Taxes in Retirement

[34rlsa]

20% for taxes? What do you mean by taxes? Have you even filled out a tax return in a while?

We just submitted our 2016 Federal tax return and even though my wife works full-time and made more money that she ever has in her life, we paid less than $4,000 in Federal income tax on income north of $140,000.

If you are going to pay 20% on taxes on $80K or even $130K, then you are doing something terribly wrong. If you are paying more than 3%, you are probably doing something wrong, too.

With regards to the OPs personal situation...

I haven't posted here for quite sometime... but after reading this I have got to call BS.

 

[CardsFan]

But, OP has stated that they plan to move to a no tax state before RMDs begin, so the 8.5% of state tax will not apply.... their tax rate will for federal only and likely less than 15%... a far cry from 20%.

You are right. But I think the 20% was based on current locale. I could be wrong. But 15% is also a far cry from LOLs 3%.

 

[LOL!]

With regards to the OPs personal situation...

I haven't posted here for quite sometime... but after reading this I have got to call BS.

Good call.

 

[CardsFan]

@LOL
Thanks for coming clean[emoji6]

You are right that there are a lot of ways to reduce tax liability.

And many are only available while working.

Good point about foreign tax credits in tax deferred accounts. You want those in the after tax accounts to get the credit.

 

[LOL!]

Good point about foreign tax credits in tax deferred accounts. You want those in the after tax accounts to get the credit.

I would not be completely "clean" unless I told everyone that Form 1116 is a PITA and there is a danger with having too much foreign dividend income which would make Form 1116 even more painful.

So when we were getting close to too much foreign dividend income, we sold foreign funds in taxable and bought them back in tax-advantaged. That is, it is perfectly OK to have funds that pay foreign taxes in one's tax-advantaged accounts.

Also if the foreign funds have a higher percentage of non-qualified dividend income, then they are likely to be better held in a tax-advantaged account.

 

[RunningBum]

I would not be completely "clean" unless I told everyone that Form 1116 is a PITA and there is a danger with having too much foreign dividend income which would make Form 1116 even more painful.

So when we were getting close to too much foreign dividend income, we sold foreign funds in taxable and bought them back in tax-advantaged. That is, it is perfectly OK to have funds that pay foreign taxes in one's tax-advantaged accounts.

Also if the foreign funds have a higher percentage of non-qualified dividend income, then they are likely to be better held in a tax-advantaged account.

1116 is a PITA but worthwhile, especially since it is a credit.

I thought foreign funds in a tax advantaged account was a bad idea. You still have to pay the foreign tax (under the covers within the fund), but don't get the credit. If it's in a tIRA, when you withdraw from the tIRA you're going to pay a tax on it, and I don't think you can take the credit then, but I could be wrong. If it's in a Roth you won't pay tax on the withdrawal, but you still had paid the foreign tax.

What am I missing?

 

[pb4uski]

20% for taxes? What do you mean by taxes? Have you even filled out a tax return in a while?

We just submitted our 2016 Federal tax return and even though my wife works full-time and made more money that she ever has in her life, we paid less than $4,000 in Federal income tax on income north of $140,000.

If you are going to pay 20% on taxes on $80K or even $130K, then you are doing something terribly wrong. If you are paying more than 3%, you are probably doing something wrong, too.

With regards to the OPs personal situation...

I haven't posted here for quite sometime... but after reading this I have got to call BS.

I dunno.... we paid $200 in tax in 2016 on $103k of income so if you have the right sources of income then what LOL! wrote seems possible and he explained how in post #25.

In our case, $103k included $70k of LTCG and qualified dividends and $33k of ordinary income. After itemized deductions and personal exemptions our taxable income was the top of the 15% tax bracket ($75k).

The $33k of ordinary income was reduced by $20k of itemized deductions and $8k of personal exemptions... remaining $5k was taxed at 10%, resulting in $500 in tax.... and the $500 in tax was reduced by $300 of foreign tax credit resulting in $200 total tax (Form 1040, line 63).

 

[LOL!]

If it's in a tIRA, when you withdraw from the tIRA you're going to pay a tax on it

If it's in the tIRA, then the tax got paid and you will not be paying tax on the foreign tax that got taken out already.

Generally, the foreign tax paid is about 7% or so of the dividend, so the credit does not cover the extra taxes paid on non-qualified dividend income. That is, it is better to pay 7% tax than to pay 25%-7% tax.

 

[RunningBum]

If it's in the tIRA, then the tax got paid and you will not be paying tax on the foreign tax that got taken out already.

Generally, the foreign tax paid is about 7% or so of the dividend, so the credit does not cover the extra taxes paid on non-qualified dividend income. That is, it is better to pay 7% tax than to pay 25%-7% tax.

