LTCG harvesting in a non-zero LTCG tax bracket

Introduction

In the context of US tax law, does it ever make sense to harvest long term capital gains (LTCG) when one's income puts one into the $15\%$ LTCG tax bracket? Perhaps there is value to be gained by paying LTCG taxes now and increasing the basis so that one pays lower LTCG taxes in the future. Is that opportunity cost worth it?

This post investigates the conditions for LTCG harvesting to yield a net benefit in after-tax spendable wealth under a simplified model. It is found that LTCG harvesting has a clear long-term advantage when done in the $0\%$ LTCG tax bracket, whereas harvesting in a positive LTCG tax bracket can provide an advantage only over a finite investment horizon assuming future LTCG tax rates are sufficiently higher. The longer the post-harvest investing duration, the greater the erosion in the advantage. Eventually, once the post-harvest investing duration crosses a break-even horizon, any advantage due to LTCG harvesting (done in a positive LTCG tax bracket) is completely lost.

Analysis of Break-Even Tax Rate for Roth Conversions

Introduction

A common rule of thumb is that a Roth conversion is attractive when the expected tax rate in retirement is higher than the tax rate paid on the Roth conversion. This rule is directionally correct. But it is also a weak condition. As will be seen below, the expected tax rate in retirement can afford be lower if the tax on the conversion is paid from a taxable account. (This effectively redirects assets from an inefficient taxable account into a tax efficient Roth account.)

This post derives, under a simplified set of assumptions, the required tax rate in retirement that makes the Roth conversion beneficial for an after-tax retirement spending scenario. (Vanguard has termed this the Break-Even Tax Rate or BETR.) Below this rate, the modeled Roth conversion produces less after-tax spendable wealth compared to leaving the money in the Traditional IRA.

The comparison is between the following two strategies:

• Default strategy: No Roth conversion. No conversion tax to pay. Hence, no withdrawals from any taxable account to pay conversion tax.
• Roth conversion strategy: An amount $P_0$ is converted from the Traditional IRA (T-IRA) to Roth IRA (R-IRA). Separately, an amount $W_0$ is consumed from a taxable account to pay conversion tax.

Both comparisons are designed to start with the same total wealth ($P_0$ in the T-IRA, $W_0$ in the taxable account). The growth of $W_0$ within the taxable account in the default strategy represents the opportunity cost of paying the conversion tax.

Redirecting Taxable investments to Roth 401(k) - An Improved Analysis

This is a follow-up to Redirecting Taxable investments to Roth 401(k). The analysis is conducted in terms of capital appreciation and dividend yield rates. It also incorporates the additional basis created in a taxable account by dividend reinvestment.