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Capital gains, and old age
Old 12-30-2007, 09:24 AM   #1
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Capital gains, and old age

When my mother died a few months ago, her portfolio included many individual stocks that she had bought half a century ago. What she originally paid for these stocks back in the 1950's and 1960's was only a tiny fraction of their worth in recent years. She could not sell them and buy other stocks that were performing better, due to the capital gains taxes that she would have had to pay. So, she was essentially "locked in" to these stocks while she was still alive.

Now that is bad enough, but what if these had been mutual funds instead of individual stocks? She not only would have got "locked into" the investment, but with a mutual fund you also get the fund manager and fees, and you would be locked into those and whatever changes may occur in these aspects, too.

Is this a non-issue? It's kind of hair-raising, thinking that in my old age I might be "locked in" to a fund manager that hasn't even been born yet, not to mention whatever fees he might dream up.

(Sorry if this question is too naive for some of you but at least I asked.)
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Old 12-30-2007, 09:51 AM   #2
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You are only 'locked in' if you make it so....

If an investment is so bad... sell it and move on... pay the tax...

If a fund manager is so bad, the same thing... sell and move on...

BTW, the fund will be buying and selling stock all the time and making distributions of capital gains over the years (unless they are an index), so the capital gain will be much smaller than you would think.

Again.... don't let taxes make a decision.... it is only one part of a decision, not the whole decision.
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Old 12-30-2007, 10:01 AM   #3
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Her capital gains are now essentially wiped out .Since everything will be brought up to the value on the day she passed .
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Old 12-30-2007, 10:12 AM   #4
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Her capital gains are now essentially wiped out .Since everything will be brought up to the value on the day she passed .
I guess my post was not clear. Yes, obviously there was a step-up in basis upon her death. However, the topic of this post is meant to be related to tax planning for old age (not estate planning).

Apparently nobody but me thinks this is a problem or is concerned about this sort of thing, though it apparently affects a lot of elderly people. I know my mother's income from her portfolio was pretty small, and certainly at some point one's life expectancy is short enough to make selling, and just swallowing capital gains tax on virtually the entire proceeds from the sale, a losing proposition for the elderly while they are alive.
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Old 12-30-2007, 10:25 AM   #5
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Even if one is young, you can get locked in to a mutual fund. For example, I own MIDAX which has doubled in value in the last 3 years. I really want to be in the low cost ETFs that are now available for the int'l small cap asset class. For me to sell MIDAX would practically double our taxable income, so it's not gonna happen this year. I feel I have to carry this fund and its 1.55% expense ratio until I stop working and jump to a lower tax bracket.

And all this applies to stocks as well. Suppose you were in Pfizer or Walmart years ago. You can relish the dividends, but the stock prices have gone nowhere in 7 years.

The solution is to get into passively-managed index funds with the asset allocation of your choice from the get-go while young.

And of course, don't forget that sometimes you just gotta sell and pay your taxes. It means you made money and there is nothing wrong with that.
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Old 12-30-2007, 10:27 AM   #6
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at some point one's life expectancy is short enough to make selling, and just swallowing the entire capital gains tax, a losing proposition for the elderly while they are alive.
Not sure what you mean when you say "losing propostion." Having huge long term capital gains taxes to pay is a very, very good thing (compared to not having them!). The LTCG tax represents only 15%. Say you Mom had a 50 year old stock she paid $1 per share for that she could have sold for $101 per share before her death. That would have been a gain of $100 per share. The tax would have been $15 per share and her spendable take on the transaction would have been $85 per share. Wonderful!

I sure would like to be able to pick a few stocks or equity funds today that would be worth a large multiple of their current price so I could pay some huge LTGC tax in the future!

Maybe I'm misreading your post? But I can't understand your concern about have equities appreciate and paying 15% capital gains tax..........
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Old 12-30-2007, 10:29 AM   #7
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Selling and paying the entire capital gains tax is NOT a losing proposition for the elderly while they are still alive. One has to have a GAIN in order to pay taxes. Sure, they pay 15% of the gain, but they get the remaining 85%.

