Switching from mutual funds to ETFs for tax reasons?

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DaveM
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Switching from mutual funds to ETFs for tax reasons?

Post by DaveM » Mon Feb 10, 2020 9:14 pm

Long time lurker, first time poster! Hello!

I have a question about the tax benefits of ETFs. I currently have about $220k with Fidelity in a taxable brokerage account: $80k in a total stock market fund (FSKAX), $40k in a total international stock market fund (FTIHX), $100k in a total US bond market fund (FXNAX). The gains are relatively small at this point, about $20k in total. I pay a flat rate of 30% tax on all my capital gains. I invest about $3-4k every month in these three funds (mostly in the stocks funds) and intend to hold these investments for the foreseeable futures. My tax situation may improve in the future (i.e., move from 30% to less than 30%), so deferring tax is probably beneficial for that reason.

Based on the above, would it make sense for me to switch to ETFs for tax reasons, since my tax rate is, or seems, relatively high? As far as I can tell, Fidelity does not offer its own ETFs corresponding to my current holdings (I cannot move from Fidelity), so I assume there may be fees involved in buying ETFs from Vanguard or another issuer. I would probably not switch to ETFs if the tax benefits are not significant, so any sense of the amounts would be helpful. I appreciate any insights.

DaveM

lexor
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Re: Switching from mutual funds to ETFs for tax reasons?

Post by lexor » Mon Feb 10, 2020 9:37 pm

Fidelity offers no commission purchase of ETFs like VTI ITOT IXUS VXUS

Also see viewtopic.php?f=10&t=302611&p=5008563#p4995292
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Dale_G
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Re: Switching from mutual funds to ETFs for tax reasons?

Post by Dale_G » Mon Feb 10, 2020 11:17 pm

Dave, don't even think about it. Those large Fidelity stock index funds are unlikely to ever pay out any capital gains - absent some change in the law that would affect both ETFs and regular mutual funds.

We don't know anything about your tax rate or holdings in tax advantaged accounts, but I would be more concerned about taxes on your bond fund in the taxable account.

Dale
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lexor
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Re: Switching from mutual funds to ETFs for tax reasons?

Post by lexor » Mon Feb 10, 2020 11:57 pm

Dale_G wrote:
Mon Feb 10, 2020 11:17 pm
Dave, don't even think about it. Those large Fidelity stock index funds are unlikely to ever pay out any capital gains - absent some change in the law that would affect both ETFs and regular mutual funds.

We don't know anything about your tax rate or holdings in tax advantaged accounts, but I would be more concerned about taxes on your bond fund in the taxable account.

Dale
If this is true it could impact my analysis in my cost matters thread. Do you have a source?

My understanding is that there would be some capital gains distributions and while not massive, over the long run it makes the ETFs the better choice
“The miracle of compounding returns is overwhelmed by the tyranny of compounding costs.” -Mr. John C. Bogle

02nz
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Re: Switching from mutual funds to ETFs for tax reasons?

Post by 02nz » Tue Feb 11, 2020 12:06 am

Dale_G wrote:
Mon Feb 10, 2020 11:17 pm
Dave, don't even think about it. Those large Fidelity stock index funds are unlikely to ever pay out any capital gains - absent some change in the law that would affect both ETFs and regular mutual funds.
What makes you say that? Fidelity Total Market Index (FSKAX) paid out capital gains distributions as recently as April 2019.

What you say would be true of Vanguard's index funds, because of their ETF patent that allows them to "flush out" capital gains via ETFs that are a share class of the same fund. But it's not true of Fidelity.

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DaveM
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Re: Switching from mutual funds to ETFs for tax reasons?

Post by DaveM » Tue Feb 11, 2020 7:04 am

lexor wrote:
Mon Feb 10, 2020 9:37 pm
Fidelity offers no commission purchase of ETFs like VTI ITOT IXUS VXUS

Also see viewtopic.php?f=10&t=302611&p=5008563#p4995292
Thanks, lexor. Good to know regarding commissions. I will have to study your earliest post.
Dale_G wrote:
Mon Feb 10, 2020 11:17 pm
Dave, don't even think about it. Those large Fidelity stock index funds are unlikely to ever pay out any capital gains - absent some change in the law that would affect both ETFs and regular mutual funds.

