Mutual Fund sale questions

[KM]

I have two questions that I was hoping someone might have some opinions on.

First, does it ever make sense to sell taxable mutual funds (paying a gain) to move them into a Traditional IRA, even if the contribution itself is not deductible? Assume I have no other way to get money into the Traditional IRA, as we are maxing out pre-tax contributions wherever we can, so we have no extra money laying around. I either sell taxable mutual funds or nothing goes in. Right now I am thinking of selling $10,000 a year ($5,000 for each of us) for the next 6 years. Also assume I would not need to touch these Traditional IRAs for at least 15 years. I am thinking that the tax on the gain will be offset by the reduction in taxes over the next 15 years on the dividend income??

Second, does it ever make sense to sell off a taxable mutual fund and pay the gain to consolidate with another fund and reduce expenses. I currently hold a mutual fund with fees at 1.18%. I hold a number of mutual funds with Vanguard and would like to move this small growth fund over to Vanguard’s Small Growth Index. But I would end up paying capital gains on about $9000. At 15%, that would be $1350 in taxes. Somehow this doesn’t feel good. Is there a better way to do this or should I just leave the money where it is? There is nothing particularly wrong with this mutual fund – I am just looking to start consolidating my accounts to Vanguard. Or is this something better to do when I retire in 6 years? Or is this just an all-around bad idea?

[LOL!]

Originally Posted by KM

First, does it ever make sense to sell taxable mutual funds (paying a gain) to move them into a Traditional IRA, even if the contribution itself is not deductible?

No that does not make sense to me at all. Why convert future capital gains taxes to ordinary income taxes. Your taxable funds should be in investments that pay little in the way of dividends like stock index funds (dividends are about 2%-4% a year).

Originally Posted by KM

Second, does it ever make sense to sell off a taxable mutual fund and pay the gain to consolidate with another fund and reduce expenses. I currently hold a mutual fund with fees at 1.18%. I hold a number of mutual funds with Vanguard and would like to move this small growth fund over to Vanguard's Small Growth Index. But I would end up paying capital gains on about $9000. At 15%, that would be $1350 in taxes. Somehow this doesn't feel good. Is there a better way to do this or should I just leave the money where it is?

I have done this when I had an offsetting capital loss which made it easier to pull the plug. I have also bailed out of a fund that I held for more than 10 years when I found a better fund going forward. But the answer is not as definitive as the answer to your first question.

[Nords]

"Maybe" and "Yes".

In the case of the IRA, if you leave the money in the taxable account you may pay taxes each year and miss out on the tax-free compounding. Of course if you're paying those annual taxes at a cap gains rate (say, 5%) but an IRA RMD would be taxed at least 15% then you'd be better off leaving the funds in a taxable account.

I think tax rates are unlikely to get lower, so a Roth IRA has the advantage of tax-free compounding while only withdrawing the money you want.

As LOL! mentioned, if you could sell those taxable funds at a loss then you'd be able to move them into an IRA while offsetting other cap gains (or up to $3000 of ordinary income). That might require selling specific shares.

However if you're converting a traditional IRA to a Roth IRA then you have to pay taxes on the conversion. You could pay those taxes from the IRA funds or you could pay them from a taxable account. If you pay those taxes from a taxable account, that leaves an equivalent sum of money in the Roth IRA, leaving more money to compound tax free. In other words, Roth IRA conversion taxes should be paid from taxable funds.

As for the second situation, you'd be paying $1350 in taxes. If you didn't sell, how much would you pay in fund expenses if you left the money in the investment that costs 1.18% every year?

We did this math over selling Tweedy, Browne Global Value (1.38%) for Powershares International Dividend Achievers ETF (0.6%). It didn't take long to appreciate paying the taxes.

[KM]

Yeah, I am having a hard time justifying #2, which says to me it is probably not a good idea.

Your response to #1 made me go back and rerun my numbers a few more times. I found a major flaw in my calculations. You are absolutely right - this would not be a very good idea after all. Thanks!!!

[KM]

Nords,

When I reran the taxable account to IRA conversion with our current tax rate, etc. it turned out to not be such a good idea after all. I don't have a loss to offset the gain with. And we cannot donate to a ROTH anymore as we are over the income limit.

In terms of selling the Small Cap account, I guess I should run the numbers to see how long it would take to recoup the taxes? Would I just multiply the value of the account by 1.18% and then do the same math with the other accounts expense (I think it is .23??)


Thanks for the input!

[Nords]

Originally Posted by KM

When I reran the taxable account to IRA conversion with our current tax rate, etc. it turned out to not be such a good idea after all. I don't have a loss to offset the gain with. And we cannot donate to a ROTH anymore as we are over the income limit.

Two comments:
- Try to put the dividend-paying assets in a tax-deferred account. Qualified dividends are taxed a lot lower today, but not that long ago they were taxed as ordinary income.
- We couldn't contribute to a Roth IRA until after I'd retired (spouse was still working). But for nearly 20 years we made non-deductible contributions to our conventional IRAs which we're now converting to Roths. So don't just look at a huge W-2 and shake your head because someday you may be able to pay conversion taxes at a much lower rate. You have to try to compare your tax rate at RMD or at retirement to your current tax rate. Social Security taxation is also an issue.

