Improving Brokerage Tax Efficiency

[MattyRolls]

Hello Bogleheads,

I came into a 6 figure sum of money due to a life insurance payout ~7 years ago (Low 6 figures). I put a large portion of that into my Vanguard brokerage account and invested the majority in the 2055 Target Date fund (VFFVX) and ~1/3 a total market fund (VTSAX).

I know now that I should have put that into a total market ETF or S&P 500 ETF to be more tax efficient. The account has made substantial gains over the last few years.

Additionally, VFFVX has caused me problems in the past come tax time with a larger than expected bill due to dividend payouts.

Vanguard will allow me to exchange all my shares of VFFVX and buy VTSAX. I will adjust my holdings in tax deferred accounts to rebalance my allocation of bonds as well.

I know this isn't ideal, but with the lower expense ratio and lesser tax implications, would this be advisable? Will this generate a taxable event I will have to pay come April 2026? I assume the tax implications would be much worse if I sold my mutual funds and purchased the comparable ETFs through Vanguard.

Any advise is much appreciated, thank you!

[steadyosmosis]

Hello Bogleheads,

I came into a 6 figure sum of money due to a life insurance payout ~7 years ago (Low 6 figures). I put a large portion of that into my Vanguard brokerage account and invested the majority in the 2055 Target Date fund (VFFVX) and ~1/3 a total market fund (VTSAX).

I know now that I should have put that into a total market ETF or S&P 500 ETF to be more tax efficient. The account has made substantial gains over the last few years.

Additionally, VFFVX has caused me problems in the past come tax time with a larger than expected bill due to dividend payouts.

Vanguard will allow me to exchange all my shares of VFFVX and buy VTSAX. I will adjust my holdings in tax deferred accounts to rebalance my allocation of bonds as well.

I know this isn't ideal, but with the lower expense ratio and lesser tax implications, would this be advisable? Will this generate a taxable event I will have to pay come April 2026? I assume the tax implications would be much worse if I sold my mutual funds and purchased the comparable ETFs through Vanguard.

Any advise is much appreciated, thank you!

Use tax software (or pen and paper) to determine your tax cost to make the move(s).
(You also asked about this in February 2022.)

[retired@50]

I know this isn't ideal, but with the lower expense ratio and lesser tax implications, would this be advisable? Will this generate a taxable event I will have to pay come April 2026? I assume the tax implications would be much worse if I sold my mutual funds and purchased the comparable ETFs through Vanguard.

Any advise is much appreciated, thank you!

Yes, an exchange from the target date fund (VFFVX) to the stock fund would be a taxable event. Depending on the size of the capital gain, it may require an estimated tax payment to the IRS and possibly to your state in the quarter in which the gain is recognized.

For more details around this see the wiki page on paying a tax cost to switch funds.
https://www.bogleheads.org/wiki/Paying_ ... itch_funds

Regards,

[MattyRolls]

Thank you for your replies. It sounds like the best course of action may be just to leave these investments where they are.

I'm not sure the potential tax bill generated by exchanging funds is worth the savings in expense ratio/dividend distributions.

[stan1]

Thank you for your replies. It sounds like the best course of action may be just to leave these investments where they are.

I'm not sure the potential tax bill generated by exchanging funds is worth the savings in expense ratio/dividend distributions.

That's why people are recommending you track the gains and losses by lot. The details matter such as when you bought this. You probably would not want to sell as is, but if there are market declines over the coming months and years there could be opportunities to reset without paying long term capital gains taxes on it.

For example, is most of the $500K+ made in one purchase (such as after a windfall) or have you been buying $10K per month for years? That's the level of detail to look at if you want to optimize this. I'd say its optional, but I also have seen that tax loss harvesting helps people stay the course through market declines. It gives people something to do that they feel is helpful rather than focusing on losses.

[Walkure]

Thank you for your replies. It sounds like the best course of action may be just to leave these investments where they are.

I'm not sure the potential tax bill generated by exchanging funds is worth the savings in expense ratio/dividend distributions.

Leaving as-is is not the best course of action. It's just the most inertial.

You should take the following steps, in this order:

1. Change your basis to SpecID.
2. Turn off all automatic capital gains and dividend reinvestment.
3. Tax loss harvest any shares of the target date fund that currently show losses - should be easy with the recent downturn to find a few, at a minimum anything from December's distributions should be a short-term loss. Make sure to replace the shares with a broad index market fund with low tax drag that you would be okay with holding for the long haul.
4. Once you have done this, reevaluate what it would take to sell off the rest of the target date shares. Remember that it's not an all or nothing thing, you can knock off a piece each year to spread out the tax bite.

[sycamore]

Thank you for your replies. It sounds like the best course of action may be just to leave these investments where they are.

I'm not sure the potential tax bill generated by exchanging funds is worth the savings in expense ratio/dividend distributions.

Leaving as-is is not the best course of action. It's just the most inertial.

You should take the following steps, in this order:

1. Change your basis to SpecID.
2. Turn off all automatic capital gains and dividend reinvestment.
3. Tax loss harvest any shares of the target date fund that currently show losses - should be easy with the recent downturn to find a few, at a minimum anything from December's distributions should be a short-term loss. Make sure to replace the shares with a broad index market fund with low tax drag that you would be okay with holding for the long haul.
4. Once you have done this, reevaluate what it would take to sell off the rest of the target date shares. Remember that it's not an all or nothing thing, you can knock off a piece each year to spread out the tax bite.

+1

Also,
5. Donate some shares to a charity & take a tax deduction (assuming you can itemize). Use the "bunching" technique for larger-than-usual donation along with property tax or other deductible expenses, to maximize the tax benefit in a single year. By donating shares you reduce the amount of unwanted div & CG distributions going forward.

Current tax law says we go back to the prior tax system (lower standard deduction) for 2026 so it may be easier to deduct in 2026 than 2025.

[retiredjg]

You brought up a similar discussion 3 years ago and apparently didn't follow through with getting rid of the target fund. Now it is bothering you again. Maybe it is time to make a different decision?

It appears you are in your late 30's. You can either fix this or keep being bothered by it for another 30 to 50 years. Which seems better to you? Or maybe the question should be "which seems worse"?

Some people will do almost anything to avoid taxes. If that applies to you, it might be helpful if you could re-evaluate your feelings about taxes. Paying taxes simply means you have made money. There is nothing bad about that. In this case, if you decide to take care of this now, you will not be bothered by the problem in the future and you will also save money on taxes each year if you make better choices about what to hold in taxable.

It does not all have to happen at one time. It can happen over a few years if necessary. And some of those shares might be gotten rid of by charitable giving instead of giving cash.

Just how big is the unrealized capital gain on this holding?