Don't be so focused on the taxes that you don't sell because you might owe some. That makes no sense. You aren't "losing" that money. It was always due unless you died. Thinking otherwise is just fooling yourself.

Sure, if you want to sell to move to a better investment, then you need to take into account that the new one should make up for the tax hit. I suppose this is the situation you are most focused on?

FWIW, if you have an investment that throws off a lot of income (which is what you probably want when elderly), then your basis will keep going up or like a bond fund won't change that much, so for those kinds of investments your capital gain might not be very large at all.

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Old 12-30-2007, 10:30 AM   #8
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Maybe a re-read of Why Smart People Make Big Money Mistakes is in order? The idea of not selling winners and holding on to losers is a big behavioral finance trap.
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Old 12-30-2007, 10:43 AM   #9
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Even if one is young, you can get locked in to a mutual fund. For example, I own MIDAX which has doubled in value in the last 3 years. I really want to be in the low cost ETFs that are now available for the int'l small cap asset class. For me to sell MIDAX would practically double our taxable income, so it's not gonna happen this year. I feel I have to carry this fund and its 1.55% expense ratio until I stop working and jump to a lower tax bracket.
That totally sux!! My sympathies. As a newbie investor, this is the kind of thing that worries me late at night.

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And all this applies to stocks as well. Suppose you were in Pfizer or Walmart years ago. You can relish the dividends, but the stock prices have gone nowhere in 7 years.
Yes, but at least with individual stocks you aren't stuck with a fund manager and fees along with the stocks. It probably sounds pretty untrusting to worry about it, but who knows what fund manager will get his claws into any given fund, and who knows what decisions he might make?

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The solution is to get into passively-managed index funds with the asset allocation of your choice from the get-go while young.
You don't have capital gains tax on passively managed index funds when you sell them at many times what you bought them for? I thought you would? :confused: Due to a windfall I may be investing 97% of my taxable nestegg almost entirely in 2008, so I have a chance to "do it right" and I am lingering on each word here.
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Old 12-30-2007, 10:49 AM   #10
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You don't have capital gains tax on passively managed index funds when you sell them at many times what you bought them for? I thought you would? :confused:
Of course you have capital gains in a taxable account. But you do not have manager risk and you do not have the high expense ratios usually associated with actively managed funds.
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Old 12-30-2007, 10:52 AM   #11
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I guess my post was not clear. Yes, obviously there was a step-up in basis upon her death. However, the topic of this post is meant to be related to tax planning for old age (not estate planning).

Apparently nobody but me thinks this is a problem. I know my mother's income from her portfolio was pretty small, and certainly at some point one's life expectancy is short enough to make selling, and just swallowing the entire capital gains tax, a losing proposition for the elderly while they are alive.
I think some can relate - our tax lady, and others, have advised that taxes not be the tail that wags the dog. It's going to be painful to sell some of the properties that we've had for over 20 years - after a (in retrospect) small purchase price and decades of depreciation Unca Sam claims that just about all the sale price will be capital gains. Get to feeling trapped by the punitive nature of the taxation. It helps me to remember a 'Lil Abner cartoon in which he was proud and pleased to be paying as many taxes as he was - because it meant he had done really well!
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Old 12-30-2007, 10:57 AM   #12
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Sure, if you want to sell to move to a better investment, then you need to take into account that the new one should make up for the tax hit. I suppose this is the situation you are most focused on?
Yes, that is what concerned me.

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FWIW, if you have an investment that throws off a lot of income (which is what you probably want when elderly), then your basis will keep going up or like a bond fund won't change that much, so for those kinds of investments your capital gain might not be very large at all.
That is true!! I am thinking of putting 30% into Wellesley, but it hasn't really increased much at all over the years. So, it should not be a problem in that respect.