We don't know anything about your tax rate or holdings in tax advantaged accounts, but I would be more concerned about taxes on your bond fund in the taxable account.
Thanks, Dale. This sounds reasonable. My tax rate is 30% for capital gains. I do not have any tax advantaged accounts (long story short, they seem unlikely to beneficial because I lack taxable income, except for my investments). Do you still think my bond holdings are concerning?

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Re: Switching from mutual funds to ETFs for tax reasons?

Post by stan1 » Tue Feb 11, 2020 8:14 am

DaveM wrote:
Tue Feb 11, 2020 7:04 am
Thanks, Dale. This sounds reasonable. My tax rate is 30% for capital gains. I do not have any tax advantaged accounts (long story short, they seem unlikely to beneficial because I lack taxable income, except for my investments). Do you still think my bond holdings are concerning?
If your capital gains tax rate is 30% and you have no earned income I'll assume you have investments well beyond the $220K in this account. In taxable accounts at your tax rate I would start by using a combination of national muni bond funds (exempt from federal tax), CA or NY muni bond funds if you are in either state (exempt from federal and state tax), and treasury bonds (exempt from state tax). Some equity dividends are taxed at a preferred rate for qualified dividends. Total Bond Market does not have any tax preferences. There can be other state by state variations.

Large taxable portfolios quickly get into a situation where they have to be assessed specifically to your situation and generic advice may or may not apply. I'd want to see what your entire portfolio looks like before saying $100K of total bond market is a concern. If you also have the muni bonds and treasury bonds or 3% plus Cds it might be reasonable.

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DaveM
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Re: Switching from mutual funds to ETFs for tax reasons?

Post by DaveM » Tue Feb 11, 2020 9:50 pm

stan1 wrote:
Tue Feb 11, 2020 8:14 am
If your capital gains tax rate is 30% and you have no earned income I'll assume you have investments well beyond the $220K in this account. In taxable accounts at your tax rate I would start by using a combination of national muni bond funds (exempt from federal tax), CA or NY muni bond funds if you are in either state (exempt from federal and state tax), and treasury bonds (exempt from state tax). Some equity dividends are taxed at a preferred rate for qualified dividends. Total Bond Market does not have any tax preferences. There can be other state by state variations.

Large taxable portfolios quickly get into a situation where they have to be assessed specifically to your situation and generic advice may or may not apply. I'd want to see what your entire portfolio looks like before saying $100K of total bond market is a concern. If you also have the muni bonds and treasury bonds or 3% plus Cds it might be reasonable.
Thanks, stan1. $220k is actually my entire account (unfortunately!). I appreciate your feedback, which gives me some ideas for alternative allocations. I should try to find tax advisor at some point, but it is probably not worth the money at this stage.

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grabiner
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Re: Switching from mutual funds to ETFs for tax reasons?

Post by grabiner » Tue Feb 11, 2020 9:57 pm

There is a worksheet on the wiki: Paying a tax cost to switch funds which you can use to estimate whether switching is worthwhile; you'll have to estimate the distributions from your Fidelity index funds.

If you don't switch, new investments and reinvested dividends should go to ETFs.

If your tax rate is 30% (non-resident alien?) you shouldn't be using the Fidelity Total US Bond Market Index now; you would be better off with municipal bonds. Fidelity doesn't have a low-cost muni fund, so you should use muni ETFs. If you drop to a lower tax rate, say 22% on non-qualified dividends, you can switch back.

If you are a non-resident alien, you should also see how your home country will tax your investments, either now or if you decide to move back.
Wiki David Grabiner

lexor
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Re: Switching from mutual funds to ETFs for tax reasons?

Post by lexor » Thu Feb 13, 2020 2:48 am

grabiner wrote:
Tue Feb 11, 2020 9:57 pm
Fidelity doesn't have a low-cost muni fund, so you should use muni ETFs.
Fidelity Municipal Bond Index Fund (FMBIX) is .07% ER

MUB is also .07%
VTEB is .08%
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Re: Switching from mutual funds to ETFs for tax reasons?

Post by samsoes » Fri Feb 14, 2020 6:03 am

OP, don't forget about dividend distributions. They are separate and distinct from capital gain distributions. Dividend distributions will be there regardless (ETF or MF).
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