Feeding the dividend-tax monster

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Diogenes

Recycles dryer sheets
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This is admittedly more a rant than a query. To get the discussion going, let's trot out my strawman friend, Smith.

Smith is in late middle-age, single, no kids. He spent his adult lifetime saving aggressively and investing. Tax-advantaged or tax-deferred savings vehicles were limited, so Smith put most of his money - call it 70% - into straight-up taxable brokerage accounts. Into a Boglehead-style 3-fund portfolio of index funds. He doesn't trade or rebalance. But every year, the dividends come, and they're all taxable. He automatically reinvests the dividends and pays the income tax out-of-pocket.

Eventually Smith realizes that he's paying more in taxes on his dividends than for... anything else. His income, while he's still working, goes mostly towards covering said taxes. While working, he can't really save any more money, no matter how frugally he lives, because everything goes to feeding to tax monster. It's either that, or make withdrawals from the portfolio, to pay taxes... which seems silly, since the whole point is to keep accumulating, right?

Smith wants to retire, but he realizes that he's crashed out of the ACA subsidy range by several multiples. Shucks, he can't even qualify for an EV credit because what the dividend distributions do to his AGI. If only he'd put everything 30 years ago into Berkshire Hathaway, which famously pays no dividends! Too late now.

Smith feels stuck. How can he un-stick himself?
 
:) Since those are dividend stocks, the capital gains should not be tremendous, at least with the recently reinvested ones. Sell those and buy growth stocks instead. Growth stocks pay very low dividends and avoid the problem of generating too much dividend income.
 
Sounds to me like Smith can retire and live off all those mostly qualified dividends as he’s accumulated so much. He’s still working and furiously saving, but why? And nothing says he can’t use his taxable dividends to pay the taxes the on earnings instead of slavishly reinvesting. Why is he not doing so? Something else is driving this - some need to maximize the size of the portfolio? Feeding the tax monster? Sounds like oversaving to me.

Also index funds, especially Vanguard equity index funds, don’t pay out a very high % in dividends. Probably only 1-3%. That’s not high and quite useful once you start living off your investments. I seriously don’t think his index funds are the culprit. Maybe he has too much in fixed income and not enough in equities which isn’t that smart while you are still working and investing.

Many of us retired folks did not qualify for ACA subsidies due to high investment income after retiring. First world problem.
 
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This story is hard to believe.
The index funds I own pay less than 2% dividends annually, mostly qualified divs.

Let's say Smith makes $100k per year of salary income and pays $50k per year in Federal income tax, $40k of which is those qualified dividends taxed at 15%.

This means Smith is getting around $250k per year in dividends, most of which are qualified.

Furthermore, this means that Smith has around $12.5M invested in stock index funds.
Are we supposed to cry for Smith or what?
 
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This story is hard to believe.
The index funds I own pay less than 2% dividends annually, mostly qualified divs.

Let's say Smith makes $100k per year of salary income and pays $50k per year in Federal income tax, $40k of which is those qualified dividends taxed at 15%.

This means Smith is getting around $250k per year in dividends, most of which are qualified.

Furthermore, this means that Smith has around $12.5M invested in stock index funds.
Are we supposed to cry for Smith or what?
In a nutshell, yes. If Smith had exactly $0, his taxes would be substantially lower. He could save more. If he lost his job, or retired early, he'd qualify for ACA. In California, he'd qualify for the new electric bike tax credit. Nice, eh? And don't forget, that even he can squeak under the 20% qualified dividends bracket, he still has 10% marginal state income tax.

One has to wonder, if perhaps a catastrophic bear-market, wiping Smith out, might not actually be better for his material standard of living.
 
In a nutshell, yes. If Smith had exactly $0, his taxes would be substantially lower. He could save more. If he lost his job, or retired early, he'd qualify for ACA. In California, he'd qualify for the new electric bike tax credit. Nice, eh? And don't forget, that even he can squeak under the 20% qualified dividends bracket, he still has 10% marginal state income tax.

One has to wonder, if perhaps a catastrophic bear-market, wiping Smith out, might not actually be better for his material standard of living.
Well here's the point. Once someone gets wealthy to a degree, they don't deal with routine salary income anymore. What's Elon's salary nowadays?

And paying low taxes is for wimps. Paying $100k+ per year in Federal income tax means you're in a good position financially...
 
One has to wonder, if perhaps a catastrophic bear-market, wiping Smith out, might not actually be better for his material standard of living.
There's a couple of people living under a bridge near me. I'll bet they're paying no taxes at all. Something to aspire to I'd suppose.

Then again, thanks, I'll pay my taxes.
 
If most of my earned income is going towards paying my dividend taxes, I would be retiring.
That was pretty much my thinly concealed point as well.
Or transition into a line of work that doesn't pay you Ordinary Income, something like Warren Buffett's gig...
 
I live exclusively on dividends and MF cap gains (and SS). I pay the taxes on my dividend income with some of my dividend income.

