Dividends and CG: Reinvest or Distribute?

[Looking4Ward]

Once I retire at the end of this month, I'll be spending down my after-tax investments over the next 15 years before I tap SS and 401k.

Currently, all of my after-tax Vanguard accounts are setup to re-invest dividends and capital gain distributions. The brunt of those investments are Wellington and Wellesley.

But I thought I read on this forum that it's better to have dividends and CG distributions distributed to a money market or bank account and spend those first rather than invest them back into the fund.

Is that true?

 

[W2R]

I have all of my dividends and capital gains sent to my Vanguard money market account. I am retired and use the dividends for my living expenses. I use the capital gains money to buy some of what is needed when I rebalance the next time.

Of course, there are a lot of different methods and viewpoints and mine is only one.

 

[samclem]

But I thought I read on this forum that it's better to have dividends and CG distributions distributed to a money market or bank account and spend those first rather than invest them back into the fund.

I think it makes sense. When the Divs and CG (in non-retirement accounts) are paid to you, they are reported to the IRS and will become part of your taxable income (though the tax rate on them may be zero if you are in the 15% bracket or below). Since you'll be paying tax on this money anyway, it's efficient and easiest just to take the money as part of your annual withdrawal rather than re-invest the $$ into shares. This decreases the number of shares you have to sell, and that generally means a lower amount of additional CG.

This is all a bit more important if you are using the "Average Cost" basis method. With the new accounting rules and tracking being done by brokers and MF companies, it is very easy to use the "Specific Shares' method instead, and in that case it makes less of a difference: The shares newly-bought with the Div and CG distributions can be expected to have a fairly high basis if sold that same year, so minimal CG (or even a loss) will likely be available in a typical year.

 

[REWahoo]

But I thought I read on this forum that it's better to have dividends and CG distributions distributed to a money market or bank account and spend those first rather than invest them back into the fund.

Is that true?

I'm not sure that it is 'better' but for me it is more convenient.

 

[GrayHare]

Historically reinvest and rebalance generates more money for you than paying out, but the % difference is not large.

 

[REWahoo]

Historically reinvest and rebalance generates more money for you than paying out...

In the drawdown phase? I'd think it would be a wash.

 

[Looking4Ward]

In the drawdown phase? I'd think it would be a wash.

That's the part I've been trying to get my head around; I plan on withdrawing funds on an annual year-end basis, so in not-so-good years or losing years when I reduce my withdrawals those proceeds throughout the year could be buying cheaper shares if reinvested rather than diverted to a MM account.

Granted, the impact might be minuscule in the grand scheme of things.

Although I do like W2R's strategy of having that cash on the sidelines for rebalancing and taking advantage of dips.

This is going to be very new for me, I'm so much more used to putting money in not taking money out.

 

[samclem]

Granted, the impact might be minuscule in the grand scheme of things.

There ya go. And, most of us have at least some allocation to cash, this just means that allocation varies a bit over the course of the year.

 

[GrayHare]

In the drawdown phase? I'd think it would be a wash.

The difference was detailed in the Morningstar video discussed here not long ago. http://www.morningstar.com/cover/videoCenter.aspx?id=641676

 

[pb4uski]

When I retired I change my elections on all my taxable accounts from reinvest to take in cash and direct them to my checking account and simply make a commensurate reduction in transfers from my online savings (cash portion of my retirement savings AA) to my checking account.

While I'm not sure if this is optimal, it is easier for me and simpler come tax time.

 

[MRG]

Think the OPs comment is also related to MAGI numbers for ACA.

Dividends count for income and MAGI. If you're using LTCG via appreciation, you don't have to declare it if you don't sell equities. MF & ETFs offer less control. Of course I could be 100% wrong.
MRG

 

[audreyh1]

Another here who takes MF distributions in cash, lets them accumulate during the year, then take annual withdraw from cash the next Jan. Taxable accounts so this method minimizes the tax consequences.

BTW - over 3/4 of my distributions are paid out in December, so the cash does not sit around very long.

 

[marko]

I have all of my dividends and capital gains sent to my Vanguard money market account. I am retired and use the dividends for my living expenses.

Me too. For me, it eliminates the need to sell at the wrong time. The money is already "in the bank" ready for withdrawal and I don't need to stress about selling low etc.

