High Tax Bracket Now/Low Bracket Later: PP Implications

[TripleB]

Typically a PP investor is better off putting LT Bonds inside tax-shelters first due to the inefficiencies of paying taxes on the interest every year.

I'm in a high tax bracket now, and expect to be in a significantly lower bracket in the future. Let's say 40% now versus 0% in 10 years. I am considering a strategy to reduce my tax burden over the next 10 years.

One idea is to put my taxable savings into equal parts of a Gold ETF, Bonds, and Stocks. Thus, whatever drops, I can sell, take an immediate tax benefit, and repurchase it within my tax shelters.

As long as I am swapping slightly different things, like GLD for SGOL, or TLT for VUSTX, or TSM for SPY, then it's not considered a wash sale.

Essentially I would be doing Tax-Loss Harvesting on 3 components of the PP at the cost of paying taxes annually on 1/3 of the taxable amount (Bonds). Since the PP is supposed to be comprised of volatile components, it seems reasonable to believe that one of the 3 components will take a big drop at some point in the next few years.

[moda0306]

If you've got IRA, 401k, or HSA space to put funds in it's an excellent way of saving when you're in a high tax bracket for lower-bracket withdrawals.

For instance, in the 40% bracket, setting aside a net $6,000 will result in $10k in your IRA (or whatever it is).  That $10k will grow to whatever $10k, not $6k, would be after x# of years.  Then, if you truly in the 0% bracket when you distribute, you'll be distributing the wealth of 67% more net realizable value than if you'd simply put $6k into a Roth, and even moreso than a normal taxable account.

Basically, the rule of thumb is that a roth is great, but if you're in a higher tax bracket now than retirement, a traditional IRA or 401(k) will net your more realizable wealth out of the same net investment today.

[WildAboutHarry]

Given the volatility of the three, I think it is appropriate to consider placing any or all of them in taxable space for potential tax-loss harvesting.

Gold is obviously best suited to being held outside of tax-deferred accounts (no dividends, you never have to realize any gains, etc.).

If you hold any foreign equity that is also a good candidate to be held in taxable space, since you cannot claim the foreign tax credit if held in tax-deferred space.  US equity also works well in taxable.

I have some reservations about holding long bonds in taxable accounts.  You get hit with the tax drag on the coupon payments, although if you live in a high-tax state those payments are not taxable at the state level.  You really have to determine whether the federal tax drag on the coupon payments is offset by any tax loss harvesting "opportunities".  Remember, too, that unless you explicitly harvest losses on individual long bonds early (and remember wash-sale rules), the PP only offers a once-in-ten-years trade on the long-bond holdings.  As you mention funds have a bit more flexibility in tax-loss/wash-sale situations.

I haven't considered harvesting losses on gold holdings, but can collectible gains/losses be offset against stock and bond gains/losses?

[TripleB]

If you've got IRA, 401k, or HSA space to put funds in it's an excellent way of saving when you're in a high tax bracket for lower-bracket withdrawals.

Already maxing them out, along with IBonds to get as much tax-deferment as I can. I'm going to hit a point next year where I can max it all out and save money into taxable too, which theoretically I could put all into gold coins, and just shift my tax-sheltered Gold ETFs into other asset classes to maintain 4x25, but it might be better to do the 3 way split in ETFs so I can get tax-breaks now.

[TripleB]

You really have to determine whether the federal tax drag on the coupon payments is offset by any tax loss harvesting "opportunities".

Exactly! I did rough "back of the napkin" calculations that suggest it is worth it. i.e. assume LTT yield 4%, and LTT are exactly 1/3 of my taxable holdings (Assuming I do a 3 way equal split between gold, stocks, LTT, because I don't know which will drop and I want to hedge my position and be guaranteed to tax-loss something). Then theoretically (ignoring the dividend yield on stocks) I'd owe 4% * (1/3) or tax on 1.3% "yield" on the taxable PP holdings. I'd be guaranteed to pay 40% taxes on 1.3% or about a 0.5% "tax" on this method.