Originally Posted by KM

In terms of selling the Small Cap account, I guess I should run the numbers to see how long it would take to recoup the taxes? Would I just multiply the value of the account by 1.18% and then do the same math with the other accounts expense (I think it is .23??)

Savings per year = (account value $$) x (1.18%-0.23%).

So if you're paying $1350 in taxes, a $142,105 account would recoup that in one year. A ~$71K account would recoup it in two years.

[jdw_fire]

Originally Posted by KM

I have two questions that I was hoping someone might have some opinions on.

First, does it ever make sense to sell taxable mutual funds (paying a gain) to move them into a Traditional IRA, even if the contribution itself is not deductible? Assume I have no other way to get money into the Traditional IRA, as we are maxing out pre-tax contributions wherever we can, so we have no extra money laying around. I either sell taxable mutual funds or nothing goes in. Right now I am thinking of selling $10,000 a year ($5,000 for each of us) for the next 6 years. Also assume I would not need to touch these Traditional IRAs for at least 15 years. I am thinking that the tax on the gain will be offset by the reduction in taxes over the next 15 years on the dividend income??

Second, does it ever make sense to sell off a taxable mutual fund and pay the gain to consolidate with another fund and reduce expenses. I currently hold a mutual fund with fees at 1.18%. I hold a number of mutual funds with Vanguard and would like to move this small growth fund over to Vanguard’s Small Growth Index. But I would end up paying capital gains on about $9000. At 15%, that would be $1350 in taxes. Somehow this doesn’t feel good. Is there a better way to do this or should I just leave the money where it is? There is nothing particularly wrong with this mutual fund – I am just looking to start consolidating my accounts to Vanguard. Or is this something better to do when I retire in 6 years? Or is this just an all-around bad idea?

Maybe it will make sense if you combine the two i.e. sell $10,000 (net) of your high expense funds this year and put that $10,000 into your IRAs. Repeat each year until all the high expense stuff is sold.

[KM]

Thanks for all the feedback everyone!!!

I ran the numbers for the account in Question #2 and I would recoup in 3.5 years (I don't have a lot in there) - which makes me think selling wouldn't be a bad idea after all. I do like jdw_fire's idea of selling off this high expense account to fund the IRAs - if I am going to sell them anyway. Unfortunately, it is not a dividend paying account.

But, if it makes sense to sell those high expense shares anyway, I might as well just use them to fund the IRA until they are gone. Then I can see if there is a loss that has arisen that I can leverage to make selling the dividend-producing fund less painful.

I had also never thought about the Roth conversion option for Traditionals. I guess I should go read up on that again. That is a strong argument for trying to get some money in the IRAs while we still can. We only have 6 years until we retire.

Great ideas/input that I never would have thought of on my own. Thanks again!!

P.S. What does RMD stand for??

[Evelyne]

RMD stands for Required Minimum Distribution.

http://www.investopedia.com/terms/r/...stribution.asp

[Texas Proud]

You might want to make the contributions to the non deductible IRAs and then convert them in 2010 to ROTHs...

I have read a couple of articles about this 'loophole' for the higher earner that can not contribute...

And you would only have to pay taxes on the gain as you would have a basis in the account that would not be taxed...

Just a thought....

BUT, I do have a question that might affect others.... do you have to combine ALL of your IRAs into figuring the basis or can you pick and choose the ones you want to convert It does not affect me as I have no regular IRAs...

[Nords]

Originally Posted by Texas Proud

BUT, I do have a question that might affect others.... do you have to combine ALL of your IRAs into figuring the basis or can you pick and choose the ones you want to convert

I used to ask this type of question of the CPAs on Ed Slott's discussion board and I was finally told to stop thinking and just start plugging through Form 8606.

And that form has you add up the value of all your traditional IRAs to determine their basis. You can't pick & choose.

[KM]

Originally Posted by Texas Proud

You might want to make the contributions to the non deductible IRAs and then convert them in 2010 to ROTHs...

I have read a couple of articles about this 'loophole' for the higher earner that can not contribute...

And you would only have to pay taxes on the gain as you would have a basis in the account that would not be taxed...

Just a thought....

BUT, I do have a question that might affect others.... do you have to combine ALL of your IRAs into figuring the basis or can you pick and choose the ones you want to convert It does not affect me as I have no regular IRAs...

I thought I read something about a 2010 conversaion. Given that, it seems like it might makes sense to try and get as much $$ as I can into those Traditional IRAs before 2010 - so I will have something to convert. My contributions will all be post-tax, so my taxes for conversion should not be bad (my taxes to get the $$ in is another story, but I am going to start with the high expense fund, as the tax expense will be recoupable with the lower expense).

[kumquat]

Don't let the tax tail wag the invesment dog. If you don't want to hold this fund, dump it now and take your lumps.