Tax question - what do I sell first in retirement?

[RISP]

Here's some background info about the situation: Until 2008, capital gains were not taxed in Germany if the stock (or stock fund) was held for more than one year. This rule has been abolished as of 01.01.2009. Therefore I own some ETFs which I bought before that date, and any capital gains on them can be realized tax-free. (The total balance is nothing to write home about as I had just started investing back then.) Any capital gains on an asset bought after that date are taxed at about 27%.
Because of that legal change, I had always planned to leave these funds untouched for a looong time - possibly forever. It makes sense to just let these stocks appreciate in value IF I EVER INTEND TO SELL THEM. But what if I'm living off investments and not touching the principal? It doesn't matter if any unrealized capital gains are taxable or not, or am I missing something? 1,000 EUR invested under the old rule will produce the same amount of dividend income as 1,000 EUR invested after 2008, right? And those dividends are taxable under both scenarios.

Fast forward 25 years into the future: Let's assume I'm FIREd by then and living completely off investments before I can start drawing my pensions. Let's further assume that interest and dividends do not cover my living expenses, so I need to sell a small part of my portfolio each year.
What do I sell first? The pre-2009 funds with non-taxable capital gains to avoid paying taxes? Or should I leave these untouched as long as possible?
Of course this is rather hypothetical as the tax legislation will probably change several times over the next decades...

 

[Animorph]

Sort of like having a Roth account here in the U.S..

1) You can use the tax-free gains to stay in a lower income tax bracket in retirement.

2) Don't let the tax impact keep you from making smart portfolio moves.

3) For income, sell the tax-free ETF's as needed to keep your asset allocation in balance. If you have similar taxable assets, sell them first (except in support of (1)). But per (2), sell the tax-free ETF's if necessary to maintain portfolio balance.

The more tax-free gains the better, so generally holding on as long as possible is good.

 

[RISP]

I do own the same ETFs in both taxable and non-taxable form.

If you have similar taxable assets, sell them first

That would mean selling the tax exempt ones never (unless I want to die pennyless), so what's the point in racking up as much tax-free gains as possible?

 

[teejayevans]

Fast forward 25 years into the future: Let's assume I'm FIREd by then and living completely off investments before I can start drawing my pensions. Let's further assume that interest and dividends do not cover my living expenses, so I need to sell a small part of my portfolio each year.
What do I sell first? The pre-2009 funds with non-taxable capital gains to avoid paying taxes? Or should I leave these untouched as long as possible?
Of course this is rather hypothetical as the tax legislation will probably change several times over the next decades...

I think you will have to wait until then, but if you were in the upper limit of a 15% tax bracket, and selling taxable assets would be taxed at the next highest bracket (say 25%), you might want to sell the non taxed funds just to avoid paying 25%. Of course, try to plan ahead, say you have 5K left in the 15% tax bracket in your earlier years, you might want to sell some investments, pay the 15% tax even if you don't need the money at that time, just to have the money later so you don't get taxed at the higher rate.
Here in the US, many do that with a IRA->Roth conversion. Its a pay now or pay later, the key thing is to plan ahead.
TJ

 

[Animorph]

I do own the same ETFs in both taxable and non-taxable form.

That would mean selling the tax exempt ones never (unless I want to die pennyless), so what's the point in racking up as much tax-free gains as possible?

There is the option to sell some of the non-taxed ETF's to keep your taxes in a lower bracket.

Selling them last just increases your net worth, as opposed to selling them before taxable ETF's. Growth on the tax-free ETF's is still tax free, growth on taxable ETF's is taxable. So you are improving your after-tax net worth by holding onto the tax-free ETF's and selling the taxable ones first. That ultimately means more to spend in retirement. If that doesn't happen (you never sell), then your estate should benefit, though again that depends on your tax laws. If nothing else, it means you have more money to pay for a great nursing home.

Given that the non-taxed ETF's continue to grow while you sell off other bits of your portfolio, they may grow large enough that you will begin to sell them, even though your portfolio has grown significantly as well. In my case, if I live long enough, all my assets will end up in the tax-free Roth accounts because they were growing while most withdrawals were made from taxable and pre-tax retirement accounts. The Roth account has tax benefits for my heirs as well, so there is no reason to drain them before I die.

 

[RISP]

Thanks for all replies. Estate planning is something I hadn't thought of.

you have more money to pay for a great nursing home

That's also good to know.

