Free The Bogleheads' Guide to Retirement Planning by Taylor Larimore, Richard A. Ferri, Mel Lindauer, Laura F. Dogu, John C. Bogle Page B
their Vanguard equivalents.
There has been ample opportunity to tax swap over the past several years. Even in an up year, there are occasional down months when you could decide to sell the specific shares that have losses (generally, the newest shares that you purchased) to book the loss.
An alternative to swapping into a similar fund is to hold cash. Simply place the sale proceeds in a money market fund for 31 days and then buy back the original holding. The downside to this approach is that you could be out of the stock market during a month when there is a large rally.
Other Important Points When Tax Loss Harvesting
• If you hold shares for less than 61 days, the dividends you receive will not be qualified, and you’ll pay a higher tax rate on them, even though your fund company may tell you that they are qualified.
• If you set your dividends or capital gains to automatically reinvest and then want to sell the fund less than 31 days later, you will trigger a wash sale for the amount of the reinvestment. In taxable accounts, it is generally easier to have dividends and capital gains paid into a money market and then manually reinvest a few times a year, which makes it easier to track tax lots and to avoid accidental wash sales.
• To avoid frequent trading, some fund companies, such as Vanguard, require you to wait 60 days before buying back a fund that you have sold. However, this restriction generally applies to online and phone transactions. Instead, you can often sell a fund online and then send a letter by mail to buy it back 31 days later.
• Buying and selling an ETF incurs commissions and bid/ask spreads on each transaction. Harvest tax losses only when the tax savings outweigh these expenses.
• If you want the ability to tax loss harvest a portion of a security rather than your entire holding, you will need to use the specific identification of shares method of tracking your cost basis by lot. Vanguard requires you to send a secure e-mail through their web site or to send the request by mail. More information is at www.bogleheads.org on the Wiki site.
• If you exchange from your preferred holding to a near-equivalent, and then prices go up and stay up, you will probably want to hold the new fund for more than a year. At that point, you can exchange back to your preferred holding and pay only the lower long-term capital gains tax on your profits. If, at any time during that year, prices drop below where you bought the new holding, you can sell immediately, take this new tax loss, and move back to your preferred holdings, provided you’ve held the shares for at least 31 days.
MINIMIZING TAXES
To maximize the return of your taxable account, you want to minimize the taxes you pay. That means using tax-efficient mutual funds and exchange-traded funds.
Stock Funds
There are several advantages to holding tax-efficient equity mutual funds in your taxable account. First, when you eventually begin to sell these funds in retirement, you will pay the lower capital gains tax rate on funds you hold in your taxable account. If you held those same funds in a tax-deferred account such as an IRA, you would pay ordinary income taxes at a potentially higher marginal tax rate. Second, your heirs will receive a stepped-up cost basis on your taxable holdings after your death. That means neither you nor your heirs will owe taxes on the appreciation that occurred in the securities. There is no stepped-up basis for funds in a tax-deferred account.
Avoid using stock mutual funds that have a high portfolio turnover of securities unless it is in an exchange-traded fund, which has a different tax structure. Funds that have a high turnover of stocks generally distribute the most capital gains each year. You can identify funds that have high turnover by reading that turnover ratio listed in the fund prospectus. The lower the turnover ratio in the fund, the less churning of securities and the more tax efficient it
There has been ample opportunity to tax swap over the past several years. Even in an up year, there are occasional down months when you could decide to sell the specific shares that have losses (generally, the newest shares that you purchased) to book the loss.
An alternative to swapping into a similar fund is to hold cash. Simply place the sale proceeds in a money market fund for 31 days and then buy back the original holding. The downside to this approach is that you could be out of the stock market during a month when there is a large rally.
Other Important Points When Tax Loss Harvesting
• If you hold shares for less than 61 days, the dividends you receive will not be qualified, and you’ll pay a higher tax rate on them, even though your fund company may tell you that they are qualified.
• If you set your dividends or capital gains to automatically reinvest and then want to sell the fund less than 31 days later, you will trigger a wash sale for the amount of the reinvestment. In taxable accounts, it is generally easier to have dividends and capital gains paid into a money market and then manually reinvest a few times a year, which makes it easier to track tax lots and to avoid accidental wash sales.
• To avoid frequent trading, some fund companies, such as Vanguard, require you to wait 60 days before buying back a fund that you have sold. However, this restriction generally applies to online and phone transactions. Instead, you can often sell a fund online and then send a letter by mail to buy it back 31 days later.
• Buying and selling an ETF incurs commissions and bid/ask spreads on each transaction. Harvest tax losses only when the tax savings outweigh these expenses.
• If you want the ability to tax loss harvest a portion of a security rather than your entire holding, you will need to use the specific identification of shares method of tracking your cost basis by lot. Vanguard requires you to send a secure e-mail through their web site or to send the request by mail. More information is at www.bogleheads.org on the Wiki site.
• If you exchange from your preferred holding to a near-equivalent, and then prices go up and stay up, you will probably want to hold the new fund for more than a year. At that point, you can exchange back to your preferred holding and pay only the lower long-term capital gains tax on your profits. If, at any time during that year, prices drop below where you bought the new holding, you can sell immediately, take this new tax loss, and move back to your preferred holdings, provided you’ve held the shares for at least 31 days.
MINIMIZING TAXES
To maximize the return of your taxable account, you want to minimize the taxes you pay. That means using tax-efficient mutual funds and exchange-traded funds.
Stock Funds
There are several advantages to holding tax-efficient equity mutual funds in your taxable account. First, when you eventually begin to sell these funds in retirement, you will pay the lower capital gains tax rate on funds you hold in your taxable account. If you held those same funds in a tax-deferred account such as an IRA, you would pay ordinary income taxes at a potentially higher marginal tax rate. Second, your heirs will receive a stepped-up cost basis on your taxable holdings after your death. That means neither you nor your heirs will owe taxes on the appreciation that occurred in the securities. There is no stepped-up basis for funds in a tax-deferred account.
Avoid using stock mutual funds that have a high portfolio turnover of securities unless it is in an exchange-traded fund, which has a different tax structure. Funds that have a high turnover of stocks generally distribute the most capital gains each year. You can identify funds that have high turnover by reading that turnover ratio listed in the fund prospectus. The lower the turnover ratio in the fund, the less churning of securities and the more tax efficient it
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