International Fund in Taxable Accounts

[slowsaver]

Last year, I started investing in a Vanguard fund called, "Tax-Managed International Fund" (VTMGX). I hold this fund in a taxable account.

Then in the middle of last year, Vanguard merged this fund with another one, and it's now called "Developed Markets Idx Admiral Fund." No mention of being tax-managed anymore.

Now I'm looking at my 2014 1099-Div, and I am annoyed about paying so much dividend tax for a fund that is worth less than what I paid for it ...

Does anybody know whether VTIAX (Total International Stock Index Fund) is better in a taxable account than VTMGX (Developed Markets Index Fund)? Is there a way to look this up? Thanks.

 

[MichaelB]

Last year, I started investing in a Vanguard fund called, "Tax-Managed International Fund" (VTMGX). I hold this fund in a taxable account.

Then in the middle of last year, Vanguard merged this fund with another one, and it's now called "Developed Markets Idx Admiral Fund." No mention of being tax-managed anymore.

Now I'm looking at my 2014 1099-Div, and I am annoyed about paying so much dividend tax for a fund that is worth less than what I paid for it ...

Does anybody know whether VTIAX (Total International Stock Index Fund) is better in a taxable account than VTMGX (Developed Markets Index Fund)? Is there a way to look this up? Thanks.

There are two differences. The distribution rate for Developed Markets Index is slightly higher, roughly 3.6% vs 3.3%. The QDI is also slightly higher for Developed Markets - 78% vs 71%. That means more of the distribution will be taxed as ordinary income for Total Int'l. The tax advantage is slightly in favor of the Developed Markets fund.

 

[karluk]

There are two schools of thought about holding international stock funds in taxable accounts. Some people dislike that fact that international stock funds typically have less than 100% qualified dividends and prefer to place them in tax sheltered accounts. Others want to be eligible for the foreign tax credit such funds offer, and keep them in taxable accounts. My own experience is that the tax on non-qualified dividends is a bigger negative than the benefit of the foreign tax credit, so I now have all of my international stocks sheltered from taxes.

Your personal experience from last year is no doubt very unpleasant, but I suspect you don't really have anything to complain about from a tax point of view. You get to claim the foreign tax credit, most of your dividends are qualified, and you could have sold your shares before the end of 2014 in order to establish the loss for tax purposes. If you had done this, the tax savings from the capital loss would probably be larger than the extra tax you have to pay on dividends.

 

[LOL!]

This is a matter of discussion of annoyed folks over on the Bogleheads forum. For instance: Bogleheads • View topic - Please double check my tax efficiency calculations

Vanguard Total International Stock Index fund was not much more tax efficient than your tax-managed international fund in 2014. Expect to pay about 0.4% to 0.46% of your holdings in taxes if you are in the 25% marginal income tax bracket. In contract, Total US stock index fund would cost you about 0.29%. There is probably no way to go below 0.25% unless one is in the 15% marginal income tax brack and qualified dividends are tax free.

Here is some more fun math for you inspired by a question in that Bogleheads thread: If you had $10,000 in total US stock index in a Roth IRA and $10,000 of Total Int'l stock index in your taxable account, you would pay 0% tax on the Total US and 0.41% tax on the Total Int'l or $41 tax total. But if you switched the two with Total Int'l in a Roth and Total US in taxable, then you would still pay the foreign taxes for Total Int'l in the Roth of $19 (no foreign tax credit) and also another $29 for the US taxes on the Total US stock in the taxable account for a total of $48. That is, it really doesn't matter which fund you place where except perhaps for changes to your AGI.

OTOH, you were lucky to put tax-managed international into your taxable account because it actually lost money, so that you were able to tax-loss harvest and offset any taxes on the dividends from this fund. So you made the right decision to lose money in taxable. One certainly does not want to lose money in their Roth IRA.

VTMGX has gone up 4.9% so far this year as have other int'l index funds, so tax-loss harvesting and buying replacement shares was a good move. If you did not TLH, then the 4.9% gain may put your positions back into positive territory and prevent tax-loss harvesting now.

 

[pb4uski]

There are two schools of thought about holding international stock funds in taxable accounts. Some people dislike that fact that international stock funds typically have less than 100% qualified dividends and prefer to place them in tax sheltered accounts. Others want to be eligible for the foreign tax credit such funds offer, and keep them in taxable accounts. My own experience is that the tax on non-qualified dividends is a bigger negative than the benefit of the foreign tax credit, so I now have all of my international stocks sheltered from taxes......