 

[RISP]

You folks in the U.S. have it made

just to avoid paying 25%

Man, every time someone mentions U.S. tax brackets, I chuckle a little. I'm in the 42% tax bracket here in Germany, and my salary is not really spectacular.
The lowest taxes in the developed world, mortgages are tax-deductible, gas is dirt-cheap, great options to save for retirement in 401(k)s and IRAs, Major League baseball on TV every day from April to October (plus Spring Training)... I honestly think many of you don't know how good you have it. OK, I get 30 days of paid leave a year and will probably be able to buy cheaper healthcare in the future, but still. Please don't get me wrong - I'm not complaining, I mean that in an encouraging way. I really envy you U.S. citizens.

 

[Brett_Cameron]

Man, every time someone mentions U.S. tax brackets, I chuckle a little. I'm in the 42% tax bracket here in Germany, and my salary is not really spectacular.
The lowest taxes in the developed world, mortgages are tax-deductible, gas is dirt-cheap, great options to save for retirement in 401(k)s and IRAs, Major League baseball on TV every day from April to October (plus Spring Training)... I honestly think many of you don't know how good you have it. OK, I get 30 days of paid leave a year and will probably be able to buy cheaper healthcare in the future, but still. Please don't get me wrong - I'm not complaining, I mean that in an encouraging way. I really envy you U.S. citizens.

Thanks!

 

[Meadbh]

RISP, in Germany are there any mandatory withdrawals? For example, here in Canada, RRSPs (Registered retirement savings plans) must be drawn down at a certain percentage per year beginning at age 71, and the withdrawals are taxed as income. For people with large RRSPs, this can be problematic. They may do better by drawing down on their RRSPs earlier and keeping total income in the lower tax brackets at all times.

 

[teejayevans]

Man, every time someone mentions U.S. tax brackets, I chuckle a little. I'm in the 42% tax bracket here in Germany, and my salary is not really spectacular.
The lowest taxes in the developed world, mortgages are tax-deductible, gas is dirt-cheap, great options to save for retirement in 401(k)s and IRAs, Major League baseball on TV every day from April to October (plus Spring Training)... I honestly think many of you don't know how good you have it. OK, I get 30 days of paid leave a year and will probably be able to buy cheaper healthcare in the future, but still. Please don't get me wrong - I'm not complaining, I mean that in an encouraging way. I really envy you U.S. citizens.

But thats just US tax rates, we have state taxes (up to 10%), medicare taxes, social security taxes, sales taxes (~6%), real estate taxes, vehicle taxes, personal property taxes, estate(death) taxes, etc, etc
Remember our country's revolution was started because of taxes imposed on us, so it's kinda of in our culture.
TJ

 

[RISP]

RISP, in Germany are there any mandatory withdrawals? For example, here in Canada, RRSPs (Registered retirement savings plans) must be drawn down at a certain percentage per year beginning at age 71, and the withdrawals are taxed as income.

It's a lot worse than that. The only way to save tax deferred is through a "Riester-" or "Rürup-Rente" (they are named after the inventors. I think it sounds only slightly worse than "401(k)" ), or contributions to a pension plan offered by one's employer. One of the requirements is that these vehicles pay a life-long pension, and you can't draw it before age 60. It's basically buying a very, very expensive annuity. Oh, and there are no low-cost index funds available to invest in, so all the tax benefits will most probably be eaten up by the fees. Yes, withdrawals are taxed as income.

 

[RISP]

But thats just US tax rates, we have state taxes (up to 10%), medicare taxes, social security taxes, sales taxes (~6%), real estate taxes, vehicle taxes, personal property taxes, estate(death) taxes, etc, etc

You do not seriously believe you can out-tax a German, do you?
- social security taxes? Check, 8.2% of my gross salary for health care, 9.8% for pension contributions, 1.5% for unemployment insurance, 0.975% for long-term care insurance (these are just my contributions - my employer adds the same amount on top).
- Sales taxes? Check, 19% (there's a reduced rate of 7% for food, books and a number of other vital items. Like race horses. German tax law is fun ).
- Real estate tax? - Check, both for buying (once, "Grunderwerbssteuer") and owning real estate (every year, "Grundsteuer").
- vehicle taxes? Check.
- estate taxes? Check.
- Shall I continue a little? We also have separate, additional taxes on beer, liquor, champagne, coffee, tobacco, lotteries, betting on horses, insurance (and separately, additionally, on fire insurance), owning a dog, hunting, energy, electricity, gasoline, natural gas, oil, kerosene, getting a license for running a bar, having a second residence in a separate community, and entertainment. The city of Cologne is taxing prostitution. I'm sure I missed some.