 

[racy]

Hi Looking,
Vanguard did a white paper on this a few years ago.
Quoting from the summary, "During the accumulation years, many investors build
retirement savings in both tax-advantaged accounts, such as IRAs or 401(k)s,
and regular taxable accounts. When these investors reach retirement, they face
decisions about how to spend from their investment portfolios—how much to
spend yearly, which accounts to draw from, and how to keep the balance of the
assets invested. In this paper, we explore the most common spending strategies,
review best practices, and discuss some pitfalls that investors should avoid".
Here is a link to the paper: https://personal.vanguard.com/pdf/s557.pdf

 

[pb4uski]

....Vanguard did a white paper on this a few years ago. .......

With respect to the topic of this thread:

For investors whose RMDs are not sufficient (or who have no RMDs), cash flows in taxable registrations should be directed into a “spending account,” which can be a money market or checking account. This account should be the next source tapped for spending, because the investor will owe taxes on these funds whether they are spent or reinvested. Since these investors will need the proceeds to meet near-term spending, reinvesting the income or capital gains and then liquidating holdings later to meet spending needs is not recommended. It also is not the most tax-efficient way to spend from a portfolio

(emphasis added)

 

[RunningBum]

http://www.early-retirement.org/for...ds-and-interest-as-they-are-earned-69588.html has an alternate view, that reinvesting gives you more flexibility to do tax harvesting or take other gains, if you use the Specific ID method to sell. It also lets you sell what you want to rebalance, just in case the type of funds throwing income is still low on your AA.

I go back and forth on this. The bolded part in pb4uski's post above mine makes a lot of sense, that NOT reinvesting is a good way to get money you are going to need anyway into a less volatile holding.

If you are in a closed fund such as Vanguard PRIMECAP, reinvesting allows you to invest more than the $25K max they allow you to add each year, if you'd like to invest more.

 

[Looking4Ward]

As always, a lot of great information. Thank you!

 

[W2R]

Another here who takes MF distributions in cash, lets them accumulate during the year, then take annual withdraw from cash the next Jan. Taxable accounts so this method minimizes the tax consequences.

BTW - over 3/4 of my distributions are paid out in December, so the cash does not sit around very long.

+1 Same here. Like Audrey, I take my annual withdrawal in January and after doing that, I rebalance. So, most of the dividend and capital gains money is only sitting in my Vanguard money market account for a couple of weeks, if that.

 

[scrabbler1]

I take my monthly dividends in cash because I use them to cover my expenses. I reinvest CG distributions so I can add shares to my funds. The CGs are erratic so I don't count them in my ER budget planning.

 

[Animorph]

Reinvesting dividends is also a potentially tricky way to trigger a "wash sale" on federal taxes. You automatically buy shares at the end of December with your reinvested dividends and then sell shares in January for that year's expenses. If you sell some shares at a loss and had bought shares in the same fund through dividend reinvestment 30 days or less before (or after) the sale, then your loss may be disallowed. Which is mostly just a paperwork headache unless you throw tax-advantaged shares into the mix.

If you have significant dividends coming each month but wanted to raise cash only yearly, then reinvestment might make sense. Otherwise it should be simpler to take dividends as cash.

Of course in the accumulation phase it is nice to reinvest distributions and not have to worry about doing it manually.

 

[pb4uski]

Good point I had heard of but forgotten about.

 

[David1961]

The decision does not have to be an "all or nothing". Assuming you don't need all of the distributions to live off of, you could have the distributions of one fund go to a money market fund and reinvest the distributions of the other fund. The main thing is you have to maintain a positive cash flow. Of course, you could also take all distributions as cash and then reinvest some of them later, if you choose.

 

[audreyh1]

Good point, Animorph! I got bit once by forgetting that I had reinvesting turned on and then took a tax loss on a fund. Oooops! What was disallowed was tiny, but it always makes the Schedule D more complicated.

I have found that even if I don't need all the distributions for annual withdrawal, I usually then them for rebalancing - that is, they would be directed to a different fund, so more tax efficient to let them accumulate in cash.

 

[scrabbler1]

The decision does not have to be an "all or nothing". Assuming you don't need all of the distributions to live off of, you could have the distributions of one fund go to a money market fund and reinvest the distributions of the other fund. The main thing is you have to maintain a positive cash flow. Of course, you could also take all distributions as cash and then reinvest some of them later, if you choose.

Good point. Since I ERed in 2008, I have changed some of the distribution options on the smaller funds I own, sometimes reinvesting them, sometimes taking them as cash depending on what I need to cover my expenses. One of my funds in a stock fund which pays dividends every quarter, not every month. There, I can take the distribution in cash if I know I will need it in the next few months should I go on a spending spree like I did in Dec2013-Jan-Feb of this year and needed the April distribution to help cover my expenses.