Selling Stocks in Taxable Accounts to Fund 401(k) and IRA

[Yachi]

I currently fund my 401(k) to the maximum company match level, this costs me around $4,000. I've stopped funding my Roth IRAs. I don't have room in my current budget to fully fund my 401(k) and IRAs, although this may change several years from now when my wife starts working.

Due to successful purchases in my cash stock account, its balance exceeds both my 401(k) and IRAs combined. I have 14 years before my first child reaches college age, but it will take all of these 14 years of selling from the cash account and investing the proceeds in the retirement accounts to substantially lower the cash account balance. As financial aid is blind to retirement accounts, but heavily penalizes cash accounts, I feel like this is what I should do, although it will result in capital gains from the cash account.

One of the things holding me back is I cannot purchase individual stock in my 401(k) account, although I have a nice S&P 500 index fund there. Our family income could conceivably be large in 14 years, eliminating financial aid anyway. Another less likely scenario could be early retirement at that same time, reducing family income. Does it make sense to move funds from this cash account into retirement accounts to save educational expenses? Does it make more sense from a taxing perspective to put the money into retirement accounts?

[LOL!]

Yes, it makes sense to move from taxable to tax-advantaged accounts if possible without commissions and tax consequences. One should have been tax-loss harvesting all along, so even if selling nowadays at a gain, one should be able to offset the realized gain with previous carryover losses.

IMHO, there is no reason to purchase individual stock in order to meet one's asset allocation plan. But in an IRA, one should have no problems with buying stocks, ETFs, mutual funds, bonds, CDs, etc.

As for funding Roth IRA, I am not sure why you are not doing that? Maybe you are. If you believe your income limits you, think again: You can probably do the "back door Roth IRA" thing. Google it.

[kaneohe]

sell stock....pay CG tax or use loss carryover at CG rather than ord rates (CON)
invest in 401K.....get tax deduction at ord rates (PRO)
"Hide" assets in 401K from FAFSA..................(PRO)
withdraw from 401K at ord rather than CG rates (CON)

seems like this is a quantitative dilemna and unless you put some numbers here like tax rates now and later, you cannot get a meaningful answer.

[Animorph]

If you are lower income, directing more of your pay into the 401k and living off your taxable account stocks may very well allow you to stay within the 0% capital gains taxable income limit. That would be just about a no brainer I think, as long as you funded Roth IRA's to the max as well.

If you are higher income and you can't afford to put more than $4k into your 401k, what the heck are you doing on this forum? You may be spending too much of your income.

[Yachi]

I didn't realize it, but I am in a tax bracket with 0% capital gains. It looks like I'm in the 15% tax bracket. Thanks to Animorph, I realized I can use 401(k) contributions to ensure I stay in this tax bracket (sometimes I have overtime, and I might get a sizable raise next year). Fortunately (or unfortunately) I don't have many losses to offset gains. I sold two losing positions a few years ago, but they are very small compared to the majority of my gains.
Our 401(k) plan also offers a Roth option, but it sounds like I should be careful with this to keep myself in the 15% tax bracket.

LOL @ why I'm on this forum, I'm spending too much of my income on student loans, commuting expenses, and diapers lately, but it wasn't always like this.

It sounds like I should sell for 0% capital gains and put the money in tax-advantages accounts.

Since I might get salary increases in the next few years that prevent me from staying in this tax bracket, can I lock in a gain now at 0%, and reset my tax basis?

[LOL!]

Folks in the 0% LTCG tax bracket practice something called "Tax Gain Harvesting". So yes, you can lock in a gain now if it makes sense.

[Animorph]

And be careful that the sum of your regular income and capital gains doesn't exceed the 15% tax bracket. It is not enough to keep just your regular income in the 15% bracket.

Since you expect your tax bracket to increase, you should put as much as you can into your Roth (401k?) at work while still staying in the 15% bracket. I'd certainly sell stocks to make normal Roth IRA contributions until you hit the income limits, and then make "backdoor" Roth contributions if you still can. This gets some of your taxable account into the Roth. Then, as you say, use the 401k to stay in the 15% bracket as long as you can. You will get a second chance to do this if you retire early, so no need to stress over getting it perfect as long as you are filling up the 401k.

[haha]

I have difficulty keeping the principle of this tax situation clear. Let me run down my working understanding; please comment or correct. I am a single taxpayer. Say my ordinary income is $25,000. After standard deduction and exemption I am in the 15% marginal bracket. Say I have total realized capital gains (LT) and qualified dividends of $50,000. My understanding is that some amount of my ltcg and qual divs will be taxed at 0%, the rest at 15%; and that none of my ordinary income will be taxed over 15%, although clearly when I add my net realized ltcgs the taxable income if it were all ordinary would put me in the 25% bracket.

Ha

[Animorph]

Quote:

Originally Posted by haha I have difficulty keeping the principle of this tax situation clear. Let me run down my working understanding; please comment or correct. I am a single taxpayer. Say my ordinary income is $25,000. After standard deduction and exemption I am in the 15% marginal bracket. Say I have total realized capital gains (LT) and qualified dividends of $50,000. My understanding is that some amount of my ltcg and qual divs will be taxed at 0%, the rest at 15%; and that none of my ordinary income will be taxed over 15%, although clearly when I add my net realized ltcgs the taxable income if it were all ordinary would put me in the 25% bracket. Ha

Yeah, that's it. Say you are $10k under the top of the 15% taxable income bracket with just your ordinary income (including non-qualified dividends and short-term capital gains distributions from mutual funds) and deduction and exemption. The first $10k of LTCG/qualified dividends are taxed at 0%. The rest ($40k) is taxed at 15%.

I've modeled this in my planning, but I'm not at the point where I can actually take advantage of it yet. So check specific cases with a tax calculator.

[haha]

Quote:

Originally Posted by Animorph Yeah, that's it. Say you are $10k under the top of the 15% taxable income bracket with just your ordinary income (including non-qualified dividends and short-term capital gains distributions from mutual funds) and deduction and exemption. The first $10k of LTCG/qualified dividends are taxed at 0%. The rest ($40k) is taxed at 15%. I've modeled this in my planning, but I'm not at the point where I can actually take advantage of it yet. So check specific cases with a tax calculator.

Thanks, Animorph.

Ha

[NW-Bound]

As I stopped having earned income in the middle of 2012, my income was low enough to let me sell, and immediately rebuy some stocks to make use of this tax-free cap gain.

In short, I was able to reset the cost basis of some stocks to $50K higher with no tax dues. Well, I forgot about my state tax, which did not allow it. But still...