There are also talks about again taxing net worth over a certain threshold (we already had that until 1996).

Remember our country's revolution was started because of taxes imposed on us, so it's kinda of in our culture.

The US Republican Party's degree of popularity here in Germany ranges somewhere between Satan and Hitler, so I can't admit to that at parties, but I'm so envious that you at least have one important political force believing that taxes should be as low as possible. (This is not meant to indicate any agreement with their program. I don't like it.) Our entire political spectrum, left to right, agrees that the government knows best how to spend MY money.

 

[NW-Bound]

Our entire political spectrum, left to right, agrees that the government knows best how to spend MY money.

I think the simplest way would be for all gummints to keep everybody's pay, then just give out vouchers to each citizen to buy food or necessities as they deem fit. That would streamline the process, no?

A couple of years ago, I received a visit from a cousin and her husband who lived in Germany. I heard that where she lived, the town kept a record of all the trees on all private lands. Home owners would be fined if they cut down a tree without asking for permission. These laws would not go down well with Americans who highly value personal liberty, although there might be some private HOAs (Home Owner Association) that have similar rules. But hey, if people are happy with their laws, who's to say what's right or wrong?

By the way, I am impressed with your English as well as knowledge of our system for retirement savings. I am not a native born American, but then I have lived here since college age. It is more difficult to master a language if one does not live in that country.

PS. By the way, here in the US we also have federal, state, or even city income taxes, SS and Medicare taxes, general sales taxes from the state, the county, and the city. Then, there are special excise taxes on tires, auto batteries, gasoline, telephone wired and wireless, beer, liquor, etc... There's auto license tax, and auto value tax. There's real estate tax of course, and inheritance tax, blah blah blah... Yes, we got them all. And these are only personal taxes and not business taxes. However, I do believe that the total taxes are lower than other developed countries.

However, taxes in the US have been creeping up over the years. Where I live, the total general sales tax (state+city, no county) was only 5% 30 years ago. It has climbed up to near 10% now. We have population growth, and one would think that there would be economy of scale. Nope!

Yep, we are catching up with you folks over the pond. Still only half of your 19% though. Ouch!

PPS. The party that is really for low taxes and more personal freedom is the minority Libertarian Party. Now, what do you think of them?

 

[RISP]

Home owners would be fined if they cut down a tree without asking for permission.

That's true, at least for older trees over a certain height.

It is more difficult to master a language if one does not live in that country.

Certainly, but English is our company language, so I'm using it every day. Mostly in conversation with other non-native speakers, though. We have a nice mix of Chinglish, Finglish, and Genglish going. And I'm far from mastering it - I keep mixing up "awsome" and "awful" for example, sometimes with interesting results. Plus, almost anything I felt passionate about in the last twenty years came from America or England: Calvin & Hobbes comic books, inline skating, Mony Python, The Simpsons, online poker, baseball, ... It forced me to read a lot of English texts in addition to my classes at school. My knowledge of your system for retirement savings comes almost exclusively from this forum.

the total taxes are lower than other developed countries.

That's a given. Here are some OECD numbers (not perfectly up to date, but should still be valid): http://www.oecd.org/dataoecd/18/17/45120766.pdf?contentId=45120767 (page 38ff. New Zealand seems nice, too. )

PPS. The party that is really for low taxes and more personal freedom is the minority Libertarian Party. Now, what do you think of them?

Is that the guys who had Ron Paul running for President once? Not that it would make a difference in a two-party system. You know, I wrote "one important political force" (emphasis by me). Have you seen the Simpsons epidode were the two aliens, Kang and Kodos, run for President on the Democratic and Republican ticket, respectively? One of them gets elected although everyone knows about their evil scheme, but "doesn't want to throw their vote away" by giving it to a minority party. But seriously, I need to do some reading on the Libertarian Party before forming an opinion.

 

[NW-Bound]

...English is our company language, so I'm using it every day. Mostly in conversation with other non-native speakers, though. We have a nice mix of Chinglish, Finglish, and Genglish going. And I'm far from mastering it - I keep mixing up "awsome" and "awful" for example, sometimes with interesting results.

