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ACA Strategy for taxable account during ER
Old 03-14-2013, 10:20 AM   #1
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ACA Strategy for taxable account during ER

Next year I intent to ER and spend down my taxable investments (starting with 1.3M at age 58) until I need to take SS, then draw down taxed advantage funds.

I am considering moving my taxable funds, which now have a dividend leaning, to stocks like BRK which has a good growth record, but pays no dividend. My goal is to minimize taxable income, while growing my taxable nest egg at a S&P 500 like growth rate in order to maximize the ACA credit. Perhaps changing the broker account to "reinvest dividends" would also be a way? Never did my own taxes.

Anyone considering such a move, see a flaw, or a better way?

PS: I see Kff.org has a new map Mapping the Effects of the ACA's Health Insurance Coverage Expansions - Kaiser Health Reform
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Old 03-14-2013, 11:11 AM   #2
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Toolman,
A lot depends on your tax bracket. If your taxable income puts you into the 15% bracket or below ($72,500 for MFJ, $36,250 if filing single), then your capital gains and taxes on qualified dividends in your taxable account would be the same: zero. Remember, those income levels are after subtracting out your deductions and exemptions, so your actual income can be quite a bit higher than that and you'd still pay zero on your capital gains.

That ACA subsidy is attractive, but be sure to look at the whole picture.
-- Will any expected lower investment return due to changes in your investments outweigh the ACA subsidies? I'm assuming you'd already be in these low-dividend funds today if you throught they'd have higher overall returns, so any changes will lower your expected returns.
-- You're probably as healthy as you are going to get. Will you be satisfied with the quality of life you can buy with low withdrawal rates at the outset of your retirement? That's what it often takes to reduce taxable income.
-- Selling funds now to buy equities with lower dividends will be a taxable event (that is, you'll be taxed on the gains in those assets). If you are working now, it's possible you'll be in a higher tax bracket now than you'd be in if you wait until you retire.
-- Stocks paying dividends can be a welcome stabilizing influence in a portfolio during market downturns. Your proposed changes will alter your portfolio more toward growth than toward value (and income): Right at the time you'll have an ongoing need for monthly income.
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Old 03-14-2013, 11:18 AM   #3
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Quote:
Originally Posted by TOOLMAN View Post
Next year I intent to ER and spend down my taxable investments (starting with 1.3M at age 58) until I need to take SS, then draw down taxed advantage funds.

I am considering moving my taxable funds, which now have a dividend leaning, to stocks like BRK which has a good growth record, but pays no dividend. My goal is to minimize taxable income, while growing my taxable nest egg at a S&P 500 like growth rate in order to maximize the ACA credit. Perhaps changing the broker account to "reinvest dividends" would also be a way? Never did my own taxes.

Anyone considering such a move, see a flaw, or a better way?

PS: I see Kff.org has a new map Mapping the Effects of the ACA's Health Insurance Coverage Expansions - Kaiser Health Reform
I don't understand how shifting them into low (or no) dividend investments will help if you are looking to spend down the taxable accounts. Does the dividend income exceed your spending plans for the period until you begin SS and drawing on the tax deferred accounts?
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Old 03-14-2013, 11:21 AM   #4
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Originally Posted by TOOLMAN View Post
My goal is to minimize taxable income, while growing my taxable nest egg at a S&P 500 like growth rate in order to maximize the ACA credit. Perhaps changing the broker account to "reinvest dividends" would also be a way? Never did my own taxes.
If I understand you right, you are considering telling your broker to "reinvest" in order to keep income down so that you have a more favorable number to get the ACA credit?

Well, turning on "reinvest" should have zero impact on your taxes. Doesn't matter. It is still reported as dividend income for tax purposes. You will create more future paperwork by buying more securities frequently. ... Basically, I don't think you want to do that.
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Old 03-14-2013, 11:37 AM   #5
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If I understand you right, you are considering telling your broker to "reinvest" in order to keep income down so that you have a more favorable number to get the ACA credit?

