Taxable account - tell me if my thinking is right on this.

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Topic Author
GaryA505
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Taxable account - tell me if my thinking is right on this.

Post by GaryA505 »

I currently have about a third of my retirement assets in my taxable account, and most of it is currently in VWAHX - Vanguard High-Yield Tax-Exempt Fund. The distribution on this has been about 3% even with today's low interest rates and I'm OK with that for now.

I would like to get to a 50/50 or maybe 60/40 AA in this account for the long term. VWAHX will lose it's attractiveness when SS starts because the federal tax-free income will still increase the percentage of my SS that gets taxed. The simplest solution would be to sell the VWAHX and buy 50% Total Stock and 50% Total Bond. Unfortunately the VWAHX holdings have about $12000 of long-term cap gains that would be taxed immediately upon the sale. So, I'm thinking of easing into the 50/50 AA over a few years to spread out the tax hit.

Current tax bracket is 24% and I expect to be in the 22% bracket after retirement.
I am not going to be allocating across taxable/deferred accounts.

Some options here:
1. Sell 100% of the VWAHX and buy 50% Total Stock and 50% Total Bond.
2. Sell 100% of the VWAHX and buy VBIAX (Vanguard Balanced).
3. Sell 100% of the VWAHX and buy VTMFX (Vanguard Tax-managed).
4. Sell 50% of the VWAHX and buy 50% Total Stock, leaving the other 50% of VWAHX alone.
For any of these, I can spread the sell/buy over a few years to spread the tax hit.

Assume no new money going into this account, and a 3% withdrawal rate.

Does anyone have any other ideas? Am I thinking about this right? I am not going to be allocating across taxable/deferred accounts so let's not go there, OK?
Get most of it right and don't make any big mistakes. All else being equal, simpler is better. Simple is as simple does.
sport
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Re: Taxable account - tell me if my thinking is right on this.

Post by sport »

If you make charitable donations, donate appreciated shares rather than cash. This escapes the CG tax. You can then invest the cash you otherwise would have donated. It is also better from a tax standpoint to have bonds in your tax deferred account and stock in taxable.
sycamore
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Re: Taxable account - tell me if my thinking is right on this.

Post by sycamore »

GaryA505 wrote: Tue Apr 13, 2021 1:42 pm Does anyone have any other ideas? Am I thinking about this right? I am not going to be allocating across taxable/deferred accounts so let's not go there, OK?
Here's my thought process:

You want to switch from VWAHX that distributes $X/year to some other option that distribute $Y/year.

Either $X or $Y increases your overall income, thereby exposing more of your SS income to taxes. Whether $X or $Y is worse in that respect depends on the option. And it may change over time.

Also, the federal tax-free nature of $Y depends the specific option.

And the risk is not equal among the various options.

Can you spreadsheet/model how much you'll save in taxes with each option?

Figuring out which option is best (financially) is complicated and not so clear-cut.

Maybe switching from VWAHX isn't really necessary?

This makes me want to go back to the Investment Policy Statement and see what it says.

I think the most important thing is to follow your risk tolerance / asset allocation plan. Going from tax-free munis to 60/40 stocks/bonds (for 1/3 of your assets) could result in a big switch. Is that okay?

For what it's worth, to get equivalent portfolio volatility of VWAHX in stocks/bonds, you'd want about 30/70 VTSAX/VBTLX.

Did you want tax-free munis only because of their tax advantage or were there other reasons?
Topic Author
GaryA505
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Location: New Mexico

Re: Taxable account - tell me if my thinking is right on this.

Post by GaryA505 »

error - deleted
Last edited by GaryA505 on Tue Apr 13, 2021 3:29 pm, edited 1 time in total.
Get most of it right and don't make any big mistakes. All else being equal, simpler is better. Simple is as simple does.
Topic Author
GaryA505
Posts: 2909
Joined: Wed Feb 08, 2017 1:59 pm
Location: New Mexico

Re: Taxable account - tell me if my thinking is right on this.

