Feedback please on switching from VTSAX to a dividend fund for tax purposes. [Moving to Portugal]

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Portugal2023
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Joined: Wed Jul 21, 2021 2:56 pm

Feedback please on switching from VTSAX to a dividend fund for tax purposes. [Moving to Portugal]

Post by Portugal2023 »

Long time follower, first time poster. Thank you in advance for any insight that may be provided. We are moving to Portugal under the D7 visa and will be applying for the 10 year NHR tax regime. Currently all of our non-retirement assets are held in VTSAX. We are strong believers of the VTSAX approach and the only reason we are considering an alternative asset allocation is because under the NHR tax regime, dividends are not taxed for the first 10 years. In contrast, capital gains are taxed at 28%. We will be living 100% off of our investment portfolio and cash reserves. With that being said, does it make sense, for at least the first 5- 10 years to switch to SCHD or VYM to increase dividend payouts and avoid the 28% tax? (We will have enough of a cash cushion to solely withdrawal dividends and not touch the principal for at least 5 years). If we were not making this move, we would definitely stay with VTSAX because I believe the growth will be greater over time. I can’t wrap my head around figuring out out to calculate the 28% tax saved from dividend payoffs vs. the % in likely reduced growth overall in the portfolio by making the switch from VTSAX to SCHD or VYM. Can anyone help me figure this out? Our portfolio value will be around 1.3M at the time of the move. THank you again for your thoughts and feedback.
sycamore
Posts: 2482
Joined: Tue May 08, 2018 12:06 pm

Re: Feedback please on switching from VTSAX to a dividend fund for tax purposes. [Moving to Portugal]

Post by sycamore »

Hello Portugal2023, welcome!

I'm not sure how to calculate the answer, but here are some important questions to help move forward...

1) To confirm, you expect to have $1.3M in your taxable account invested in VTSAX?

2) How much do you expect to withdraw each year for spending? The less you need to withdraw overall, the less likely it is that switching from VTSAX to another dividend fund would make sense.

3) When you sell shares, some of the proceeds are simply a return of your basis, the rest is the capital gain (or even a loss). Does the NHR tax regime allow you to specify which shares you're selling ("Spec ID") or does it require/assume something like average cost basis, or maybe even require First In First Out share selection?

Point being, if you can select which shares you sell, and those shares have a high basis, that means a lower amount will be taxed as a gain.

4) Part of the calculation depends on the tax cost you bear upfront for selling VTSAX and buying the alternative SCHD or VYM. This tax cost depends on your current tax bracket. It could be 0%, 15%, or 20%. And maybe an additional 3.8% for the Net Investment Income Tax if your income is high enough. This upfront tax cost may be a high hurdle.

5) What are the current yields for VTSAX, SCHD, and VYM?

5a) Whatever yields are now, know that future dividend yields are unknown. They could go up or down by (I'm guessing) 10%, so you'll want to plan for getting an actual payout within a range like 1.8% to 2.2% (made-up numbers). If the dividends aren't as high as you want, plan to sell shares to cover the difference.

5b) VTSAX also distributes dividends... how much of its annual dividends (on 1.3M) cover your annual expenses? Any expenses not covered by dividends would have to come from selling shares, so how much per year might that be?

5c) The increased yield for SCHD and VYM may not be all that much, and thus not enough to overcome the upfront tax hurdle; and you might have to sell some shares anyway.
Topic Author
Portugal2023
Posts: 2
Joined: Wed Jul 21, 2021 2:56 pm

Re: Feedback please on switching from VTSAX to a dividend fund for tax purposes. [Moving to Portugal]

Post by Portugal2023 »

Sycamore, Thank you for taking your time to write such a detailed response! Much appreciated and the questions you posed are super helpful in my thinking through the analysis. My responses to the questions are below in blue.


1) To confirm, you expect to have $1.3M in your taxable account invested in VTSAX?

yes

2) How much do you expect to withdraw each year for spending? The less you need to withdraw overall, the less likely it is that switching from VTSAX to another dividend fund would make sense.

Approximately 30K for years 1-5 (we will have enough cash cushion to supplement during those years. Then, absent unforeseen circumstances, approximately 65K for years 5-10. (At that point we will no longer be under the NIF tax break for dividends and would switch back over to VTSAX

3) When you sell shares, some of the proceeds are simply a return of your basis, the rest is the capital gain (or even a loss). Does the NHR tax regime allow you to specify which shares you're selling ("Spec ID") or does it require/assume something like average cost basis, or maybe even require First In First Out share selection?

