Shielding income from taxes.

[modhatter]

I have 1,400,000 to invest. I am 65 yrs. old and will be receiving ss in about 10 months. I am very conservative I think, there fore I do not want more than 40% in stocks at this time. I HAVE NO TAX SHELTERED ACCOUNTS except one IRA with only $8,000 in it and can't contribute more than $5,000 a year to it.

On the 40% stock portion ($560,000) I am leaning towards dividend paying stocks thereby generating maybe 3% income being taxed at capitol gains rate which I would like to re-invest all dividends. (This is my grow portion)

As for the remaining 60% ($840,000) I am looking for income. My tax bracket will be whatever my portfolio produces in income plus $20,000 a year in Soc Sec.
I do not want an annuity, so count that one out. But I am looking for ways to minimize my tax bite on all this "unsheltered income"

Since, I don't think I will be in a high tax bracket (past 25%) the state issued muni's don't pay enough and besides I'm in Florida with no state income tax.

Most tax free bond issues have pretty meager interest rates. I am interested in looking at MLP's because of nice yield and tax advantage. Possibly I-bonds, though rate sucks. Possibly preferds and some individual bonds (which I would hold to end)

I am new to all of this and have been trying hard to learn as much as I can in the last year. I have read all the right books, but generally lack first hand experience. I am leary of stock market now, as I feel for the most part it is overvalued, and our federal deficit and continued spending really scares me. (though no one in Washington seems to want to address this matter)
Thus my reluctance to put more than 40% in stock funds at the momment.

So you more experienced investors out there who crave income, but know how to watch tax bite-----ANY WORDS OF WISDOM?

I figure I need a minimum of $24,000 a year clear to supplement my Soc Sec., plus an undetermined amount to pay taxes.

If I didn't find some way of sheltering some of the income- here's how it would break out:

$540,000 generating 3% dividends=$16,200 x 15% tax = $2,430
$840,000 generating 6% income= $50,400 x 25% taxes= 12,600
Social Security $18,360 (85%) x Tax 25% = $4,590
Rental income: $5,000 taxed at $25% = $1,250
That's $ $20,870 going to taxes.
I sure hate to have to pay that much in taxes in retirement. (and this will probably go up, as I am sure we are going to see some tax hikes in the future to get out of this huge deficit)

My other objective I must point out, it to be able to leave as much inheretance as possible. SO THERE YOU HAVE IT.

 

[LOL!]

Well, go for the highest after-tax return. It is no sin to pay taxes if you end up with more in your pocket. My MIL had about $5000 in income each year. She only bought tax-free muni bonds because she didn't like to pay taxes. You tell her that she could have more money if she bought corporate bonds or Treasuries and paid the taxes on the income, but she would not hear of it.

Anyways, are you married? I read on another forum where a 65-year old, married filing jointly could make $80,000 a year and pay only $6400 in taxes.

With $24,000 in income plus SS bennies, you should have almost no taxes. Did you run TurboTax to see?

 

[ERD50]

Yes, you are using *marginal* tax rates - your taxes won't be anywhere near that high.

As an example, my taxable income was a fair ways into the 15% marginal bracket in 2006, and my *average* federal taxes were 3.9%

I have some credits than brought that down, but check it out.

-ERD50

 

[shiny]

You might be interested in the Tax Managed Balanced fund at Vanguard. IIRC it is slightly less than 50% stocks and the rest bonds - very tax efficient.

 

[modhatter]

No, I am single.

Here are Federal Tax Rates for 2006:
Schedule X — Single
If taxable income is over-- But not over-- The tax is:
$0 $7,550 10% of the amount over $0
$7,550 $30,650 $755 plus 15% of the amount over 7,550
$30,650 $74,200 $4,220.00 plus 25% of the amount over 30,650
$74,200 $154,800 $15,107.50 plus 28% of the amount over 74,200
$154,800 $336,550 $37,675.50 plus 33% of the amount over 154,800
$336,550 no limit $97,653.00 plus 35% of the amount over 336,550

As stated in my original post - my total income with no tax shelter would be $89,960 of which ($16,200 would be in dividends taxed at 15%)and $73,760 would be taxed at regular tax rate. Don't you count the dividend income in as your total income for your tax bracket? If so, I would be in the 28%. If not I would be in the 25% bracket.

If not counted in total income, then I would pay
$4, 220 + 25% over $30,650 ($43,110 over x 25%) = $10,777.50
Pluss Capitol gains income of $16,200 at 15% = $2,430
Total: $17,427 taxes

I guess the question I have now is - when you have income that is considered dividend income, is that income calculated into your total income for establishing your tax rate bases?

Are my calculation above incorrect?.

