Regular Savings vs Taxable Savings - Educate Me

[mountainsoft]

I am familiar with standard savings accounts. First with my local bank, then I switched to a Discover online savings account earlier this year. The interest rate is fairly low (1.8% at the moment), but it's FDIC insured and I can add or withdraw money any time. Come tax time the bank sends me a 1099-INT so I can plug the numbers into my tax return. Easy Peasy.

I started looking at taxable investment accounts through Vanguard today and have to confess I'm confused. I choose investments, make contributions, and understand losses can occur (not FDIC insured). I assume I can take money out any time I want. However, I don't understand the tax side of things. What are dividends and capital gains, and how do they factor in come tax time? Do they send an equivalent 1099-INT statement, or would I have to track and fill out additional tax forms on my tax return?

New stuff is always scary...

 

[RunningBum]

I'll respectfully suggest if you don't know what dividends and capital gains are, you have some reading to do. I'm not even sure what to suggest for this level. https://www.bogleheads.org/readbooks.htm is a start for a book list.

Mutual Funds 101 actually might be a good place to start for basics, and beyond. I've always found Fairmark to be well-written and understandable.

For a quick answer, yes, VG will send a 1099 consolidated form with all the various 1099s that apply to your tax situation, and it can be given to a tax preparer or imported into a tax program.

 

[HI Bill]

If you have multiple accounts, VG will send an annual consolidated tax information statement. Mine includes the following forms: 1099-INT, 1099-DIV, Foreign Taxes Paid (international mutual funds), and Summary of proceeds from Broker and Barter Exchange Transactions.

The money market earnings actually show up on the 1099-DIV, as that's how you earn $ in VMFXX (VG Money Market Reserves).

 

[mountainsoft]

I'll respectfully suggest if you don't know what dividends and capital gains are, you have some reading to do ... Mutual Funds 101 actually might be a good place to start for basics ... For a quick answer, yes, VG will send a 1099 consolidated form with all the various 1099s that apply to your tax situation, and it can be given to a tax preparer or imported into a tax program.

Thanks, respectfully accepted. The linked page was helpful. I knew some of the basics (in limited detail), but hadn't encountered these on the tax forms before. Sounds like it's not as bad as I was envisioning.

 

[HI Bill]

Sounds like it's not as bad as I was envisioning.

They are not. If you use Turbo Tax to do your taxes, you can import the forms directly from VG into your tax return...no need to even read or understand them...but you should, so you know the tax implications of your investment decisions!

 

[travelover]

.........What are dividends and capital gains, and how do they factor in come tax time? ..........

This is actually kind of important. You pay taxes on interest the same as if you'd earned it in wages, but dividends and capital gains are taxed not at all for lower income and only at 15% for most people.



https://www.investopedia.com/ask/answers/12/how-are-capital-gains-dividends-taxed-differently.asp


One book I recommend to start with is the Bogleheads book.

 

[pb4uski]

^^^^ to be clear though, the 0% and 15% rate on qualified dividends only apply to certain equity (stock) fund or ETF dividends.... dividends on bond or money market funds or ETFs do not qualify.

 

[audreyh1]

This is actually kind of important. You pay taxes on interest the same as if you'd earned it in wages, but dividends and capital gains are taxed not at all for lower income and only at 15% for most people.



https://www.investopedia.com/ask/answers/12/how-are-capital-gains-dividends-taxed-differently.asp


One book I recommend to start with is the Bogleheads book.

Qualified dividends are taxed not at all for lower income and only at 15% for most people.

Plenty of mutual funds pay dividends that are not qualified: bond funds, REIT funds, money market funds, etc. And non-qualified dividends are treated just like interest income for tax purposes.

 

[travelover]

Qualified dividends are taxed not at all for lower income and only at 15% for most people.

Plenty of mutual funds pay dividends that are not qualified: bond funds, REIT funds, money market funds, etc. And non-qualified dividends are treated just like interest income for tax purposes.