Not much different from my paycheck days: you make money, you use some of it for taxes.

Not quite sure what problem we're trying to solve here. Just stop reinvesting some of the dividends.
 
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Smith is stupid and has no understanding whatsoever about investing, taxes or how to handle his own personal finances.

That may be so, but what's his cardinal mistake (and please don't say, living in California)? Remember, that he already maxed-out whatever IRAs or 401Ks were available to him. And he already uses index funds instead of mutual funds, to minimize the tax-drag.

Not quite sure what problem we're trying to solve here. Just stop reinvesting some of the dividends.
The problem is that we're conditioned essentially from birth, to keep accumulating and saving. If Smith were 70, OK, relax and enjoy. 60? Not so clear. 50? Forget about it! So, Smith wants to save more, to keep adding to his portfolio.. but he can't, because the tax monster consumes the available resources from his W2.
 
Why can't Smith take the divs in cash rather than reinvest and pay the tax out of that?

Never mind, already asked and (poorly) answered before.
 
That may be so, but what's his cardinal mistake (and please don't say, living in California)? Remember, that he already maxed-out whatever IRAs or 401Ks were available to him. And he already uses index funds instead of mutual funds, to minimize the tax-drag.


The problem is that we're conditioned essentially from birth, to keep accumulating and saving. If Smith were 70, OK, relax and enjoy. 60? Not so clear. 50? Forget about it! So, Smith wants to save more, to keep adding to his portfolio.. but he can't, because the tax monster consumes the available resources from his W2.
That's not how it actually works; you're making this up.
His W2 income hardly matters anymore.
His investment income is taxed at a low 15% rate compared to rates of 24% and above for W2 income.

His $12M stash will grow nicely on its own at this point without further contributions.

Please stop trolling us...
 
You all know that OP is talking about himself, right? He has posted about his own situation along the same line in earlier threads. He just needs to retire and enjoy life.
 
There are, in essence, two choices here:

A. Make $1000 in dividends, pay whatever the tax rate is (0% or 15% if QDIV. Say 22% or 24% if not QDIV) and net the rest - say $760 worst case; or

B. Make zero in dividends and pay zero in taxes, and net ZERO

I suppose there could be an alternative universe where Option B is better than Option A, but I don't think I'd want to live in it.
 
Smith needs pb4uski to let him know that money is fungible.
Yeah, we haven't heard that fungible money stuff in a few days! What gives? Certainly one of the players of that one note piano will show up soon!
 
There are, in essence, two choices here:

A. Make $1000 in dividends, pay whatever the tax rate is (0% or 15% if QDIV. Say 22% or 24% if not QDIV) and net the rest - say $760 worst case; or

B. Make zero in dividends and pay zero in taxes, and net ZERO

I suppose there could be an alternative universe where Option B is better than Option A, but I don't think I'd want to live in it.
Actually Gumby, there is a cohort here who abhor dividends and would positively choose alternative B. There have been several threads.
 
There are, in essence, two choices here:

A. Make $1000 in dividends, pay whatever the tax rate is (0% or 15% if QDIV. Say 22% or 24% if not QDIV) and net the rest - say $760 worst case; or

B. Make zero in dividends and pay zero in taxes, and net ZERO

I suppose there could be an alternative universe where Option B is better than Option A, but I don't think I'd want to live in it.
No mention of Option C: invest differently, so that less of value created annually gets distributed as dividends, and more is reinvested back into the company? There are, one hears, equity funds that specialize in doing this. But they tend to have higher expense ratios and rather lackluster cumulative progress.

As to the quip about trolling, I shall forebear from taking offense. But I do wish that folks would realize, that Financial Independence merely means having no literal necessity to work. It doesn't mean self-absolution to start enjoying one's money, or to conclude the stage of life, that made accumulation possible in the first place.
 
That may be so, but what's his cardinal mistake (and please don't say, living in California)? Remember, that he already maxed-out whatever IRAs or 401Ks were available to him. And he already uses index funds instead of mutual funds, to minimize the tax-drag.


The problem is that we're conditioned essentially from birth, to keep accumulating and saving. If Smith were 70, OK, relax and enjoy. 60? Not so clear. 50? Forget about it! So, Smith wants to save more, to keep adding to his portfolio.. but he can't, because the tax monster consumes the available resources from his W2.
Seriously, if he’s amassed that at 50, retire already. Or go off and do things that earn little. I retired just before 40. What do you mean forget about it?

Poor Smith just wants to earn and save more. Doesn’t sound like much of a life to me!

We each have to learn to get beyond any “conditioning” if we want to live our own meaningful life.
 
But I do wish that folks would realize, that Financial Independence merely means having no literal necessity to work. It doesn't mean self-absolution to start enjoying one's money, or to conclude the stage of life, that made accumulation possible in the first place.
Huh? Why not? Sure it can. If someone doesn’t need to work anymore then it’s time to open one’s eyes and see what else our life can offer!
 
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