Guess I should have had that SECOND cup of coffee this morning.
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Old 12-30-2007, 10:59 AM   #13
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I think some can relate - our tax lady, and others, have advised that taxes not be the tail that wags the dog. It's going to be painful to sell some of the properties that we've had for over 20 years - after a (in retrospect) small purchase price and decades of depreciation Unca Sam claims that just about all the sale price will be capital gains. Get to feeling trapped by the punitive nature of the taxation. It helps me to remember a 'Lil Abner cartoon in which he was proud and pleased to be paying as many taxes as he was - because it meant he had done really well!
LOL!!! If only I could be as wise as Li'l Abner!
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Old 12-30-2007, 11:03 AM   #14
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Of course you have capital gains in a taxable account. But you do not have manager risk and you do not have the high expense ratios usually associated with actively managed funds.
Just to be devil's advocate - - (or worrywart, or whatever) - - I know that now, when I am looking at funds to buy, the expense ratios are lower for index funds. But is there any ironclad reason why expense ratios on index funds could not be raised after a couple of decades?
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Old 12-30-2007, 11:04 AM   #15
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Well, when I am early retired I expect to pay virtually no taxes. I will have the fixed income assets in a tax-advantaged account. The taxable account will be tax-efficient equities. I expect stocks to go up more than bonds over the long term, so I will need to rebalance by drawing down on equities. There will be a little bit of qualified dividend income from equities -- well below the exemptions and standard deductions -- and some LT cap gains income, but most withdrawn will be return of capital which is tax-free.

To beat the RMDs starting in the year after I reach age 70.5, I will be converting IRA assets to Roth IRA before then. I might pay a little bit of taxes in those years.

But if I end up paying more taxes than I think, I will still be happy the rate is not as high as 33% which it is for me now.
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Old 12-30-2007, 11:23 AM   #16
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When my mother died a few months ago, her portfolio included many individual stocks that she had bought half a century ago. What she originally paid for these stocks back in the 1950's and 1960's was only a tiny fraction of their worth in recent years. She could not sell them and buy other stocks that were performing better, due to the capital gains taxes that she would have had to pay. So, she was essentially "locked in" to these stocks while she was still alive.
Now that is bad enough, but what if these had been mutual funds instead of individual stocks? She not only would have got "locked into" the investment, but with a mutual fund you also get the fund manager and fees, and you would be locked into those and whatever changes may occur in these aspects, too.
Is this a non-issue? It's kind of hair-raising, thinking that in my old age I might be "locked in" to a fund manager that hasn't even been born yet, not to mention whatever fees he might dream up.
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Apparently nobody but me thinks this is a problem or is concerned about this sort of thing, though it apparently affects a lot of elderly people. I know my mother's income from her portfolio was pretty small, and certainly at some point one's life expectancy is short enough to make selling, and just swallowing capital gains tax on virtually the entire proceeds from the sale, a losing proposition for the elderly while they are alive.
Hey, c'mon, W2R, some of us need a couple days to catch up on the threads. Perhaps the nature of the responses may reflect the age of the respondent.

I've begun to think that investor psychology boils down to admitting to ourselves that we're going to do stupid things with our money, and the question at hand is only the degree of stupidity. Once one arrives at that admission then there's no worry about looking stupid by selling an investment and paying taxes-- only an admission that one has delayed admitting one's stupidity before now or that one was stupid for selling too soon. My "stupid stock" is Berkshire Hathaway.

Investor psychology has nothing to do with logic, either, especially if other elder concerns rise above it. When spouse's grandfather was near death, he adamantly insisted (to the point of cardiac care) that his daughter (spouse's mother) sell his savings bonds. We're talking the old-school Es & Hs in the 1990s, some of which had stopped paying interest years ago and were more valuable to the Smithsonian than to the investor or the U.S. Treasury. There were literally shopping bags full of paper which required a couple of days (and a dedicated bank teller) to process. Of course the taxes were humongous and could have been avoided by an inheritance basis step-up, something my MIL regrets to this day. (She says that she would have made a lot of money by lying to him.) Her father's point was that he didn't want to "be a burden" by having to use estate lawyers and probate to get the money to her, which was just as irrational as holding onto dead bonds. He'd rather screw a lawyer out of a few hundred in fees, even if he had to pay 10x that amount in taxes.