Well, turning on "reinvest" should have zero impact on your taxes. Doesn't matter. It is still reported as dividend income for tax purposes. You will create more future paperwork by buying more securities frequently. ... Basically, I don't think you want to do that.
I have never reinvested the dividends in order as to keep my cost basis simple.
Seems that I should not change as there is no tax benefit.

Thanks
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Old 03-14-2013, 11:44 AM   #6
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FWIW I retired last year and am doing the same as you plan - living off my taxable investments which are all in stock funds so my taxable income is principally dividend income from these funds and any capital gains from my taxable account. My federal income tax bill for last year was zero since my total income was within the 15% bracket (by design I limited my capital gains to stay in the 15% bracket).

Since dividend income is taxed at 0% if you stay within the 15% tax bracket (~$70k of taxable income for MFJ) I see no need to redo your taxable investments unless you will be over the 15% bracket once you retire. You can check by looking at this year's tax return and adjusting it for changes once you are in retirement (no wages, etc.)

I had to pay income taxes for state since my capital gains exceeded the state exclusion.

I was a bit miffed that my federal taxes were nil but I still had to pay state income taxes, but I'm over it.
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Old 03-14-2013, 12:04 PM   #7
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I don't understand how shifting them into low (or no) dividend investments will help if you are looking to spend down the taxable accounts. Does the dividend income exceed your spending plans for the period until you begin SS and drawing on the tax deferred accounts?
My plan to drawn from taxable assets, starts at 75k/yr (current expenses) and ramps up to 150k/yr. Starting with 1.3M, I expect I will use all the dividen income + draw down some from the principle. My expected dividend income would put me in the 15% tax bracket. I understand from another reply that divided income is not taxable in this bracket, but it is income ... and will effect the ACA credit?

An alternative I was considering; move all 1.3M to BRK-B, then my income would be $0.00 which would maximize ACA credits. I expect there must be a catch to this strategy

PS: I have spent my working days making money, now I need to learn about taxes.
Working for the man I was told by my CPA I had very little options to reduce my taxes.
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Old 03-14-2013, 12:16 PM   #8
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Originally Posted by TOOLMAN View Post
My plan to drawn from taxable assets, starts at 75k/yr (current expenses) and ramps up to 150k/yr. Starting with 1.3M, I expect I will use all the dividen income + draw down some from the principle. My expected dividend income would put me in the 15% tax bracket. I understand from another reply that divided income is not taxable in this bracket, but it is income ... and will effect the ACA credit?

An alternative I was considering; move all 1.3M to BRK-B, then my income would be $0.00 which would maximize ACA credits. I expect there must be a catch to this strategy

PS: I have spent my working days making money, now I need to learn about taxes.
Working for the man I was told by my CPA I had very little options to reduce my taxes.
Yes, even though the dividend income is not taxable it does count for ACA. But the thing to think through is whether that dividend income (and capital gains as you are cashing out taxable accounts) will exceed 400 FPL. If it does, then you have an issue to deal with. If not, then not.

I don't know if I would move it all into one stock. A domestic tax managed equity fund might be better as it would provide more diversification.

Actually, that makes it even more important for me to take capital gains in 2013 while I am still subject to 0% gains to increase my basis so I can manage my income to be less than 400 FPL in 2014.
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Old 03-14-2013, 12:43 PM   #9
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FWIW I retired last year and am doing the same as you plan - living off my taxable investments which are all in stock funds so my taxable income is principally dividend income from these funds and any capital gains from my taxable account. My federal income tax bill for last year was zero since my total income was within the 15% bracket (by design I limited my capital gains to stay in the 15% bracket).

Since dividend income is taxed at 0% if you stay within the 15% tax bracket (~$70k of taxable income for MFJ) I see no need to redo your taxable investments unless you will be over the 15% bracket once you retire. You can check by looking at this year's tax return and adjusting it for changes once you are in retirement (no wages, etc.)

I had to pay income taxes for state since my capital gains exceeded the state exclusion.

