, with the aim of "freeing up" the most dollars I could to move over to index funds. As opposed to prioritizing gain (or ER reduction) for any particular holding(s). Another consideration may be how concentrated your overall portfolio is in these holdings, and how diversified (apart from expense ratio) these holdings are compared to your desired portfolio/asset allocation. My parent's portfolio needed the broad diversity of index funds (Total Stock, Total Intl Stock, Total Bond, for example), since they previously had a high percentage of their portfolio in a relatively small quantity of holdings (individual stocks, sector funds, and MLPs).

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Re: Minimizing capital gains taxes when moving to low-cost funds?

Post by grabiner » Thu Jul 13, 2017 11:13 pm

cap396 wrote:I'm no expert, but if you pay 15% tax on your unrealized gains, that would be $14,550. Your expenses for three years keeping your funds as-is would be $13,190. The two numbers are close, but (if my math is right), it would be slightly better to wait three years and then switch to the low-cost funds.
The cost is higher than this, because the actively managed funds are likely to distribute capital gains in the three years you hold them.
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Tannhauser
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Re: Minimizing capital gains taxes when moving to low-cost funds?

Post by Tannhauser » Fri Jul 14, 2017 1:57 am

Yeah, these funds are in a taxable account. They represent about a quarter of my total portfolio. Almost all the remainder is already in index funds.

Good idea on looking at specific lots -- I'll see if I can implement that strategy.

Thanks everybody for your advice!

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Re: Minimizing capital gains taxes when moving to low-cost funds?

Post by Uniballer » Fri Jul 14, 2017 7:52 am

I would also look at tax efficiency to help you decide what to sell first or continue to hold. For example, FKINX is generating non-qualified dividends that are taxed as ordinary income (just saying).

Tannhauser
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Re: Minimizing capital gains taxes when moving to low-cost funds?

Post by Tannhauser » Sat Jul 15, 2017 4:20 am

Yeah, I've definitely got some tax efficiency things to sort out. Thanks for the reminder!

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Re: Minimizing capital gains taxes when moving to low-cost funds?

Post by GeraniumLover » Mon Dec 03, 2018 7:52 pm

I hope you unloaded Hennessey Focus (HFCSX) fund--they are estimating paying $13.92/shr in long term capital gain distributions this month!

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Re: Minimizing capital gains taxes when moving to low-cost funds?

Post by bradpevans » Mon Dec 03, 2018 10:04 pm

Tannhauser wrote:
Thu Jul 13, 2017 1:02 pm
Hi everybody, thanks for reading this message.

I need to sell a bunch of high expense-ratio mutual funds (which my former financial advisor put me into) so that I can put that money into low-cost Vanguard funds. But I’m debating about when exactly I should sell, trying to understand the trade-offs between high ERs and capital gains taxes. I'm wondering what you would do in my situation.

Here’s a bit more info about that situation. I’m in the 25% income tax bracket now. I’m already FI, and expect to be retired in three years maximum. (I'm still working because my job is interesting.) When I retire, I expect to be in the 0% tax bracket for long-term capital gains.

I’ve provided below the list of funds I need to sell, their amounts, ERs, and unrealized capital gains. Do you think it makes more sense to sell sooner rather than later and pay the higher capital gains tax in order to get away from these high ERs? Or should I wait a couple years, put up with the high ERs, and sell when I won’t pay long-term capital gains?

Thanks very much for thinking about this. Any advice appreciated!


Fund ER Amount Unrealized cap gains
SGENX 1.10 $216k $65k
SGOVX 1.14 $90k $18k
FKINX .61 $18k $3k
HFCSX 1.50 $59k $11k
Why wouldn’t you wait three years till you are in thrb0 LTCG bucket?

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grabiner
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Re: Minimizing capital gains taxes when moving to low-cost funds?

Post by grabiner » Mon Dec 03, 2018 11:11 pm

bradpevans wrote:
Mon Dec 03, 2018 10:04 pm
Tannhauser wrote:
Thu Jul 13, 2017 1:02 pm
Fund ER Amount Unrealized cap gains
SGENX 1.10 $216k $65k
SGOVX 1.14 $90k $18k
FKINX .61 $18k $3k
HFCSX 1.50 $59k $11k
Why wouldn’t you wait three years till you are in thrb0 LTCG bucket?
You have to work out the costs. The expenses plus capital gains over the next three years will probably be more than the gains due immediately. In addition, particularly if the market goes up over the next three years, the capital gain on selling the funds may increase enough that selling them all in 2022 will result in a large part of the gain being taxed at 15%.
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Re: Minimizing capital gains taxes when moving to low-cost funds?