I worked with a couple of American engineers who spent a few years working in Germany, while knowing no or little German. They survived fine communicating in English. On the other hand, my visiting cousin and her husband knew little English.

Plus, almost anything I felt passionate about in the last twenty years came from America or England: Calvin & Hobbes comic books, inline skating, Mony Python, The Simpsons, online poker, baseball, ... It forced me to read a lot of English texts in addition to my classes at school. My knowledge of your system for retirement savings comes almost exclusively from this forum.

Hey, you seem to know more about the things listed above than I do. Seriously, every single item. You might be more Americanized than I am.

That's a given. Here are some OECD numbers (not perfectly up to date, but should still be valid): http://www.oecd.org/dataoecd/18/17/45120766.pdf?contentId=45120767 (page 38ff. New Zealand seems nice, too. )

Yeah. I have been to NZ once on a vacation. For a country with such low taxes, I did not see that they were missing anything. Hmm... Should I plan a longer visit for "fact finding" down there?

Is that the guys who had Ron Paul running for President once? Not that it would make a difference in a two-party system. You know, I wrote "one important political force" (emphasis by me). Have you seen the Simpsons epidode were the two aliens, Kang and Kodos, run for President on the Democratic and Republican ticket, respectively? One of them gets elected although everyone knows about their evil scheme, but "doesn't want to throw their vote away" by giving it to a minority party. But seriously, I need to do some reading on the Libertarian Party before forming an opinion.

No, I do not watch much TV. I do know about the Simpsons show, that's all.

I am not a Libertarian, but have been exposed to their ideology from a close friend of mine who is one.

When I quizzed my friend about how certain policies that they promoted would be carried out, what the ramifications would be, he admitted that because the Libertarians were for individualism, it was difficult for them to even agree between themselves to form a united front. Nonetheless, it is impossible for them to get a foothold in the US bipartisan system. They do have some interesting ideas, and it is worthwhile, for me anyway, to listen to some minority dissenting arguments.

 

[MichaelB]

RISP, great to hear that you like Monty Python. Their sketches make frequent appearances here.

Regarding taxes, Bruce Bartlett did an analysis that looked at total taxes - national, regional & local, property, and added the cost of health care. His conclusion was across the OECD countries the total burden was similar. Certainly the US and major European countries were all very close.

 

[RISP]

Yeah, I think I saw the Four Yorkshiremen here once or twice. Love that one.

Bruce Bartlett did an analysis that looked at total taxes [...]

You don't happen to have a source? I'd like to read it.

 

[MichaelB]

Yeah, I think I saw the Four Yorkshiremen here once or twice. Love that one.
You don't happen to have a source? I'd like to read it.

Sure. Here's the source Bruce Bartlett: Health Care Costs and the Tax Burden - NYTimes.com
Bartlett is a well known economist with public policy experience.

 

[RISP]

Interesting read, thank you. I would agree that our higher tax load does indeed provide us with some benefits. In addition to health care, as mentioned in the article, education comes to mind.

I'm not sure if Bartlett accounts correctly for all the differences between countries. E.g., the part of my salary that is deducted from my gross for health insurance is only about 50% of the total costs. The rest is paid for by my employer, or at the end of the day, again by me "through lower wages". Also, what Bartlett calls "family allowances" is just a tax credit, as in the U.S. The difference, as I understand it, is simply that in Germany there is a minimum payment for every family, even those that pay little or no taxes.

OTOH, I'm not sure if looking at average rates gives an accurate picture. I would argue (but I don't have the data to prove it) that Germany provides a much higher level of welfare to the poor and especially the unemployed. So, while quite a bunch of people will pay no taxes (and even receive money from the government), the middle class is taxed heavily to pay for these benefits.

It would be interesting to compare the actual situation of two individuals or families in Germany and the U.S. with similar income, and to take into account also health care costs, education, quality of public infrastructure...
Of course that picture changes all the time. As an example, I still had to do 9 months of compulsory military service for hardly any pay. That cost me several 10,000 Euros in salary I couldn't earn during this time. Draft service has been abolished last year.

 

[NW-Bound]

Anytime there is a social program, there will be people who benefit and people who feel they carry more of the burden.