Yes, you are correct. I was trying to keep it simple and emphasize that the way different investments are taxed is important and can be used strategically. Those specifics are in the investopedia link.

 

[marko]

I choose investments, make contributions, and understand losses can occur (not FDIC insured).

Losses are only losses if you sell that stock when it's low. A drop in stock price is a 'loss' but not really.

Within your context, a stock loss like Enron going belly-up and the stock vanishing would be a true loss and not covered by FDIC.

As others have noted, some good heavy homework might be in order.

 

[DayDreaming]

... and I can add or withdraw money any time. Come tax time the bank sends me a 1099-INT so I can plug the numbers into my tax return. Easy Peasy.

Keep in mind that withdrawing money / selling funds can be a taxable event when you realize any capital gains, assuming that fund has grown.

 

[mountainsoft]

Which funds would you recommend in a taxable account? I would want a fund that minimizes taxes, provides better returns than the 1.8% I get with my regular savings account, but less risk than I have in my traditional IRA account.

Two I was looking at are:
VTMFX - Vanguard Tax-Managed Balanced Fund Admiral Shares.
VASIX - Vanguard Life Strategy Income Fund

 

[OldShooter]

Well, to minimize taxes you do not want to be earning interest income -- which both of these funds do. You want a passive equity fund. I favor VTWSX, which is a total world fund, but you may prefer a mix of a total US stock market fund like VTSMX and an international fund like VGTSX. This latter approach allows you to "tune" your international exposure. 30% seems to be a popular point. VTWSX is about 45% IIRC.


Hold the income funds in your tax sheltered accounts.

 

[COcheesehead]

Well, to minimize taxes you do not want to be earning interest income -- which both of these funds do. You want a passive equity fund. I favor VTWSX, which is a total world fund, but you may prefer a mix of a total US stock market fund like VTSMX and an international fund like VGTSX. This latter approach allows you to "tune" your international exposure. 30% seems to be a popular point. VTWSX is about 45% IIRC.


Hold the income funds in your tax sheltered accounts.

The exception being muni bond funds. Those will work in a taxable account.

 

[OldShooter]

The exception being muni bond funds. Those will work in a taxable account.

True, but it is necessary to carefully evaluate the muni fund yield versus the net after taxes for non-exempt options. It is not at all uncommon for people to become enthralled with the no-taxes aspect and end up with a smaller net than they would have had with a taxable alternative. Risk is another factor; high-yielding munis are riskier than more vanilla taxable options.


Given the OP's relative lack of expertise and goal of simplicity in this area I would suggest that trying to evaluate muni options is probably not a good idea.

 

[COcheesehead]

True, but it is necessary to carefully evaluate the muni fund yield versus the net after taxes for non-exempt options. It is not at all uncommon for people to become enthralled with the no-taxes aspect and end up with a smaller net than they would have had with a taxable alternative. Risk is another factor; high-yielding munis are riskier than more vanilla taxable options.


Given the OP's relative lack of expertise and goal of simplicity in this area I would suggest that trying to evaluate muni options is probably not a good idea.

I was just clarifying statements you made that appeared to be more general then what the OP asked. Tax free income is still possible in a taxable account. Evaluation of quality and return is still needed as always.
Carry on.

 

[pb4uski]

Which funds would you recommend in a taxable account? I would want a fund that minimizes taxes, provides better returns than the 1.8% I get with my regular savings account, but less risk than I have in my traditional IRA account.

Two I was looking at are:
VTMFX - Vanguard Tax-Managed Balanced Fund Admiral Shares.
VASIX - Vanguard Life Strategy Income Fund

Your best choices for tax efficiency are international and domestic stocks... like Vanguard Total International Stock Fund and Vanguard Total Stock Insex Fund or their ETF equivalents. For most people, qualified dividends are taxed at preferential rates of 0% or 15% depending on your income level and you can take a tax credit for any foreign taxes paid.

Then load your tax-deferred accounts with bonds and stocks as needed to get to your target AA.

