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Confused About Taxes on Savings Account Interest
Old 05-31-2020, 05:54 PM   #1
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Confused About Taxes on Savings Account Interest

If my spouse and I retire at the end of this year, we will have about 1/3 of our nest egg in 401k accounts and 2/3 in savings accounts (which is 90% in CD's as of now).

My concern is with taxes on the interest from the savings accounts and CD's.

Where could I put this money so that it is taxed as LTCG instead of ordinary income?
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Old 05-31-2020, 07:20 PM   #2
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put it in a stock fund and hold it it long enough to fit LT part of LTCG. You could also dividend stocks that are qualified which has similar taxing as LTCG.


now you won't get the investment characteristics of a bank account.
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Old 05-31-2020, 07:26 PM   #3
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Originally Posted by bingybear View Post
put it in a stock fund and hold it it long enough to fit LT part of LTCG. You could also dividend stocks that are qualified which has similar taxing as LTCG.

now you won't get the investment characteristics of a bank account.

+1


You have to put your money more "at risk" than a savings account to get the benefits of the LTCG tax rate.
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Old 05-31-2020, 08:03 PM   #4
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At today's interest rates you'd have to have a lot of money to have enough interest income to get to material tax rates. I'd be more concerned that you would be getting ultra low returns on 2/3's of your savings.
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Old 05-31-2020, 08:04 PM   #5
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Thanks. I understand but how can anyone in their right mind put two-thirds of their nest egg into today's market... especially with FIRE coming in 7 months?


Makes me wonder what the least risky stock fund would be at this point.
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Old 05-31-2020, 08:10 PM   #6
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At today's interest rates you'd have to have a lot of money to have enough interest income to get to material tax rates. I'd be more concerned that you would be getting ultra low returns on 2/3's of your savings.
We have enough in savings to get by even with a 2.56% return for the next 45 years. Two years ago, I used a deterministic model to find what nest egg amount we needed without having to take too much risk. With that number, we decided to work an extra two years. No big deal, and it's done. Now we can get through to age 95 even with modest returns, higher future taxes, and potentially no social security... all worst case scenarios in some ways.

I also used FIRECalc and FRP. With average returns on either of those two software pieces, our future looks amazing. But with low returns, we get through "very comfortably". So I'd rather be comfortable and have little risk instead of being possibly extraordinarily wealthy and not sleep at night.

With that said, we still need 2.56% if we are being taxed at the ordinary income rate. If I can get the nest egg returns taxed 7% lower (from 22% to 15% LTCG), then we don't even need 2.56%. And yes, I know that 2.56% in savings accounts and CD's is not too likely in the near future.
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Old 05-31-2020, 08:17 PM   #7
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Thanks, that helps explain it. A conservative approach may make sense then. If you wanted to go a little more aggressive a short term or intermediate term bond fund could be used for part of the savings.

For me, if I thought I was pretty set, I'd stay on the mid level aggressive side (50/50 or even 60/40 AA) and try to grow my nest egg for my kids.
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Old 05-31-2020, 08:21 PM   #8
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Thanks, that helps explain it. A conservative approach may make sense then. If you wanted to go a little more aggressive a short term or intermediate term bond fund could be used for part of the savings.

For me, if I thought I was pretty set, I'd stay on the mid level aggressive side (50/50 or even 60/40 AA) and try to grow my nest egg for my kids.

The interesting thing about FRP is that it shows a great probability of success using risk averse investments instead of aggressive ones.

My wife and I don't have children nor any family to speak of but we have set up a will that if we don't make it to 95, the funds all go to the Little Sisters of the Poor.

Ultimately, the question still remains... what is the least risky investment (specifically) that generates as much return as a decent CD so that we can be taxed on LTCG instead of ordinary income?
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Old 05-31-2020, 09:01 PM   #9
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You may want to study this: https://www.bogleheads.org/wiki/Tax-...fund_placement

Most of us keep our bonds in tax-deferred accounts and equities in taxable accounts. If international equitie are part of your asset allocation you want them in taxable accounts so you can take advantage of the foreign tax credit... whichgoes to waste in tax-deferred or tax-free accounts. Domestic equities in taxable accounts get preferential tax rates for qualified dividends and long-term capital gains.
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Old 05-31-2020, 09:04 PM   #10
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..... Ultimately, the question still remains... what is the least risky investment (specifically) that generates as much return as a decent CD so that we can be taxed on LTCG instead of ordinary income?
There are many investment grade preferred stocks whose dividends are qualified and LTCG are taxed at preferential rates and yield around 5%.