This is a great question but I do not know the answer to it. I will have to do some more research on this issue.

Point being, if you can select which shares you sell, and those shares have a high basis, that means a lower amount will be taxed as a gain.

4) Part of the calculation depends on the tax cost you bear upfront for selling VTSAX and buying the alternative SCHD or VYM. This tax cost depends on your current tax bracket. It could be 0%, 15%, or 20%. And maybe an additional 3.8% for the Net Investment Income Tax if your income is high enough. This upfront tax cost may be a high hurdle.

I was hoping to do an in-kind transfer from Vanguard to Schwab, and then choose SCHD as the ETF I’d be moving the money into. Would this eliminate the tax cost up front because we wouldn’t be selling, just transferring to a different brokerage? Or, maybe this isn’t even an option (perhaps an in-kind transfer would be only for holding VTAX at Vanguard to holding VTAX at Schwab?) Great question that obviously I need to know the answer to first.

5) What are the current yields for VTSAX, SCHD, and VYM?

VTSAX: 1.25%; SCHD: 2.81%; VYM: 2.82%

5a) Whatever yields are now, know that future dividend yields are unknown. They could go up or down by (I'm guessing) 10%, so you'll want to plan for getting an actual payout within a range like 1.8% to 2.2% (made-up numbers). If the dividends aren't as high as you want, plan to sell shares to cover the difference.

Good point, thank you.

5b) VTSAX also distributes dividends... how much of its annual dividends (on 1.3M) cover your annual expenses? Any expenses not covered by dividends would have to come from selling shares, so how much per year might that be?

Using Vanguard’s Dividend Calculator, it looks like VTSAX would distribute approximately $16,250 per year in dividends (at 1.3M), SCHD would distribute $36,540, and VYM would distribute $36,660. We have approximately a 20K per year cash cushion for years 1-5. So, the amount that would come from selling shares would be 50K - dividend distributions - 20K cash cushion per year.

5c) The increased yield for SCHD and VYM may not be all that much, and thus not enough to overcome the upfront tax hurdle; and you might have to sell some shares anyway.
You are 100% correct, especially if I am not able to do the in-kind transfer from VTSAX to SCHD or VYM like I thought I could do. If you have any insight in that possibility, please let me know. Our capital gains tax rate would be 15%.
sycamore
Posts: 2482
Joined: Tue May 08, 2018 12:06 pm

Re: Feedback please on switching from VTSAX to a dividend fund for tax purposes. [Moving to Portugal]

Post by sycamore »

Portugal2023, here's a quick reply on one thing. I'll have to think some more about how to estimate whether using SCHD/VYM could save money or not...
Portugal2023 wrote: Wed Jul 21, 2021 5:12 pm ...I was hoping to do an in-kind transfer from Vanguard to Schwab, and then choose SCHD as the ETF I’d be moving the money into. Would this eliminate the tax cost up front because we wouldn’t be selling, just transferring to a different brokerage? Or, maybe this isn’t even an option (perhaps an in-kind transfer would be only for holding VTAX at Vanguard to holding VTAX at Schwab?) Great question that obviously I need to know the answer to first.
You do want to do an in-kind transfer of VTSAX to Schwab but unfortunately you don't get to pick a different fund when you transfer; you have to keep the same fund. There's no way to get out of one fund and into a different fund without paying capital gains. That's just the nature of taxable account investing.

If you decide to keep some of your $1.3M in the Total Stock Market Fund you have two options:
1) Stick with the mutual fund VTSAX. I don't think Schwab imposes any transaction fee for selling but double check that at https://www.schwab.com/legal/schwab-pri ... -investors.

2) Before transferring assets to Schwab, you could convert VTSAX to its ETF equivalent VTI without incurring any capital gains. This only works because Vanguard has a patent that allows them to structure the Total Stock Market Fund to have multiple share classes (VTSAX is Admiral class, VTI is ETF class). You are allowed to convert from the mutual fund class to the ETF class, but not vice versa. It is not a taxable transaction, which is good. The conversion can only be done at Vanguard, not at any other brokerage. ETFs are far more "portable" than mutual funds, and most brokerages charge no transaction fee for buying or selling ETFs, so using VTI could be a good choice for the future.
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