My experience is the inverse. The incremental taxes on non-qualified international fund dividends is less than the value of the foreign tax credit. Not by a lot though. The net benefit is about 1% of my total dividends but it is a small benefit.

 

[karluk]

My experience is the inverse. The incremental taxes on non-qualified international fund dividends is less than the value of the foreign tax credit. Not by a lot though. The net benefit is about 1% of my total dividends but it is a small benefit.

My experience was a very clear cut advantage to U.S. stocks in taxable. At one time I owned both VTSAX and VTIAX in taxable accounts. Being in the 15% tax bracket and generally getting 100% qualified dividends from VTSAX, I would pay $0 Federal tax on the domestic stocks. In contrast, VTIAX never came close to 100% qualified dividends, nor did the foreign tax credit ever completely offset the taxes due on the non-qualified dividends. I always ended up owing some small, but non-zero tax on VTIAX.

I eventually gave up hoping that Vanguard would figure out a way to make more of VTIAX's dividends qualified and sold it from my taxable account in order to put more taxable money into VTSAX.

Your experience and LOL's earlier post lead me to suspect that one's tax bracket plays a big role in the tax tradeoffs. I don't monitor this issue every tax year, so I suppose things may have changed. But I got hit with a bigger tax bill for too many years. That discourages me from even thinking about buying VTIAX in taxable.

Oddly enough, last year was one clear example of why it might pay off to hold VTIAX in taxable - the tax loss harvesting possible last year would have generated a net tax benefit, even after paying the extra taxes on non-qualified dividends. But naturally this is not something that can be planned in advance. Very few investors make an investment in taxable soley hoping to lose money for tax purposes.

 

[LOL!]

Yes, one's tax bracket does play a big role. For someone who pays 0% tax on qualified dividends, they cannot always use the foreign tax credit to offset taxes that they didn't pay. (Don't forget the foreign tax credit is used to offset US taxes that one pays, so if you don't pay taxes, then there should be no credit given.)

And for someone who pays 28% or more on non-qualified dividends, then those should definitely go into a tax-advantaged account.

Everyone should do their own calculations, but I realize that not everyone likes to do the tax math.

 

[slowsaver]

I don't really "sell" funds yet, but I'd like to be smarter this year. So what I should have done at the end of last year is check how much dividends I accumulated (~$1600), then sell enough of the fund to lose $1600, correct? The capital loss would have cancelled-out the dividend.

The foreign tax credit was only $68.

 

[Free To Canoe]

My experience was kind of the opposite of the Ops. I bought VDMAX a while back for the international large cap exposure without the emerging markets. I was peeved that it got merged with the tax advantaged fund to form VTMGX.
I stuck with it and also bought the etf VEA.

 

[FUEGO]

I did the analysis a long time ago and figured the foreign tax credit gave a slight advantage to international in my taxable accounts. Of course I've always been near the 0% tax bracket (briefly breaking out of the 10% into the 15% for a couple of years). Now that I'm back to the zero percent bracket it still doesn't matter since 0% is 0% whether it's cap gains, qualified divs or non-qual'd divs.

 

[pb4uski]

So your taxable income is zero?

 

[LOL!]

I don't really "sell" funds yet, but I'd like to be smarter this year. So what I should have done at the end of last year is check how much dividends I accumulated (~$1600), then sell enough of the fund to lose $1600, correct? The capital loss would have cancelled-out the dividend.

The foreign tax credit was only $68.

No, I think you should have sold ALL shares that had a loss near the end of 2014, but before the December dividend was paid. I described all of this and the reasons in this post: http://www.early-retirement.org/forums/f44/lol-s-market-timing-newsletter-57042-13.html#post1528480

 

[slowsaver]

No, I think you should have sold ALL shares that had a loss near the end of 2014, but before the December dividend was paid. I described all of this and the reasons in this post: http://www.early-retirement.org/forums/f44/lol-s-market-timing-newsletter-57042-13.html#post1528480

Hmm, this sounds suspiciously similar to buying-high and selling-low.

 

[LOL!]

Not if one buys replacement shares in another fund that is not substantially identical.

Lots of folks don't "get" tax-loss harvesting at first, but when they do, they really embrace it.