Post by jalbert » Tue Dec 04, 2018 1:24 am

FKINX .61 $18k $3k
HFCSX 1.50 $59k $11k
I would be inclined to sell those two now and the other two when you stop working, unless there are high cost basis shares you may sell sooner. FKINX is tax-inefficient as mentioned above, and it’s gain is low. The $270 in ER and taxes on distributions from FKINX are roughly a break-even in comparison to the $450 in cap gains tax if you sell now.

HFCSX has a lot of concentration risk, and at the current price the ER for 3 years will cost you more than the taxes.

Be sure you are not reinvesting dividend or capital gains distributions for any of these, as you don’t want more of them.
Risk is not a guarantor of return.

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Re: Minimizing capital gains taxes when moving to low-cost funds?

Post by SRenaeP » Tue Dec 04, 2018 8:40 am

If you regularly make charitable contributions, start donating appreciated shares instead of cash. This will allow you to forgo any taxes on the gains.

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Re: Minimizing capital gains taxes when moving to low-cost funds?

Post by Taylor Larimore » Tue Dec 04, 2018 11:13 am

Minimizing capital gains taxes when moving to low-cost funds?
Tannhauser:

I cover this problem in The Bogleheads' Guide to the Three-Fund Portfolio:

1. Stop making contributions into unwanted and tax-inefficient securities.

2. Stop reinvesting distributions.

3. Determine the amount of gain or loss in each taxable security.

4. If any security has a loss, consider selling and taking the tax-loss benefit.

5. If any security has a profit, consider selling up to the amount of your losses (after being held for one year to benefit from the lower capital gains tax rate).

I hope this helps.

Best wishes.
Taylor
"Simplicity is the master key to financial success." -- Jack Bogle

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Re: Minimizing capital gains taxes when moving to low-cost funds?

Post by bradpevans » Tue Dec 04, 2018 7:13 pm

grabiner wrote:
Mon Dec 03, 2018 11:11 pm
bradpevans wrote:
Mon Dec 03, 2018 10:04 pm
Tannhauser wrote:
Thu Jul 13, 2017 1:02 pm
Fund ER Amount Unrealized cap gains
SGENX 1.10 $216k $65k
SGOVX 1.14 $90k $18k
FKINX .61 $18k $3k
HFCSX 1.50 $59k $11k
Why wouldn’t you wait three years till you are in thrb0 LTCG bucket?
You have to work out the costs. The expenses plus capital gains over the next three years will probably be more than the gains due immediately. In addition, particularly if the market goes up over the next three years, the capital gain on selling the funds may increase enough that selling them all in 2022 will result in a large part of the gain being taxed at 15%.
The OP said this:
Here’s a bit more info about that situation. I’m in the 25% income tax bracket now. I’m already FI, and expect to be retired in three years maximum. (I'm still working because my job is interesting.) When I retire, I expect to be in the 0% tax bracket for long-term capital gains.

Certainly at retirement there is more room in the 0% bucket (because the W2 income drops away)
I'd try to spread out the sales over multiple years

The ER is high .... but 0% LTCG vs 15% can cover those ERs

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Re: Minimizing capital gains taxes when moving to low-cost funds?

Post by grabiner » Tue Dec 04, 2018 10:51 pm

Taylor Larimore wrote:
Tue Dec 04, 2018 11:13 am
4. If any security has a loss, consider selling and taking the tax-loss benefit.

5. If any security has a profit, consider selling up to the amount of your losses (after being held for one year to benefit from the lower capital gains tax rate).
This pair of suggestions doesn't quite combine properly. If you sell for a loss, you can sell for an equal gain, either short-term or long-term, and pay no tax; long-term losses will cancel out short-term gains once they have cancelled all your long-term gains.

If your gains exceed your losses and you still want to sell, then you need to avoid paying taxes on long-term gains.
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Re: Minimizing capital gains taxes when moving to low-cost funds?