One of our nephews married a girl from a Scandinavian country. He told us that the girl's family was not happy with their social system, which they felt penalize the workers too much. The girl's uncle family has emigrated to the US, and was happier here, I was told.

On the other hand, I personally knew of a family who emigrated from Holland to the US. After 2 years of living here, they moved back. The reason: they had to work too hard to pay for health insurance.

 

[RISP]

Anytime there is a social program, there will be people who benefit and people who feel they carry more of the burden.

You are of course right. Maybe my argument came out wrong.

 

[NW-Bound]

Maybe my argument came out wrong.

Not necessarily.

Although I value individualism, I also believe in "enlightened self-interest", and that what one contributes to society will come back to benefit the individual. Even the earlier settlers in the Wild Wild West could not exist alone and had to rely on others for trade. We do not exist in a vacuum, or on an isolated island.

But even if a social program has a good intention (don't they all?), and seems to achieve its objective, one should always ask if there is not a better way to obtain the same results. I get suspicious of people who always suggest throwing money at a problem, as if that would bring about a solution. As an engineer, I have seen plenty of money being wasted on ill-defined projects, and suspect that the same would happen on social programs everywhere.

Thus, efficiency of various social policies as implemented in different countries should be compared. Hence, it is intriguing to compare tax rates of different developed countries and to see how their respective citizenry fares.

 

[RISP]

Thanks for the link, I hadn't heard the term "enlightened self-interest" before. It's basically the opposite of what Adam Smith meant when he said "It is not from the benevolence of the butcher, the brewer, or the baker that we expect our dinner, but from their regard to their own interest", right?

Thus, efficiency of various social policies as implemented in different countries should be compared.

I'm most worried about the incentives they provide. E.g., I'm 100% sure that too generous unemployment benefits will result in more unemployment. Here's an example: A family of four on welfare gets about 1.864 € per month (this includes direct payments as well as their rent being paid by the state). Combine that with some other benefits like discounts on public transport or cultural events, and you have a level of income that can hardly be achieved by working most low-paying jobs. In other words, a warehouse man or hairdresser will think twice whether they want to work hard if they can achieve a similar lifestyle by NOT working. Even if they could make, say, 2.000 €, does it make sense for them to work full-time for an additional 136 bucks?
Now, I'm not saying 1.864 € for a family with two children is much or too much, but I think there must be a significant "lifestyle gap" between those working and those on the dole.

Our system provides strong incentives NOT to give on's best effort. I'm making good money, so I'm in a high tax bracket. The marginal rate is 42%, so for every additional $ I earn, 42ct go directly to the tax man. Now, will I really put in the 60-hour work weeks necessary to get that Director's position? Maybe I'm doing just fine with my current salary, and the stress level is lower...

 

[NW-Bound]

No, the enlightened self-interest philosophy does not at all contradict what Adam Smith preached.

What Adam Smith said was that we should not expect and could not demand the baker to give out free bread. But a baker, out of enlightened self-interest, would extend credit to a regular customer of his who was short one week, knowing that this customer would most likely pay him back at the next paycheck. We cannot force the baker to do this, but it would be beneficial to him to keep good regular customers this way.

In the example you gave, if the chronically unemployed can get nearly as much as a low-wage worker, then it is not at all an enlightened social policy. We do not want people dying in the streets or Dickensian misery, but the former should be somewhat "hungry" to give him an incentive to work. Finding the right level of hunger so that he wants to work to get more, yet not let him starve to the point of incapacity, now that's enlightenment. Of course, another problem is to make sure there are jobs out there for him.

As I said, when I was down in NZ for a vacation more than 10 years ago, I thought it was a nice place, with no dead bodies on the streets, no squalor that I could see (well, I did not spend that much time to really know), and I do not recall seeing any beggar either. Just now learned from you that they have low tax rates. How do they do that?

I just now checked and found that the latest NZ unemployment rate was 6.7%, not too bad given the current world-wide economic condition. Could it be that this is a more enlightened nation? Makes me want to spend more time down there for my own personal study into sociopolitical issues. It could be a lot more interesting than watching TV.

 

[RISP]

I didn't mean that this concept contradicts Smith. As I understand his concept of the "invisible hand", he believes that if everbody acts selfishly in their own best interest, this will result in greater prosperity for all of society.

Again, as I understand it, enlightened self-interest claims that if one furthers the interests of others, they will ultimately serve their own self interest.

Kind of the opposite, isn't it?