PP and taxes

[jason]

Hello,

I have not found much information anywhere regarding the taxes I should expect to pay with a 4x25 PP in a taxable account.  Since the portfolio averages around 9.5% per year, what should I expect to earn, after taxes, assuming the highest tax bracket?  If the PP continues to average around 9.5% per year, is 8.5% after taxes a realistic estimate?  Or should I expect to earn closer to 7.5% after taxes, for example? 

Thanks!

[goodasgold]

Taxes are  important, but also very important is whether gains are recorded in "real" (i.e., after inflation) dollars. Sometimes this distinction is not always clear, even in the statements of PPers.

[chrikenn]

This is an extremely off the cuff calculation, but it gives you a starting point.

Say you have a $1 million portfolio.

$250K TLT.  ~3.4% SEC YIELD = $8,500 ordinary income.

$250K SHV. ~0% SEC YIELD = $0 ordinary income.

$250K IAU.  No dividends or interest.

$250K VTI.  ~2.0% SEC YIELD = $5,000 call it 100% qualified dividends.

For simplicity's sake, let's say you are 35% federal and 5% state.  Your bond interest will net $8,500 * 0.4 = $3,400 in tax.

Your VTI will net $5,000 * 0.188 (15% qualified dividends rate + 3.8% medicare tax) = $940 in tax (assuming 0% state income tax on qualified dividends.  Might be an incorrect assumption, but bear with me for simplicity's sake).

That's a total of $4,340 on a $1,000,000 portfolio.  Not bad, overall.

Using your number of 9.5% return, your portfolio would have grown from $1,000,000 to $1,095,000.  After you subract the $4,340 in tax, you are at $1,090,660, for a net after tax return of ~9.07%.

I think that tax calculation should be roughly accurate, assuming no capital gains due to rebalancing.  If you are in the accumulation phase, you should be able to avoid rebalancing gains, for the most part, by continuing to contribution as much as possible to your PP.

Also, as interest rates continue to rise, the tax ratio will increase.  It does not take a rocket scientist to see that if TLT were yielding 7% and SHY were yielding 3%, you'd have much higher ordinary income from the bond interest.

Some of my numbers might be off a little here and there, but for the most part, I think this gives an accurate idea of how taxes work on the PP.  Seems pretty tax efficient to me.

FWIW, I hold 40% of my portfolio as a PP, and the other 60% as a more typical 50% equity / 50% bond Boglehead type portfolio.  90% of my holdings are in taxable accounts.  So I can relate to your tax concerns!

[jason]

This is an extremely off the cuff calculation, but it gives you a starting point.

Say you have a $1 million portfolio.

$250K TLT.  ~3.4% SEC YIELD = $8,500 ordinary income.

$250K SHV. ~0% SEC YIELD = $0 ordinary income.

$250K IAU.  No dividends or interest.

$250K VTI.  ~2.0% SEC YIELD = $5,000 call it 100% qualified dividends.

For simplicity's sake, let's say you are 35% federal and 5% state.  Your bond interest will net $8,500 * 0.4 = $3,400 in tax.

Your VTI will net $5,000 * 0.188 (15% qualified dividends rate + 3.8% medicare tax) = $940 in tax (assuming 0% state income tax on qualified dividends.  Might be an incorrect assumption, but bear with me for simplicity's sake).

That's a total of $4,340 on a $1,000,000 portfolio.  Not bad, overall.

Using your number of 9.5% return, your portfolio would have grown from $1,000,000 to $1,095,000.  After you subract the $4,340 in tax, you are at $1,090,660, for a net after tax return of ~9.07%.

I think that tax calculation should be roughly accurate, assuming no capital gains due to rebalancing.  If you are in the accumulation phase, you should be able to avoid rebalancing gains, for the most part, by continuing to contribution as much as possible to your PP.

Also, as interest rates continue to rise, the tax ratio will increase.  It does not take a rocket scientist to see that if TLT were yielding 7% and SHY were yielding 3%, you'd have much higher ordinary income from the bond interest.

Some of my numbers might be off a little here and there, but for the most part, I think this gives an accurate idea of how taxes work on the PP.  Seems pretty tax efficient to me.

FWIW, I hold 40% of my portfolio as a PP, and the other 60% as a more typical 50% equity / 50% bond Boglehead type portfolio.  90% of my holdings are in taxable accounts.  So I can relate to your tax concerns!

Thanks for the info.  Cash and bonds can be an issue for taxes.  Back in the 80s when both cash and bonds had double digit yields, that surely would have triggered significant taxes.  I am not currently adding any cash, so I think I will have more capital gains.  I wish there was some kind of simulator that could tell us what the PP yielded after taxes each year, starting in 1972, and then we could figure out the CAGR after taxes.