Post by GaryA505 »

sycamore wrote: Tue Apr 13, 2021 2:56 pm
GaryA505 wrote: Tue Apr 13, 2021 1:42 pm Does anyone have any other ideas? Am I thinking about this right? I am not going to be allocating across taxable/deferred accounts so let's not go there, OK?
Here's my thought process:

You want to switch from VWAHX that distributes $X/year to some other option that distribute $Y/year.

Either $X or $Y increases your overall income, thereby exposing more of your SS income to taxes. Whether $X or $Y is worse in that respect depends on the option. And it may change over time.

Also, the federal tax-free nature of $Y depends the specific option.

And the risk is not equal among the various options.

Can you spreadsheet/model how much you'll save in taxes with each option?

Figuring out which option is best (financially) is complicated and not so clear-cut.

Maybe switching from VWAHX isn't really necessary?

This makes me want to go back to the Investment Policy Statement and see what it says.

I think the most important thing is to follow your risk tolerance / asset allocation plan. Going from tax-free munis to 60/40 stocks/bonds (for 1/3 of your assets) could result in a big switch. Is that okay?

For what it's worth, to get equivalent portfolio volatility of VWAHX in stocks/bonds, you'd want about 30/70 VTSAX/VBTLX.

Did you want tax-free munis only because of their tax advantage or were there other reasons?
I would love to spreadsheet these options to see the tax results, if I knew how.

Yes, I would like to increase my allocation to stocks to between 40% and 60%, so 50% is fine with me.

I only hold the tax-free munis because of their tax advantage for now, but much of advantage that is lost when I start SS.

I'm familiar with the equivalence of VWAHX to 30/70 VTSAX/VBTLX. Until I start SS (in a few months) the risk/reward of VWAHX is still attractive to me. Actually, if you use VWALX and VTSMX/VBMFX you can get more history, and the equivalence looks like it's closer to 25/75 or even 20/80.

At this time I'm thinking about selling off the VWAHX gradually and buying VTSAX. To help the change in allocation along a bit, I can sell 3% VWALX annually for my planned withdrawal.

I want a simple AA in the end, with 1 or 2 funds only. There are really 3 questions here:
1. How to sell off the VWAHX to minimize/spread the tax hit, and how much of the VWAHX to sell each year.
3. What to buy with the cash from the sale of the VWAHX.
If I am going to VBIAX, I have to sell off all of the VWAHX so I have to pay all of the cap gains tax.
If I am going to VTMFX, I have to sell off all of the VWAHX so I have to pay all of the cap gains tax.
If I am going to VTSAX/VBTLX (maybe 50/50), I have to sell off all of the VWAHX so I have to pay all of the cap gains tax.
If I am going to VTSAX/VWAHX (maybe 30/70), I have to sell off less of the VWAHX so I will have less cap gains tax (for now).

Going forward, the VTSAX/VBTLX and VTSAX/VWAHX combos would probably be slightly more tax efficient then VBIAX or VTMFX, but the single fund solution is nice to have. I'm not too worried about balancing the VTSAX/VBTLX or VTSAX/VWAHX combos, since I plan to withdraw 3% per year I can just sell off whichever is higher.
Get most of it right and don't make any big mistakes. All else being equal, simpler is better. Simple is as simple does.
Topic Author
GaryA505
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Location: New Mexico

Re: Taxable account - tell me if my thinking is right on this.

Post by GaryA505 »

Maybe the simplest solution is to go for about 40/60 of VTSAX/VWAHX. This combo has acted a lot like 50/50 VTSAX/VBTLX in the past.

1. Use the 10% cash in this account to buy VTSAX (Total Stock).
2. Over the next few years (maybe 2-5), sell off another 30% of the VWAHX to buy VTSAX.

Done.
Get most of it right and don't make any big mistakes. All else being equal, simpler is better. Simple is as simple does.
sycamore
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Joined: Tue May 08, 2018 12:06 pm

Re: Taxable account - tell me if my thinking is right on this.