I was a bit miffed that my federal taxes were nil but I still had to pay state income taxes, but I'm over it.
This is/was my plan, I did have an unexpected distribution in Dec 2012, which made me pay $7 in Fed, .01% effective tax rate.
But got thrown a cancer curve ball and decided to take SS immediately. Ms G and I have decided to pretty much stay with our grandfathered BCBS, until I hit 65 and Medicare. The market has done so well, that even though I took every nickel of LTCG in 2012 as I have in my plan, every year I have had some. It looks like with SS I may top the chart this year. But we still have 8 months to do the Black Swan dive. So I am not letting the HC thing make tax decisions for me.
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Old 03-14-2013, 12:50 PM   #10
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What is "the Black Swan dive"
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Old 03-14-2013, 12:57 PM   #11
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What is "the Black Swan dive"
I guess a dive in the stock market is really expected.


From Wikipedia

The black swan theory or theory of black swan events is a metaphor that describes an event that is a surprise (to the observer), has a major effect, and after the fact is often inappropriately rationalized with the benefit of hindsight.

The theory was developed by Nassim Nicholas Taleb to explain:

The disproportionate role of high-profile, hard-to-predict, and rare events that are beyond the realm of normal expectations in history, science, finance, and technology
The non-computability of the probability of the consequential rare events using scientific methods (owing to the very nature of small probabilities)
The psychological biases that make people individually and collectively blind to uncertainty and unaware of the massive role of the rare event in historical affairs
Unlike the earlier philosophical "black swan problem," the "black swan theory" refers only to unexpected events of large magnitude and consequence and their dominant role in history. Such events, considered extreme outliers, collectively play vastly larger roles than regular occurrences.[1]
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Old 03-14-2013, 01:21 PM   #12
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Gotcha.

I plan to limit my income/capital gains to fall under 400 FPL in 2014 (tentatively ~$62k for a couple). If you exceed 400 FPL but stay within the 15% tax bracket to take advantage of the 0% qualified dividends/capital gains rate, the loss of the HC subsidy is a pretty significant economic "tax" on that income.

If I have $62k of income then I would get a subsidy of $14.8k. If I have $63k or more of income the subsidy goes away. If I go to the top of the 15% bracket I would have ~$90k of income. So while I would pay no federal income tax on the additional $28k of income I would lose the subsidy, so the economic cost of the additional $28k of income is $14.8k or a 52.8% "cost". Too much.

YMMV and the numbers above are broad, but I believe indicative, estimates.
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Old 03-14-2013, 03:12 PM   #13
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An alternative I was considering; move all 1.3M to BRK-B, then my income would be $0.00 which would maximize ACA credits. I expect there must be a catch to this strategy
The catch is that you can't "move" it to BRK-B--or anywhere else. If it is invested in stocks (or MFs/ETFs) now, then you have to sell them to invest the funds in BRK-B (or anything else). When you sell them, you'll have taxes due on the gains unless you are in the 15% bracket or lower. And all the gains will be income for purposes of the ACA.
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Old 03-14-2013, 03:54 PM   #14
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I plan to limit my income/capital gains to fall under 400 FPL in 2014 (tentatively ~$62k for a couple). If you exceed 400 FPL but stay within the 15% tax bracket to take advantage of the 0% qualified dividends/capital gains rate, the loss of the HC subsidy is a pretty significant economic "tax" on that income.
pb4uski, may I ask a question, are you using any LTGC as income, or do you just re buy and step up your basis. I have all kinds of ways to avoid income up to the 15% bracket. In talks with the boss, Ms G just says stay with the plan, we don't know the future.
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Old 03-14-2013, 04:00 PM   #15
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pb4uski, may I ask a question, are you using any LTGC as income, or do you just re buy and step up your basis. I have all kinds of ways to avoid income up to the 15% bracket. In talks with the boss, Ms G just says stay with the plan, we don't know the future.
For now, I am mostly just selling for taxable gains at 0% and rebuying and stepping up my basis. I have another liquidity bucket in an online savings account/ST bond fund that I am currently using for living expenses. I hope to have very little unrealized gains in my taxable accounts going into 2014 so as I draw for living expenses I won't be creating income so I can stay under 400 FPL.