Post by Taylor Larimore » Tue Dec 04, 2018 11:01 pm

grabiner wrote:
Tue Dec 04, 2018 10:51 pm
Taylor Larimore wrote:
Tue Dec 04, 2018 11:13 am
4. If any security has a loss, consider selling and taking the tax-loss benefit.

5. If any security has a profit, consider selling up to the amount of your losses (after being held for one year to benefit from the lower capital gains tax rate).
This pair of suggestions doesn't quite combine properly. If you sell for a loss, you can sell for an equal gain, either short-term or long-term, and pay no tax; long-term losses will cancel out short-term gains once they have cancelled all your long-term gains.

If your gains exceed your losses and you still want to sell, then you need to avoid paying taxes on long-term gains.
Grabner:

How would you re-word my #4 and #5 suggestions?

Thank you and best wishes.
Taylor
"Simplicity is the master key to financial success." -- Jack Bogle

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Re: Minimizing capital gains taxes when moving to low-cost funds?

Post by grabiner » Wed Dec 05, 2018 12:08 am

Taylor Larimore wrote:
Tue Dec 04, 2018 11:01 pm
grabiner wrote:
Tue Dec 04, 2018 10:51 pm
Taylor Larimore wrote:
Tue Dec 04, 2018 11:13 am
4. If any security has a loss, consider selling and taking the tax-loss benefit.

5. If any security has a profit, consider selling up to the amount of your losses (after being held for one year to benefit from the lower capital gains tax rate).
This pair of suggestions doesn't quite combine properly. If you sell for a loss, you can sell for an equal gain, either short-term or long-term, and pay no tax; long-term losses will cancel out short-term gains once they have cancelled all your long-term gains.

If your gains exceed your losses and you still want to sell, then you need to avoid paying taxes on long-term gains.
Grabner:

How would you re-word my #4 and #5 suggestions?

Thank you and best wishes.
Taylor
4. If any security has a loss, consider selling it to take the tax-loss benefit.

5. Consider selling securities with moderate gains, because the tax cost will be low. If your capital gains would exceed your capital losses, don't let your short-term gains (on securities held one year or less) exceed your short-term losses. If that happens, hold onto securities with short-term gains until the gains become long-term, to take advantage of the lower rate on long-term gains.

6. If you plan to make large charitable donations, make them from securities with large long-term capital gains, rather than cash.
Wiki David Grabiner

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Taylor Larimore
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Re: Minimizing capital gains taxes when moving to low-cost funds?

Post by Taylor Larimore » Wed Dec 05, 2018 8:08 am

Grabiner:

Thank you for your quick reply.

If I later update my book, I'll incorporate your suggestion.

Best wishes.
Taylor
"Simplicity is the master key to financial success." -- Jack Bogle

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Re: Minimizing capital gains taxes when moving to low-cost funds?

Post by abuss368 » Thu Dec 06, 2018 8:12 pm

grabiner wrote:
Wed Dec 05, 2018 12:08 am
6. If you plan to make large charitable donations, make them from securities with large long-term capital gains, rather than cash.
I would add: Consider the possibility of making a charitable contribution directly from an IRA (up to $100,000). This may achieve the best of both worlds: 1) a possible deduction (if a taxpayer itemizes deductions and 2) excluding (up to $100,000) of income taxed at ordinary tax rates. An additional benefit is a reduction of the estate.
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Re: Minimizing capital gains taxes when moving to low-cost funds?

Post by grabiner » Thu Dec 06, 2018 11:24 pm

abuss368 wrote:
Thu Dec 06, 2018 8:12 pm
grabiner wrote:
Wed Dec 05, 2018 12:08 am
6. If you plan to make large charitable donations, make them from securities with large long-term capital gains, rather than cash.
I would add: Consider the possibility of making a charitable contribution directly from an IRA (up to $100,000). This may achieve the best of both worlds: 1) a possible deduction (if a taxpayer itemizes deductions and 2) excluding (up to $100,000) of income taxed at ordinary tax rates. An additional benefit is a reduction of the estate.
While this is a good idea (provided you are eligible; you must be at least 70-1/2), you don't get a double deduction.

The real advantages of a qualified charitable distribution are that it reduces your taxable income even if you don't itemize deductions, and it reduces your adjusted gross income, which may affect some phase-ins in the tax code such as Social Security taxation.