Post by sycamore »

Back of the envelope tax estimates:

Assumes:
1) Fed income tax rate of 22%, qualified divided rate of 15%
2) State tax doesn't matter (much)
3) VWAHX roughly equivalent to 30/70 split of VTSAX/VBTLX
4) Your non-SS income is high enough that 85% of your SS income is taxable

VWAHX distribution yield lately is 3.0%, SEC yield 1.8%
VTSAX SEC yield 1.28%
VBTLX distribution yield lately is 1.92%, SEC yield 1.33%

Current plan: for $100k VWAHX, that's $3000 in distributions, $0 in fed tax
Tax on SS of 85% of $3000 = $561
Total tax = $561

Proposed plan:
For $30k VTSAX, that's $384 in distributions, $57.6 in dividend tax. Tax on SS of 85% of $384 = $71.81
For $70k VBTLX, that's $1344 in distributions, $295.68 in income tax. Tax on SS of 85% of $384 = $251.33
Total tax = $676.42

By switching from VWAHX to 30/70 VTSAX/VBTLX you'd be paying $115 more per $100k invested.
You do pay less in SS tax BUT the tax on your taxable distributions outweighs the difference.


Using SEC yield of distribution yield for VWAHX and VBTLX, the same story holds; although you get less $ in distributions in both cases, the drop in yield is greater with VWAHX (than VBTLXH's drop) so the comparison looks a bit worse.

Also, the above doesn't account for cap gains tax for selling VWAHX.

This is all back of the envelope math; I'm not super familiar with taxation on SS income. Best idea is to use a tax calculator like https://www.mortgagecalculator.org/calc ... ulator.php to compare the two scenarios.
Topic Author
GaryA505
Posts: 2909
Joined: Wed Feb 08, 2017 1:59 pm
Location: New Mexico

Re: Taxable account - tell me if my thinking is right on this.

Post by GaryA505 »

sycamore wrote: Wed Apr 14, 2021 5:28 am Back of the envelope tax estimates:

Assumes:
1) Fed income tax rate of 22%, qualified divided rate of 15%
2) State tax doesn't matter (much)
3) VWAHX roughly equivalent to 30/70 split of VTSAX/VBTLX
4) Your non-SS income is high enough that 85% of your SS income is taxable

VWAHX distribution yield lately is 3.0%, SEC yield 1.8%
VTSAX SEC yield 1.28%
VBTLX distribution yield lately is 1.92%, SEC yield 1.33%

Current plan: for $100k VWAHX, that's $3000 in distributions, $0 in fed tax
Tax on SS of 85% of $3000 = $561
Total tax = $561

Proposed plan:
For $30k VTSAX, that's $384 in distributions, $57.6 in dividend tax. Tax on SS of 85% of $384 = $71.81
For $70k VBTLX, that's $1344 in distributions, $295.68 in income tax. Tax on SS of 85% of $384 = $251.33
Total tax = $676.42

By switching from VWAHX to 30/70 VTSAX/VBTLX you'd be paying $115 more per $100k invested.
You do pay less in SS tax BUT the tax on your taxable distributions outweighs the difference.


Using SEC yield of distribution yield for VWAHX and VBTLX, the same story holds; although you get less $ in distributions in both cases, the drop in yield is greater with VWAHX (than VBTLXH's drop) so the comparison looks a bit worse.

Also, the above doesn't account for cap gains tax for selling VWAHX.

This is all back of the envelope math; I'm not super familiar with taxation on SS income. Best idea is to use a tax calculator like https://www.mortgagecalculator.org/calc ... ulator.php to compare the two scenarios.
Wow, thanks! That's just what I needed.

It's possible that I could be at the top of the 12% tax bracket so that would change things a little but probably not enough to consider.
Get most of it right and don't make any big mistakes. All else being equal, simpler is better. Simple is as simple does.
Topic Author
GaryA505
Posts: 2909
Joined: Wed Feb 08, 2017 1:59 pm
Location: New Mexico

Re: Taxable account - tell me if my thinking is right on this.

Post by GaryA505 »

A couple of things I realized/discovered since I first posted:
1. My current tax bracket is 22% and my expected tax bracket in retirement is 12%. That's a big difference between what I initially thought (24% now and 22% retired), especially when it comes to cap gains tax rates.
2. Changes in my taxable account (sell and buy) at this time would cost me significant cap gains taxes. Assuming I am in the 12% tax bracket (0% on cap gains) in retirement, the same changes may not cost anything at all.
Get most of it right and don't make any big mistakes. All else being equal, simpler is better. Simple is as simple does.
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