OTOH, too much in unrealized gains is a nice problem to have.
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Old 03-14-2013, 04:17 PM   #16
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pb4uski, one more question if I could you seem so knowledgeable about ACA. Does it help to stay well below the 400 FPL, say around the 200 FPL, if I have BCBS for both at
10K annually and Medicare for me only in 3 years?

david
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Old 03-14-2013, 10:11 PM   #17
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pb4uski, one more question if I could you seem so knowledgeable about ACA. Does it help to stay well below the 400 FPL, say around the 200 FPL, if I have BCBS for both at
10K annually and Medicare for me only in 3 years?

david
Interesting question. I'm no expert, still learning but I recall someone long ago suggesting that it might be better to be even lower than 400 FPL.

If I targeted 200 FPL of income ($31k) rather than 400 FPL ($62k), the subsidy would be $1,560/month vs $1,232/month. So for the extra $31k of gains, I would lose $3,936 of subsidy, a 12.7% "tax" on the extra $31k of gains even if the federal income taxes on the extra $31k of gains is zero.

Once I factor in state income taxes, the 12.7% will probably be ~16%. Ugh. But a lot better than the over 50% rate if I exceed 400 FPL (see post #12).
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Old 03-14-2013, 11:06 PM   #18
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The catch is that you can't "move" it to BRK-B--or anywhere else. If it is invested in stocks (or MFs/ETFs) now, then you have to sell them to invest the funds in BRK-B (or anything else). When you sell them, you'll have taxes due on the gains unless you are in the 15% bracket or lower. And all the gains will be income for purposes of the ACA.
By switching to a non-dividend stock, the OP may have gains the year of the switch, but none in later years.
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Old 03-15-2013, 05:23 AM   #19
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My plan to drawn from taxable assets, starts at 75k/yr (current expenses) and ramps up to 150k/yr. Starting with 1.3M, I expect I will use all the dividen income + draw down some from the principle. My expected dividend income would put me in the 15% tax bracket. I understand from another reply that divided income is not taxable in this bracket, but it is income ... and will effect the ACA credit?

An alternative I was considering; move all 1.3M to BRK-B, then my income would be $0.00 which would maximize ACA credits. I expect there must be a catch to this strategy

PS: I have spent my working days making money, now I need to learn about taxes.
Working for the man I was told by my CPA I had very little options to reduce my taxes.
Letting ACA tax credit drive your investment strategy is IMO risky. I would think it more important to have a diversified equity portfolio exposed to a couple of different asset classes, such as US, int'l and emerging market equities.

If the average dividend yield across the portfolio is 2.5%, the total dividend income on $1.3m is $32.5k, which is less than 4x the FPL. Add capital gains, and you may be closer but still below.
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Old 03-15-2013, 09:04 AM   #20
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Letting ACA tax credit drive your investment strategy is IMO risky. I would think it more important to have a diversified equity portfolio exposed to a couple of different asset classes, such as US, int'l and emerging market equities.

If the average dividend yield across the portfolio is 2.5%, the total dividend income on $1.3m is $32.5k, which is less than 4x the FPL. Add capital gains, and you may be closer but still below.
I have abandoned a NO dividend strategy for the taxable portion, after being schooled on where CAP Gains kicks in.

My total AA; taxed + taxed advantage will be: 75% stocks / 25% bonds, + 4 yrs cash in 4 ALLY CD's. Stocks are 75% USA, 25% International. Most all stock will be VG index funds across company sizes. Will move to a 60/40 split as I age.

My bond portion is still being built, and this is where I have problems following conventional wisdom. My bond or "bond like mix" will end up at; 8% MLP's, 10% REIT "VNQ", 10% Junk "HGY", 30% "I bonds", 38% VG "VWIUX". As interest rates rise I will move out of "HGY" and "VWIUX" into "VBTLX"
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