So maybe your mother's version of investor psychology has nothing to do with the stock's relatively recent performance. Maybe she felt that she'd never find another stock with a record approaching the stocks she already held. Maybe, like some of my relatives, she'd rather lose body parts than pay "those bahstahds at the IRS" their due-- even if a taxed profit is better than a tax-deductible loss. Maybe the money has just grown too big to wrap their brain around-- my FIL will regale his granddaughter for hours about 1940s prices but choke at having to pay $2 to a parking meter even if it means driving around for 30 minutes or risking a $30 ticket. Maybe she hesitated to break into the principal for living expenses despite her reduced remaining life expectancy, or she wanted to pass on a gargantuan inheritance-- even if both approaches led to deprivation instead of frugal living.

IMO two things can help work through the stupidity psychology. The first is a well-crafted quantitatively-oriented "investment policy statement" that allows for changes to an asset allocation. If an investor has put a lot of work into an IPS (for example, as much work as they put into picking those stocks) then they're willing to assess their portfolio against the IPS and make the changes. If the IPS says "stocks that have above-market 10-year-records" or "funds with expenses less than 1%" then people become anchored in the effort they put into the IPS. When the portfolio no longer meets those criteria, it's time to either bite the tax bullet and follow the IPS, or it's time to rewrite the IPS. Most would choose to do the former.

BTW, for those guys who've written "I'm dead" letters to their spouses telling them how to run the portfolio-- that's an IPS too.

A second technique is to look at all the money-- not just the tax paid but the money saved by avoiding future expenses. Spouse and I liquidated Tweedy, Browne Global Value last year by selling shares that we'd held over a decade and had more than doubled in value. It hurts to pay those IRS bahstahds a tax amount that will be bigger than some of my old W-2s, or by paying all the commissions to buy into an equivalent ETF. However we've made it up in less than a year just by not paying Tweedy's expense ratio, and we've liquidated during what's likely to be among history's lowest long-term cap gain rates. I also don't have to feel critical of Tweedy's management anymore. Were we stupid? Could be, especially if Tweedy outperforms. But OTOH they're re-opening Global Value next week and they're still charging a 1.38% ER-- doesn't seem very fiduciary (let alone customer-friendly) to me.

Maybe neither of those would've helped your mother, especially if she didn't have an IPS and didn't record how much she paid in brokerage commissions or how much she could make in other investments. Maybe these techniques could be of use to us in 20-30 years, but only if we think in those terms today. What helped with my FIL, though, was pointing out that a $2 parking fee today was worth about 15 cents in 1940. At that point my MIL would clench her jaw, telling him to stop being silly and just park the damn car. So maybe the "reduce it all to dollars" technique has to also adjust your mother's dollars to their 1950s-60s equivalent when those stocks were purchased. It might mean more to someone like my FIL who thinks bread is overpriced at $1 or remembers when movies cost a nickel.

BTW, how bad were your mother's stocks? Were they like GE & Phillip Morris/Altria, which have greatly outperformed the Dow over the last four decades, or were they really so bad? The reason I ask the question is because long-term sucky stocks tend to get bought out or bankrupted, a survivor bias which eliminates subpar performance. Meanwhile stocks with great multi-decade records (which is why they have multi-decade records!) are called "bad" just because they've lagged for five or even ten years.

At least one investor on this board has shares of a stock that return more in ANNUAL dividends than his cost basis, yet a couple years ago that stock was declared dead just because its margins were no longer above 40% and its competitor was making inroads. AT&T & Microsoft have been bad-mouthed for their five-year performance, but anyone owning shares before AT&T's 1984 breakup or even MSTF's 1995 financial report would be a multi-gazillionaire today. Same for Apple in 1993, Pfizer from about the same era-- I could go on for hours.

She could be certain of paying cap gains if she sold, but she couldn't be certain that the new stocks would outperform. So maybe it was just a question of not wanting to deal with the degree of stupidity.

Enough philosophizing. Next week spouse and I are selling a chunk of Berkshire Hathaway...
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Old 12-30-2007, 12:02 PM   #17
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I've begun to think that investor psychology boils down to admitting to ourselves that we're going to do stupid things with our money, and the question at hand is only the degree of stupidity.
I should frame that statement and put it up on the wall! There are so many stupid things that can be done (and I have either done, or thought about doing, many of them).