 

[Cobra9777]

When I was working and in a high tax bracket, I kept international equities in tax-deferred accounts to avoid high taxation on the non-qualified portion of the dividends. After retiring, I moved it to the taxable account. For 2014, I probably jumped the gun, as I'm still in a high bracket due to exercising some Megacorp stock options. As a result, the incremental tax on the non-qualified portion of the international dividends was slightly more than the foreign tax credit. It's a very small difference however, and the tax loss harvesting at year-end was quite profitable by comparison. Ordinarily, I will have enough taxable income in the 15% bracket to utilize the foreign tax credit, which should exceed 15% of the non-qualified dividend. Even then, it's a fairly small advantage. Also, this is based on the historical mix of qualified/non-qualified for the ETFs I'm holding, which could change over time.

 

[pb4uski]

....Lots of folks don't "get" tax-loss harvesting at first, but when they do, they really embrace it.

"Unfortunately" I don't have a single purchase lot in a loss position in my taxable accounts so my tax management opportunities are limited.

 

[karluk]

No, I think you should have sold ALL shares that had a loss near the end of 2014, but before the December dividend was paid. I described all of this and the reasons in this post: http://www.early-retirement.org/forums/f44/lol-s-market-timing-newsletter-57042-13.html#post1528480

LOL, I'm not convinced that OP should have sold the international stock fund before the ex-dividend date. Your situation was different than OP's in that you were concerned about your short holding period making all of your dividends non-qualified. OP, on the other hand, appears to have owned the international fund at least since midyear and should be eligible to receive qualified dividends from the year end distribution.

So, as a simple example, suppose that OP owns 1,000 shares of an international fund that in early December was selling for $10 per share and has a cost basis of $12,000. Selling before the ex-dividend date would establish a $2,000 loss for tax purposes.

But let's say the fund is planning on issuing a $1 per share dividend in mid December. Ignoring the day to day fluctuations in NAV, that gives OP the option of waiting until late December to sell, receive a $1,000 dividend distribution in cash and then sell the fund at about $9 per share. The net result is $9,000 from the selling the shares - $12,000 cost basis + $1,000 dividends = $2,000 loss. I.e. OP would get the same net loss by waiting until late December to sell and end up with the same AGI as selling in early December. But waiting until late December would magically convert some of the AGI into qualified dividends, thus lowering the net tax bill more than selling in early December.

I am too lazy to run this scenario through tax software to verify the net tax effect. But it seems to me that waiting until after the ex-dividend date can't hurt one's tax situation and might very well help it.

 

[photoguy]

I went with VTMGX/VEA (developed markets) over VTIAX (total international) primarily because I wanted separate funds for emerging markets. VTIAX is about 20% emerging.

As a bonus VTMGX has an expense ratio of only 0.09 vs 0.14 for vtiax.

 

[Cobra9777]

I went with VTMGX/VEA (developed markets) over VTIAX (total international) primarily because I wanted separate funds for emerging markets. VTIAX is about 20% emerging.

As a bonus VTMGX has an expense ratio of only 0.09 vs 0.14 for vtiax.

+1

I owned VXUS last year, which is the ETF equivalent of VTIAX - total international with about 85/15 mix of developed/emerging. I sold this for tax loss harvesting in late December last year and bought a 50/50 mix of VEA (developed) and VWO (emerging). I like the higher emerging and the flexibility to adjust going forward. But as you noted, as a bonus, the net ER is lower than VXUS because VEA is 0.09%.

 

[LOL!]

But waiting until late December would magically convert some of the AGI into qualified dividends, thus lowering the net tax bill more than selling in early December.

I am too lazy to run this scenario through tax software to verify the net tax effect. But it seems to me that waiting until after the ex-dividend date can't hurt one's tax situation and might very well help it.

Please think more carefully about this:

Is it better to magically convert some of the AGI into qualified dividends or to have a lower AGI to begin with? Which is taxed at a higher rate: qualified dividends or no income?

It is true that once one received the dividends, then waiting a couple of weeks to make them qualified might be useful, but avoiding them in the first place I think is better.

 

[karluk]

Please think more carefully about this:

Is it better to magically convert some of the AGI into qualified dividends or to have a lower AGI to begin with? Which is taxed at a higher rate: qualified dividends or no income?