If neither of those is relevant (that is, you are itemizing deductions anyway, 85% of your Social Security will be taxed, and you aren't over the limit for deductible charitable contributions), then it is better to donate appreciated stock to charity and withdraw an equal amount from your IRA (buying stock if appropriate). The tax is the same as if you make the QCD, but you get rid of the unrealized capital gain.
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Re: Minimizing capital gains taxes when moving to low-cost funds?

Post by abuss368 » Fri Dec 07, 2018 9:35 am

grabiner wrote:
Thu Dec 06, 2018 11:24 pm
abuss368 wrote:
Thu Dec 06, 2018 8:12 pm
grabiner wrote:
Wed Dec 05, 2018 12:08 am
6. If you plan to make large charitable donations, make them from securities with large long-term capital gains, rather than cash.
I would add: Consider the possibility of making a charitable contribution directly from an IRA (up to $100,000). This may achieve the best of both worlds: 1) a possible deduction (if a taxpayer itemizes deductions and 2) excluding (up to $100,000) of income taxed at ordinary tax rates. An additional benefit is a reduction of the estate.
While this is a good idea (provided you are eligible; you must be at least 70-1/2), you don't get a double deduction.

The real advantages of a qualified charitable distribution are that it reduces your taxable income even if you don't itemize deductions, and it reduces your adjusted gross income, which may affect some phase-ins in the tax code such as Social Security taxation.

If neither of those is relevant (that is, you are itemizing deductions anyway, 85% of your Social Security will be taxed, and you aren't over the limit for deductible charitable contributions), then it is better to donate appreciated stock to charity and withdraw an equal amount from your IRA (buying stock if appropriate). The tax is the same as if you make the QCD, but you get rid of the unrealized capital gain.
That was the point I was trying to make (but perhaps I should have worded different). Correct - a taxpayer would not be able to report both an itemized deduction and exclusion from income.
John C. Bogle: "You simply do not need to put your money into 8 different mutual funds!" | | Disclosure: Three Fund Portfolio + U.S. & International REITs

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Re: Minimizing capital gains taxes when moving to low-cost funds?

Post by abuss368 » Fri Dec 07, 2018 9:44 am

grabiner wrote:
Thu Dec 06, 2018 11:24 pm
abuss368 wrote:
Thu Dec 06, 2018 8:12 pm
grabiner wrote:
Wed Dec 05, 2018 12:08 am
6. If you plan to make large charitable donations, make them from securities with large long-term capital gains, rather than cash.
I would add: Consider the possibility of making a charitable contribution directly from an IRA (up to $100,000). This may achieve the best of both worlds: 1) a possible deduction (if a taxpayer itemizes deductions and 2) excluding (up to $100,000) of income taxed at ordinary tax rates. An additional benefit is a reduction of the estate.
While this is a good idea (provided you are eligible; you must be at least 70-1/2), you don't get a double deduction.

The real advantages of a qualified charitable distribution are that it reduces your taxable income even if you don't itemize deductions, and it reduces your adjusted gross income, which may affect some phase-ins in the tax code such as Social Security taxation.

If neither of those is relevant (that is, you are itemizing deductions anyway, 85% of your Social Security will be taxed, and you aren't over the limit for deductible charitable contributions), then it is better to donate appreciated stock to charity and withdraw an equal amount from your IRA (buying stock if appropriate). The tax is the same as if you make the QCD, but you get rid of the unrealized capital gain.
Essentially in your example the difference is the taxpayer is achieving the same thing (i.e. charitable contribution & RMD) but avoiding capital gains taxes on appreciated securities.
John C. Bogle: "You simply do not need to put your money into 8 different mutual funds!" | | Disclosure: Three Fund Portfolio + U.S. & International REITs

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Re: Minimizing capital gains taxes when moving to low-cost funds?

Post by GeraniumLover » Mon Dec 10, 2018 9:17 am

On Friday Hennesey Focus Fund (HFCSX) paid a long-term capital gain distribution of $14.47031/shr with a reinvestment price of $67.71/shr. An unwelcome surprise but at least if you don't have distributions automatically reinvest, you can avoid paying the 1.5% ER on the distributed amount.

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