The question is whether I will realize a net benefit compared to potential tax savings. The goal here would be to get $3k of annual tax-losses to write off against W2 income. In the 40% bracket, $3k of writeoff is $1200 in tax savings.

Thus, I have to incur a loss of less on my 0.5% tax  (from holding the treasuries in taxable) than $1200.

I would have to hold $240k of PP in taxable savings, to have a 0.5% tax rate = $1200. First of all, I won't have anywhere near that, especially starting out. Second of all, if I have $240k in taxable PP, then that means $80k are in each of the 3 assets. That only would allow for writing off losses on a 4% drop in any one asset, since I can't take more than $3k of tax write offs my W2 income in any given year.

The answer seems resoundingly in favor of using this method, because the net benefit from the W2 writeoff, is much greater than the LTT tax.

The question should then arise: at what point is the marginal benefit worth it? Clearly in this example, having $240k+ of PP taxable savings means that you are breaking even at best as opposed to simply putting all taxable into gold coins and stocks.

Assume a 10% downward shift in any of the 3 assets in any one year time frame. That seems reasonable as an average annual drop of the worst asset (maybe even conservative). We want the $3k tax write off to be 10% of the worst performing asset, so a 10% drop = a $3k writeoff. That means we have $30k in one asset, and the 10% drop = $3k. This means we have $90k in all 3 assets, because we dont know which will drop 10% so we put equal parts in all 3.

Thus, I'd estimate that $90k would be worthwhile to split into the mixed-taxable-PP method described above. Beyond $90k it's better to use Gold Coins and Stocks (specifically foreign as mentioned in a previous post for the FTC). This means the optimal amount of LTT to hold in taxable is $30k. We can adjust that figure based on better estimations of the average drop of the worst performing asset, since 10% is just a rough guess and it might be 15% or 20% drop on average.




I haven't considered harvesting losses on gold holdings, but can collectible gains/losses be offset against stock and bond gains/losses?










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[WildAboutHarry]

This means we have $90k in all 3 assets, because we dont know which will drop 10% so we put equal parts in all 3.

Based on a quick, unscientific review of Simba's spreadsheet from 1972 to 2010, volatility is:  Gold >> Stocks >> Bonds.  That would suggest a priority or a means for scaling placement of assets in taxable space from a tax loss perspective.  Given the current valuations of gold and LT bonds, perhaps valuations argue instead for directing gold and bonds to taxable space.

Having equal amounts of all three volatile assets in taxable space does seem to fit the Harry Browne tenent that the future is unknowable.

[TripleB]

If you have the spreadsheet can you do a calculation of the average drop of the worst performing asset in any given year? i.e. whatever of the 3 assets lost the most %-wise, just take that percentage and average it with the rest of the years.

I'd be curious to see what the average drop for the worst performing asset in a given year is historically.

[moda0306]

I believe with gold you have to use average basis, and can't use individual selection method like you can with stocks/bonds.

So while the volatility and valuation might be in your favor, the allowable basis recognition methods may not.

I would be less hesitant today to do this with TLT than a few months ago when bonds were at 4.4% and LT bonds appeared (to me) to be a very good value.  Today, the tax penalty of holding them and earning the income is less, and the valuations aren't nearly as good, so take what you will from that.

Here are some random thoughts:

Do you have a wife to help you max out these i-bonds (or retirement contributions)? 

Have you considered going into EE bonds in your taxable space?  Considering their 3.53% "phantom" rate if held for 20 years, and 1.1% guaranteed rate (higher than a 5-year treasury) they're a very good deal right now.

Have you considered doing a HSA with a HDHP?  You can put another $3k into that, and they're income tax AND payroll-tax-dectible if done through an employer.

Depending on your expected future tax situation some Roth IRA contributions may be reasonable, and these have higher "effective" contribution limits because they don't carry an implied future tax liability (and don't give you a tax deduction at contribution).  Diverting some IRA funds to a Roth should help get more into tax deferred accounts.

Do you have kids or a nephew/niece that you want to help with education?  529 plans and ESA's should help.

If you own a home, paying down your mortgage can be a way of using "extra savings" to earn a decent rate of return over time, though this may or may not be smart depending on your situation.