Please read through my example again. There is no change at all between AGI in the two scenarios. The only difference is how much of the (equal) AGIs consists of qualified dividends. So your question should really be, "Is it better to magically convert some AGI to qualified dividends without increasing AGI at all?" I say the answer is yes.

 

[pb4uski]

LOL, I'm not convinced that OP should have sold the international stock fund before the ex-dividend date. Your situation was different than OP's in that you were concerned about your short holding period making all of your dividends non-qualified. OP, on the other hand, appears to have owned the international fund at least since midyear and should be eligible to receive qualified dividends from the year end distribution.

So, as a simple example, suppose that OP owns 1,000 shares of an international fund that in early December was selling for $10 per share and has a cost basis of $12,000. Selling before the ex-dividend date would establish a $2,000 loss for tax purposes.

But let's say the fund is planning on issuing a $1 per share dividend in mid December. Ignoring the day to day fluctuations in NAV, that gives OP the option of waiting until late December to sell, receive a $1,000 dividend distribution in cash and then sell the fund at about $9 per share. The net result is $9,000 from the selling the shares - $12,000 cost basis + $1,000 dividends = $2,000 loss. I.e. OP would get the same net loss by waiting until late December to sell and end up with the same AGI as selling in early December. But waiting until late December would magically convert some of the AGI into qualified dividends, thus lowering the net tax bill more than selling in early December.

I am too lazy to run this scenario through tax software to verify the net tax effect. But it seems to me that waiting until after the ex-dividend date can't hurt one's tax situation and might very well help it.

Please think more carefully about this:

Is it better to magically convert some of the AGI into qualified dividends or to have a lower AGI to begin with? Which is taxed at a higher rate: qualified dividends or no income?

It is true that once one received the dividends, then waiting a couple of weeks to make them qualified might be useful, but avoiding them in the first place I think is better.

I think it depends on your circumstances. In the example, if you have other ordinary income it would be better to wait until the dividend is paid as that would create a bigger loss that can be used to offset more ordinary income and if you sold before the dividend is paid and then the qualified portion of the dividend attracts a preferential tax rate.

If you don't have other income then I'm not sure it matters if you have a $2k capital loss vs $1k of dividends and a $3k capital loss because your total income is a $2k loss no matter how you frame it.

 

[karluk]

In the example, if you have other ordinary income it would be better to wait until the dividend is paid as that would create a bigger loss that can be used to offset more ordinary income and if you sold before the dividend is paid and then the qualified portion of the dividend attracts a preferential tax rate.

If you don't have other income then I'm not sure it matters if you have a $2k capital loss vs $1k of dividends and a $3k capital loss because your total income is a $2k loss no matter how you frame it.

I've just examined the 2013 Qualified Dividends and Capital Gains worksheet, and I think you're exactly correct. If you have ordinary income, a capital loss appears to be subtracted from the ordinary income first, not from the qualified dividends. You retain the benefit of having some of your AGI converted to qualified dividends through this maneuver.

To sum up the tax loss situation as I understand it: If you sell in early December, you get a $2,000 capital loss to subtract from ordinary income, which is worth $2,000 * .15 = $300 in the 15% tax bracket. If you sell in late December, you get a $3,000 capital loss to subtract from ordinary income, but also have to pay tax on the $200 portion of the dividends that is non-qualified. The net tax savings in the 15% tax bracket is $3,000 * .15 - $200 * .15 = $420. It appears to be well worth taking the trouble to wait and collect the dividend before selling your shares.

Edit: I should also explain that I got the $200 non-qualified dividends by making the approximation that 80% of the dividends would be qualified. I believe that's close to the percentage that Vanguard reported for OP's international fund. In real life, of course, you would have to use the actual percentage of qualified dividends as reported by your mutual fund company.

 

[LOL!]

And if you already have $5,000 (or $10,000 or $100,000) in tax losses from other things?

 

[karluk]

And if you already have $5,000 (or $10,000 or $100,000) in tax losses from other things?

I was actually about to run some trial scenarios on just this type of situation, where the capital loss is larger than the maximum $3,000 deduction from ordinary income. You get a capital loss carryover, which may or may not be worth more than the effect on the current year's taxes. I think you would probably always come out ahead "in the long run", but it may require such a long wait as to not make it worth your while in real life.

Still, this is a real handy maneuver to remember for the next time I have to realize a capital loss. One's gut reaction is to avoid the year end dividend, but it's awfully easy to come up with a scenario where that's the wrong thing to do.