35% of your nestegg in 5% preferreds and 65% in CDs at 1% would have an after-tax yield of about 2% (35%*5%*(1-15%)+65%*1*(1-22%)=2.0%....as does 2.56%*(1-22%).
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Old 05-31-2020, 11:41 PM   #11
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OP. Just a quick read of your posts. IMHO. It appears you are very "risk adverse". As illustrated by your allocation.

And to avoid having to pay a higher, tax on your CD interest income, You are now willing to take on "more" risk by investing in the stock market.

And you are assuming you will have "long term gains"..(not losses) .. IMHO...You may want to sit down, and
re-think, the type of investor you are. ie. Your risk tolerance.

Good luck.....
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Old 06-01-2020, 06:11 AM   #12
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OP. Just a quick read of your posts. IMHO. It appears you are very "risk adverse". As illustrated by your allocation.

And to avoid having to pay a higher, tax on your CD interest income, You are now willing to take on "more" risk by investing in the stock market.

And you are assuming you will have "long term gains"..(not losses) .. IMHO...You may want to sit down, and
re-think, the type of investor you are. ie. Your risk tolerance.

Good luck.....
+1

There's an expression over on bogleheads: don't let the tax tail wag the dog.
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Old 06-01-2020, 06:15 AM   #13
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Thanks. I understand but how can anyone in their right mind put two-thirds of their nest egg into today's market... especially with FIRE coming in 7 months?
Well, unless you're planning on spending that 2/3 in the next 5 years or so, I certainly would put it in the market, even though I think it's pretty likely that we're smack in the middle of a W-shaped recession. But I can see keeping 5-10 years of expenses in cash right now, instead of the more common 2-3 years, but for most people that's more like 1/3 or less.

But it doesn't matter what anyone else thinks, as long as you understand your strategy and its pros and cons and you're happy with it, more power to you.
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Old 06-01-2020, 06:19 AM   #14
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Quote:
Originally Posted by Swetch View Post
If my spouse and I retire at the end of this year, we will have about 1/3 of our nest egg in 401k accounts and 2/3 in savings accounts (which is 90% in CD's as of now).

My concern is with taxes on the interest from the savings accounts and CD's.

Where could I put this money so that it is taxed as LTCG instead of ordinary income?
Before you get too concerned about taxes you should first do a pro forma tax return as if you were retired. Unless you have better than average pensions plus a lot of interest it is likely that your effective and marginal tax rates are a lot lower than you think they will be.

For example, let's say that a married couple has $90k of ordinary income in 2020 and no other sources of income... assuming they use the standard deduction their taxable income would be $65,200 (assuming they are less than 65). Their marginal tax bracket would be 12% and their tax would be $7,429 (8.25% of the $90k of income).

Now on the other hand, let's say that the $90k of income is $30k of qualified dividends/LTCG (aka qualified income) and $60k of ordinary income. Their taxable income is still $65,200, but $30k is qualified income and $35,200 is ordinary income. The marginal tax bracket is still 12%, but the tax is only $3,829 (4.25% of the $90k of income).

There is no tax on qualified income if your taxable income is less than $80k in 2020.
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Old 06-01-2020, 10:21 AM   #15
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There are tax free alternatives as well. I built a muni ladder, but for someone wanting something easier with quality and "OK" interest something like PBMFX (1.6% yield) or for shorter duration SHM (1.2% yield). Both of these will give you interest close to what high yield savings accounts offer and better than most CDs, but tax free interest.
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Old 06-01-2020, 03:54 PM   #16
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There are tax free alternatives as well. I built a muni ladder, but for someone wanting something easier with quality and "OK" interest something like PBMFX (1.6% yield) or for shorter duration SHM (1.2% yield). Both of these will give you interest close to what high yield savings accounts offer and better than most CDs, but tax free interest.
Given that my taxable account is all parked in VWSUX right now you would have thought that I would think of tax-exempt too.
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Old 06-01-2020, 06:44 PM   #17
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OP. Just a quick read of your posts. IMHO. It appears you are very "risk adverse". As illustrated by your allocation.

And to avoid having to pay a higher, tax on your CD interest income, You are now willing to take on "more" risk by investing in the stock market.

And you are assuming you will have "long term gains"..(not losses) .. IMHO...You may want to sit down, and
re-think, the type of investor you are. ie. Your risk tolerance.

Good luck.....

We're not risk adverse. We simply don't need risk to get to our targeted retirement spending level.

The question ultimately was more about what specific investments will give us qualified dividends (instead of ordinary income) without significantly upping our risk.
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