Most discussions of whether it makes sense to pay taxes now,
or pay them later, is in regard to the efficacy of a conversion to
Roth IRA. To a first approximation, it makes sense to convert
if you expect a higher tax rate when you'll withdraw the money.
I am not trying to re-open that discussion here, but rather to
propose that the mathematics are VERY different when we're
talking about whether or not to reset one's basis on assets in
a taxable account. That is, to sell a position with the intent
of re-investing the proceeds, either to re-allocate or to simply
move to a better (e.g. lower OER) fund.
Let's say I'm thinking of reseting a position that's worth $125K,
of which $25K is capital gain. (I'm assuming the gains are all
long-term, and that I'll pay the taxes with other money,
reinvesting all $125K). Conventional wisdom might say
"of course it's a good idea to do this, capital gains tax will
very likely be higher down the road". But this is different
than the Roth conversion decision, because "down the road" I
will STILL have to pay cap-gains tax on the additional gains
(above the reset basis of $125K). So the $25K * 15% tax
I might pay today, is an investment whose return is only
$25K * X%, where X% is the future cap-gains taxrate. So,
if I cash in the posion 25 years from now, even if the
cap-gains tax has increased to 30%, my ROI on that money
(with which I paid the tax) is only about 3% (annualized).
Maybe everyone else knows this, but it just dawned on me,
and I think this analysis makes sense (I hope my explanation
is adequate).
It certainly complicates the decision of whether or not to sell
some sub-optimal funds, with significant cap-gains, to replace
with better ones !
or pay them later, is in regard to the efficacy of a conversion to
Roth IRA. To a first approximation, it makes sense to convert
if you expect a higher tax rate when you'll withdraw the money.
I am not trying to re-open that discussion here, but rather to
propose that the mathematics are VERY different when we're
talking about whether or not to reset one's basis on assets in
a taxable account. That is, to sell a position with the intent
of re-investing the proceeds, either to re-allocate or to simply
move to a better (e.g. lower OER) fund.
Let's say I'm thinking of reseting a position that's worth $125K,
of which $25K is capital gain. (I'm assuming the gains are all
long-term, and that I'll pay the taxes with other money,
reinvesting all $125K). Conventional wisdom might say
"of course it's a good idea to do this, capital gains tax will
very likely be higher down the road". But this is different
than the Roth conversion decision, because "down the road" I
will STILL have to pay cap-gains tax on the additional gains
(above the reset basis of $125K). So the $25K * 15% tax
I might pay today, is an investment whose return is only
$25K * X%, where X% is the future cap-gains taxrate. So,
if I cash in the posion 25 years from now, even if the
cap-gains tax has increased to 30%, my ROI on that money
(with which I paid the tax) is only about 3% (annualized).
Maybe everyone else knows this, but it just dawned on me,
and I think this analysis makes sense (I hope my explanation
is adequate).
It certainly complicates the decision of whether or not to sell
some sub-optimal funds, with significant cap-gains, to replace
with better ones !