 

[youbet]

If you did your taxes yourself this year and used a program such as TurboTax, just go back and plug in your projected income and you'll get the results.

 

[MasterBlaster]

For your taxable income you need to subtract off either the standard deduction which is $5150 for 2006 or your actual itemized deductions you also need to subtract off the exemption credit ($3300 for 2006).

therefore your taxable income is no greater than $89960 - $5150 - $3300 = 81510.

Therefore assuming that you take the standard deduction if we subtract off the dividends we get a taxable income of (81510 - 16200) = 65310.

That means that you would pay income tax of $12885 plus the $2430 tax on the dividends ==> $15315

Your marginal tax rate is only 25 % not 28%

 

[runchman]

I'd be inclined to go to taxact.com, sign up and fill out the form like you are doing a real tax return. Then you can see what really happens in this scenario.

- John

 

[aenlighten]

If you have any debt, this is the time to consider eliminating it. That will offer a better return than bonds. Cutting expenses works better than taxes.

 

[modhatter]

Thank you for responses. No I don't have any debt, except small amounts I usually pay off every month on credit card. Whenever I selll my home, I will not longer have a mortgage in new smaller home.(house oon market)


I don't have Turbo Tax, so I will try suggested site on line.
I will also check out reccommended Vanguard fund.

Any thoughts on more tax friendly forms of income for me?
Is the income from Preferred Stock considered dividends?

What is your thinking on Preferreds vrs. individual bonds held to maturity?
And how do you rate MLP"s compared to above?

 

[tiredofwork]

You might try Vanguard Wellesley Income (VWINX). A summary of the fund's objectives (copied from yahoo finance) is:

The investment seeks to provide long-term growth of income and a high and sustainable level of current income, along with moderate long-term capital appreciation. The fund invests approximately 60% to 65% of assets in investment-grade corporate, U.S. Treasury, and government agency bonds, as well as mortgage-backed securities. The remaining 35% to 40% of fund assets are invested in common stocks of companies that have a history of above-average dividends or expectations of increasing dividends.

The expense ratio is only .25%, the yield is north of 4%, and it has a 5-star Morningstar rating. The fund has a track record starting in 1970.

 

[jdw_fire]

Have you considered a closed end fund that invests in munis? I've seen some paying ~5% yield tax free that invest in insured munis. The yields are even higher for some that don't limit themselves to insured munis and you can buy some of them (both insured and not) at a discount to NAV.

 

[LOL!]

My understanding is that income from MLPs get no preferential tax rate like qualified dividends do.

Because you do not want to have more equities with tax-free unrealized capital gains and want more bonds which generate taxable fixed income, you are in a bit of a quandary. If I knew I only need $24K plus SS bennies to live on, I would build a portfolio of index funds and ETFs that would just pay a little bit more than that. I would try to reduce income and bond funds to no more than 20% of my portfolio. To get $30K of stock dividends, you would need about $1.5million invested which is a bit over your assets. With $1.4MM you can expect to withdraw about $56K a year in perpetuity. I'll run some numbers in TurboTax for you this evening.

Also, if you are trying to leave an inheritance, why not start giving your money away now? You can then enjoy seeing the benefit of your kindness now. When you are dead, you won't see the joy you will bring to the lives of others.

Or get married and reduce your tax burden.

 

[brewer12345]

Any thoughts on more tax friendly forms of income for me?
Is the income from Preferred Stock considered dividends?

What is your thinking on Preferreds vrs. individual bonds held to maturity?
And how do you rate MLP"s compared to above?

Tax treatment of preferred stock coupons depends considerably on the type of preferred stock. Any preferred issued by a REIT generates ordinary (interest) income. Any preferred that is a "trust preferred" generates ordinary (interest) income. Other preferreds generally give you dividend tax rates on the income. So this is a buyer-beware scenario.

Preferreds are basically long-dated deeply subordinated bonds that are typically callable. You have basically zero protection if something funny goes on with teh issuer (example: leveraged buyout), so if you do this, pick carefully and diversify. I happen to like the preferreds of large, stable financial institutions because they essentially cannot be LBO'd and if any of them ever got into serious trouble they would get bailed out by the gummint.

Individual bonds held to maturity don't differ much from bond funds, so I am not sure I would be eager to incur the concentrated credit risk for little or no extra return, unless we are talking about treasuries and agencies.

MLPs can be attractive, but tax shelter characteristics vary from company to company. Don't be fooled: these are equities. They are also usually a PITA at tax time.

 

[jIMOh]

Do you want to maximize after tax return, or reduce taxes paid? Don't let the tax tail wag the return dog. If you find something which returns 8%, but you have to pay taxes on the gain (making at a 6.5% after tax return), that is better than a 5% tax free return.

I'd rather have a tax problem than an income problem.