Remember when investing with Tech stocks was the smart thing to do? And then when borrowing to the hilt to buy a McMansion, to sell for double the price the next year was the smart thing to do? Well, it seems like now, buying mutual funds is the smart thing to do. Who knows? In 20 years we could find out that doing so was just another stupid move. Or not.

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So maybe your mother's version of investor psychology has nothing to do with the stock's relatively recent performance. Maybe she felt that she'd never find another stock with a record approaching the stocks she already held. Maybe, like some of my relatives, she'd rather lose body parts than pay "those bahstahds at the IRS" their due-- even if a taxed profit is better than a tax-deductible loss.
That could have been part of it. She was born in 1909, and so she had less patience with taxes than many.

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When the portfolio no longer meets those criteria, it's time to either bite the tax bullet and follow the IPS, or it's time to rewrite the IPS. Most would choose to do the former.
I guess. The tax bite still seems substantial, but if the criteria were loose enough then one could at least bail out of a sinking ship.

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Maybe neither of those would've helped your mother, especially if she didn't have an IPS and didn't record how much she paid in brokerage commissions or how much she could make in other investments.
Well, she had Morgan Stanley and Merrill Lynch helping her with one or all of her trusts. The banks were charging exorbitant fees to administer the trusts. I am hearing all of this third hand in pieces from my CPA/CFO brother, since she has passed away and he is executor. He is working in our best interest, but was talking about why she had kept all these stocks for so many years.

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BTW, how bad were your mother's stocks? Were they like GE & Phillip Morris/Altria, which have greatly outperformed the Dow over the last four decades, or were they really so bad? The reason I ask the question is because long-term sucky stocks tend to get bought out or bankrupted, a survivor bias which eliminates subpar performance. Meanwhile stocks with great multi-decade records (which is why they have multi-decade records!) are called "bad" just because they've lagged for five or even ten years.
They didn't look THAT bad to me, but what do I know? I'm not sure which stocks were being kept for tax reasons, but among her investments she had a whole lot of Coca-Cola, Altria, Kraft, Bristol-Meyers/Squibb, GE, and IBM, among others. I notice that her Coca-Cola, Altria, GE, and Kraft were all worth more than 15 times their basis, for example. I would assume that maybe these are the ones in question, perhaps, though I do not know!

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She could be certain of paying cap gains if she sold, but she couldn't be certain that the new stocks would outperform. So maybe it was just a question of not wanting to deal with the degree of stupidity.
It's hard to know what she was thinking, though I have heard older people say similar things before. I guess it doesn't matter. To tell the truth, I am just taking potshots at my own financial planning trying to find weak points now, rather than later.
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Old 12-30-2007, 12:08 PM   #18
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A few ideas on taxes:

1) Don't buy funds with large unrealized gains for a taxable account.

2) Try to put equity money you may want to move around in tax deferred accounts.

3) Consider putting broad based index funds in taxable accounts.

4) Try to make use of the next 3 years to unload cap gains up to the max of the 15% tax bracket.

I guess it's been said above but many good, low ER, low turnover funds make distributions each year so your tax burden is generally not concentrated and does not build up to an unual level. Here is a tax picture for the Vanguard Total Stock Market fund: Vanguard Total Stock Mkt Idx Report (VTSMX) | Tax Analysis
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Old 12-30-2007, 12:18 PM   #19
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WTR....

I do know what your OP was intended... and yes, we have some individual stocks with huge cap gains with my mom, but they are good and we do not want to sell...


Let me go from the other side.... my BIL sold a bunch of MF in Oct and died in Nov... $40K cap gain that we could have avoided if he had not sold... but life is not so cut and dried... you make decisions based on the facts you have at the time and live with what happens... would we like to 'take it back'... sure, can we? NOPE...

As I said and others.... don't make an investment decision on taxes... another example.... I sold one of my 'flyer' stock picks in my testosterone account with only 30 or so days before it went long term.... just had a bad feeling... well, the stock went down a lot and I would not have had any gain if I tried to get it long term... Uncle Sam made out, but so did I....
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