METAR is an investment board where we all try to maximize returns from our investments (commensurate with our individual risk tolerances).
But we all know that it’s what you keep that matters. With taxes due on April 15, this may be a good time to discuss taxation. (Personally, I filed our taxes weeks ago and the only taxes I’m doing recently are for volunteer Tax Aide.)
The U.S. tax code is unbelievably abstruse and constantly changing. In addition to being boosted into a higher tax bracket, a year with a high taxable income can trigger a higher fee for Medicare, called “IRMAA.” I learned about this the hard way when I converted a lump sum from my Traditional IRA to my Roth IRA.
The Tax Strategies Board on TMF has excellent tax advice from highly experienced people. The amazing aj485 has saved me tens of thousands of dollars in taxes by helping me plan to spread out taxes on the interest from my I-Bonds instead of paying them at maturity.
**For Taxes, Where You Hold Your Investments Really Matters**
**Retirement investments that are fine in tax-sheltered accounts can generate big headaches without that protection. Vanguard’s target date funds are a case in point.**
**By Jeff Sommer, The New York Times, March 25, 2022**
**Generally speaking, once you have money for emergencies set aside in accounts you can easily access without penalties, then putting the most tax-inefficient assets in retirement accounts is the general rule of thumb...**
**For example, if you are going to invest in a taxable bond mutual fund [or hold individual bonds], it may be wise to hold it in a tax-sheltered account because bonds tend to produce a lot of income. Similarly, actively managed stock mutual funds that trade frequently may produce sizable capital gains when they sell shares.**
**On the other hand, municipal bonds are generally well-suited for taxable accounts because at least some of the income they generate typically isn’t taxed. Holding stocks directly can be tax efficient, too, because unless you sell the shares, you don’t owe capital gains taxes on them, though the dividend income is taxable. Low turnover stock index funds or exchange traded funds are often appropriate for taxable accounts, too.**
**But target date funds are different. They produce taxable income from several sources: interest income from bond holdings; dividends from stock; and, crucially, taxable capital gains distributions, especially when large numbers of investors sell the funds. When that happens, fund managers may be forced to sell underlying shares of appreciated securities and the capital gains are passed on to investors....** [end quote]
It’s also worth remembering that distributions from Traditional IRAs are taxed as ordinary income, even if the distribution included money from capital gains. On the other hand, ordinary (non-IRA) long-term capital gains and losses get special tax treatment. So it would be better to put stocks into non-IRA and bonds into IRA accounts.
People who are still working are probably in a higher tax bracket than retirees. It’s better to convert a Traditional into a Roth IRA when in a lower tax bracket.
Many retired people have large Traditional IRAs/ 401(k)s which can be gradually converted into Roth IRAs over a period of years to avoid large Required Minimum Distributions at age 72 and after. This is especially true for married retirees who may both have large Traditional IRAs.
Before making any moves, ask on the Tax Board because the @#$%! tax code has many gotchas. For example, aj485 explained recently that it’s best to leave some money in a Traditional IRA since distributions can be tax-exempted if used for large health care expenditures while Roth distributions (on which tax has already been paid) can’t.