So let's say you have $100K in an international fund, and you get a 5% dividend on it, or $5K.

If it's in a taxable account, if it's non-qualified (I usually find about 2/3 of it is non-qualified in the VG Total Intl, but let's keep it simple and say it's 100% NQ), you pay the marginal rate. Let's use the 25% you used. You owe $1250 to the US. You paid 7% to foreign governments under the covers, or $350, but you get that back in a credit.

Now suppose it's in a tIRA. You owe 0 to the US that year, and paid $350 under the covers to foreign govts and don't get any of that in a tax credit. You now have $105K in your tIRA. Eventually you will withdraw it, and assuming you are still in that same 25% bracket, you're going to pay that on the entire $105K, including the $5K that was dividend growth. So you're still paying the $1250 on that $5K, plus you paid the 7% foreign tax with no credit.

Unless you tell me how you can avoid paying on that dividend amount that you eventually withdrew. You didn't pay it right away, but eventually you did. It would require a whole lot of accounting in your tIRA for foreign taxes paid over the years.

 

[pb4uski]

If you hold foreign equities in tax-deferred or tax-free accounts then you never get any benefit from the foreign taxes paid. If it is in a taxable account, then you get a benefit to the extent of your taxes.

For us, we actually end up with a net tax benefit for international held in our taxable account as the foreign tax credit exceeds the tax on non-qualified dividends... an example, for 2016:

Total dividends: $100
Qualified dividends: $72
Foreign taxes paid: $7

Tax on non-qualified dividends @ 10%: $3
Foreign tax credit: $7
Net taxes: $4 BENEFIT

I'm actually thinking of forgoing my Roth conversion this year so I can sell domesitc equities in my taxable account and reinvest the proceeds in international equities to increase these benefits... and rebalance by selling international and buying domestic equities in my tax-deferred accounts.

 

[LOL!]

@RunningBum, I guess I'd do a different comparison than you did.

I have to decide whether to put something like VFIAX in a taxable account or a tIRA and put a foreign fund like VTIAX (VG Total Intl) in the other account. That is, I have $100K taxable account and a $100K tIRA.

Do I put VFIAX in taxable and VTIAX in tIRA?
-or-
Do I put VTIAX in taxable and VFIAX in tIRA?

Note that VFIAX is 100% qualified dividend income and in my 15% tax bracket that would have a tax of 0%.

 

[RunningBum]

@RunningBum, I guess I'd do a different comparison than you did.

I have to decide whether to put something like VFIAX in a taxable account or a tIRA and put a foreign fund like VTIAX (VG Total Intl) in the other account. That is, I have $100K taxable account and a $100K tIRA.

Do I put VFIAX in taxable and VTIAX in tIRA?
-or-
Do I put VTIAX in taxable and VFIAX in tIRA?

Note that VFIAX is 100% qualified dividend income and in my 15% tax bracket that would have a tax of 0%.

OK, I think I get it. While it would be inefficient to put an international fund in a tIRA, it might be even less efficient to put a different fund in a tIRA, so you put the one that's "least inefficient" in the taxable.

It's really an individual situation type of thing and it's not helpful to make general statements. Plus it was incorrect when you said you wouldn't pay the tax on the dividends in a tIRA since eventually you will. The important factor is whether losing the foreign tax credit is better than the difference in overall taxes had you put the other fund in the tIRA. I'm sure you knew what you meant, but there was a gap in that and what you wrote, or maybe just in how I interpreted it.

 

[pb4uski]

Put VTIAX in taxable and VFIAX in tax-deferred. The calculations in my post above are based on VTIAX... even at 15% ordinary tax rate the foreign tax credit would exceed the taxes on the non-qualified dividends.

 

[LOL!]

OK, I think I get it. While it would be inefficient to put an international fund in a tIRA, it might be even less efficient to put a different fund in a tIRA, so you put the one that's "least inefficient" in the 401K.

It's really an individual situation type of thing and it's not helpful to make general statements. Plus it was incorrect when you said you wouldn't pay the tax on the dividends in a tIRA since eventually you will. The important factor is whether losing the foreign tax credit is better than the difference in overall taxes had you put the other fund in the tIRA. I'm sure you knew what you meant, but there was a gap in that and what you wrote, or maybe just in how I interpreted it.

It will definitely all depend on one's personal tax situation. Folks in high tax brackets are affected more by non-qualified dividends than folks in low tax brackets. Also in play are tax brackets while working and tax brackets while retired and when withdrawing.

I'll give an extreme example: I could withdraw from my tIRA and say the withdrawals are tax-free because of exemptions and deductions.

 

[wyecrabber1]

Thanks pb4uski; you and I are on the same page. Had to goggle YMMV.