See https://www.bogleheads.org/wiki/Principles_of_tax-efficient_fund_placement for more details.

 

[mountainsoft]

Your best choices for tax efficiency are international and domestic stocks... like Vanguard Total International Stock Fund and Vanguard Total Stock Index Fund

Those have too much risk for my comfort level. I can't tap into my IRA for another five years, and I wouldn't want to lose half our savings if the market tanks just as we have an unplanned situation.

 

[travelover]

Those have too much risk for my comfort level. I can't tap into my IRA for another five years, and I wouldn't want to lose half our savings if the market tanks just as we have an unplanned situation.

That is exactly why you have a mix of stocks and bonds. You need the growth of stocks to offset inflation and bonds to draw from when stocks are down. I "lost" almost half my stock investment value in the great recession, but because I did not sell any stocks / stock funds, I didn't lose a dime.

 

[mountainsoft]

That is exactly why you have a mix of stocks and bonds. You need the growth of stocks to offset inflation and bonds to draw from when stocks are down.

If I only have stocks in my taxable account and the market tanks before I can access the bonds in my tax deferred IRA account for five years, wouldn't my only option be to sell stocks?

 

[pb4uski]

Yes, but you then rebalance within your tax deferred.

An example.

Joe retires with $1m... $200k taxable and $800k in tax deferred.. a 60/40 AA and 3.5% WR ($35k).

When he retires, his taxable account is $35k in MM and $165 in stocks and his IRA is $435k stocks and $365k in bonds... so overall he has $600k of stocks and $400k of bonds.

Fast forward one year. Joe has spent his $35k in cash and stocks have dropped 20%.

Joe has $132 of stocks left in his taxable account and his IRA is $348k of stocks and $365k of bonds... he has $845k in total.

Joe sells $35k of stocks in his taxable account for cash for the next year's spending, leaving $97k in stocks in taxable. Since his new equity target is $507k (60% of $845k total) and he has $97k in taxable, he needs $410k of equities in tax deferred and he only has $348k... so he sells $62k of bonds and buys $62k of equities. That leaves him with $303k in bonds, which when combined with the $35k in cash is $338k.... 40% of the $845k total.

Rinse and repeat as needed.

 

[mountainsoft]

Yes, but you then rebalance within your tax deferred. An example. Joe retires with $1m

"Joe" is more dedicated than me, and a lot richer too. I'm the "set it and forget it" type. I don't want to spend my time monitoring investments and rebalancing every year. I put money in as I have it, take money out when I need it, and hopefully earn a decent return in between. That's about as much as I care to get involved. Easy button dummy investing. It's one reason I prefer the all-in-one balanced funds.

As long as the net effect of earnings and taxes is higher than the 1.8% I'm earning with a regular savings account, that's good enough for me. I'm not trying to chase every last little tax savings.

 

[pb4uski]

It takes Joe less than an hour a year, but the benefits are substantial so it is worth an hour of his time.

Joe could do it with two funds (Vanguard Total Stock and Total Bond) but he is a bit adventureous and actually uses three (Vanguard Total International Stock in addition to the two above).

 

[Chuckanut]

Those have too much risk for my comfort level. I can't tap into my IRA for another five years, and I wouldn't want to lose half our savings if the market tanks just as we have an unplanned situation.

Sleeping well at night is an important part of anybody's financial plan.

 

[pb4uski]

Those have too much risk for my comfort level. I can't tap into my IRA for another five years, and I wouldn't want to lose half our savings if the market tanks just as we have an unplanned situation.

One thing to keep in mind is that your overall AA modulates your risk of loss.

For example, I m 60/40 so if stocks declined 50%, then my portfolio decline would be 30%... now realistically, if stocks declined 50% then bonds might become more valuable and partially offsetthe loss in stocks.

Now OTOH, if a 50% loss in stocks in your taxable account would cause you to have to tap your IRA early then that would be a concern. In that case, you might want to have a ladder for your pre-59 1/2 spending and put any excess in equities.