There is a tax efficient mutual fund with a real high minimum, which was returning 8-15% with ZERO tax liability... I will post ticker once I find it. Something to consider.

 

[aenlighten]

Inflation will halve the value of your bonds after 24 years. That isn't the way to leave a large inheritance.

 

[jazz4cash]

I have a similar debate with my brother at least once per year. He has alot of fully depreciated rental property. This may sound harsh, but I will tell you like I tell him....you need a better understanding of taxes before you can minimize them. I think the suggestion to run this years taxes on any available software would be extremely helpful.........

Beyond that, I have tried to convince my brother to consider selling his rental property, thereby converting the rental income into capitol gains income. Of course this works better when real estate values are not declining! It would also work well to structure a contract sale. Maybe insignificant in your case as your rental income is a small slice of your total

 

[LOL!]

...If I didn't find some way of sheltering some of the income- here's how it would break out:

$540,000 generating 3% dividends=$16,200 x 15% tax = $2,430
$840,000 generating 6% income= $50,400 x 25% taxes= 12,600
Social Security $18,360 (85%) x Tax 25% = $4,590
Rental income: $5,000 taxed at $25% = $1,250

Taking $16,200 in qualified dividends, $50,400 in interest, $21,600 in SS and $5,000 in rental gives a born-in-1941 single-filer AGI of $89,960 which is quit some moolah and a tax bill of about $15,000.

Delay SS and tax bill is $10419. Delay SS and convert your interest to qualified dividends and your tax bill goes to $6221.

 

[jIMOh]

I have 1,400,000 to invest.

If I didn't find some way of sheltering some of the income- here's how it would break out:

$540,000 generating 3% dividends=$16,200 x 15% tax = $2,430
$840,000 generating 6% income= $50,400 x 25% taxes= 12,600
Social Security $18,360 (85%) x Tax 25% = $4,590
Rental income: $5,000 taxed at $25% = $1,250
That's $ $20,870 going to taxes.
I sure hate to have to pay that much in taxes in retirement. (and this will probably go up, as I am sure we are going to see some tax hikes in the future to get out of this huge deficit)

My other objective I must point out, it to be able to leave as much inheretance as possible. SO THERE YOU HAVE IT.

There is a fund called Managers First Quadrant (MFQTX). It is tax efficient (as in ZERO capital gains), and has solid returns. It is a loaded fund with a $1.5 M minimum. Something to think about.

It solves your tax shelter problems.

 

[brewer12345]

There is a fund called Managers First Quadrant (MFQTX). It is tax efficient (as in ZERO capital gains), and has solid returns. It is a loaded fund with a $1.5 M minimum. Something to think about.

It solves your tax shelter problems.

Looks like an equity fund to me.

 

[ERD50]

Is there any sort of fund or other investment that would act like an intermediate term bond fund, but rather than pay dividends (taxable in the year received), roll the ~ 5%/year directly back into the NAV? That way, one could pull out principle as needed and only pay cap gains.

EX:

A $1M in a Bond fund paying 5% would pay out $50K/year - all taxable income.

$1M in a hypothetical stable 5% NAV increase fund. Take out $50K after a year, and only 5% of $50K ($2,500) is taxable as cap gains, the rest is principle. The cap gains % would increase by about 5% each year. And, you would have the flexibility to pull it in one tax year vs another if that helped your tax situation.

Zero-coupon bonds are kind of structured this way, but you still pay taxes each year on the 'imputed income', IIRC.

Any such animal? -ERD50

 

[brewer12345]

The closest thing I can think of is *gulp* an annuity, but you give up so much that it isn't worth it. Alternatively, maybe a tax managed balanced fund or a low volatility equity fund. But if you are retired, chances are you still come out ahead after taxes with the standard portfolio choices.

 

[ERD50]

Thanks brewer, hmmm, the 'a' word, huh? Well, if someone was in that camp of people that would consider an annuity for that end-of-life 'insurance', maybe this tax benefit helps sway the decision a bit.

But, I'll stop there. I know it is a busy topic.

-ERD50

 

[FinanceDude]

There is a fund called Managers First Quadrant (MFQTX). It is tax efficient (as in ZERO capital gains), and has solid returns. It is a loaded fund with a $1.5 M minimum. Something to think about.

It solves your tax shelter problems.

Unless the prospectus is wrong, you need $2.5 million to get in. The ER is .99%, almost 1 percent on an insitutional fund that tries to roughly approximate the Russell 3000?

Too rich for my blood...........there's a LOT of tax-managed funds you can buy for less than .99% ER and $2,5 million to get in............

 

[FinanceDude]

Looks like an equity fund to me.

With almost a 1% ER and $2.5 million minimum...........