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.

Redirecting Taxable investments to Roth 401(k)

Preface

This article is for those in the USA who

• have access to after-tax 401(k) contributions with immediate in-plan conversion to Roth 401(k), aka, Mega Back Door Roth (MBDR), and
• have a taxable brokerage account with sufficient assets that can be leveraged to facilitate the MBDR.

Introduction

Usually, people focussed on saving and investing set their retirement contributions so that their net pay covers living expenses. Assuming one is already maxing out contributions to tax-advantaged retirement accounts and has accumulated a nontrivial amount of investments in a taxable brokerage, the question naturally arises:

Does it make financial sense to take advantage of the MBDR even if it means that one has to draw down on the taxable brokerage to fund living expenses?

Comparing mortgages for buying or refinancing a house

Questions that come up in scenarios related to buying or refinancing a home:

1. Is mortgage A better than mortgage B?
• Each mortgage may be amortized over a different duration (e.g., $15$ vs. $30$ years)
2. Given that I'm part-way through mortgage C, should I refinance to mortgage D?

Setting aside the emotional aspects, there is almost always a clear answer based on the Net Present Value ($NPV$) calculation of the cashflows related to the principal, interest, and loan fees. For a fixed-rate mortgage with no taxes or unusual features:$$\begin{align*}NPV &= F + P_0 + \sum_{k=1}^N \frac{PMT_k}{(1+d)^k}\\&=F + P_0 + PMT\left[\frac{1-(1+d)^{-N}}{d}\right]\;\text{for a fixed-rate loan}\end{align*}$$where

• $F$ is the amount in fees paid to acquire the loan
• $P_0$ is the initial cash outflow ("downpayment"), if any, outside of fees
• $N$ is the total number of payment periods
• For a $30$ year mortgage with monthly payments, $N = 30 \times 12 = 360$
• $PMT_k$ is the payment due at the end of the $k^\text{th}$ period
• The $PMT$ is a constant for a fixed-rate mortgage
• $d$ is the chosen discount rate per period

The $NPV$ formula, as specified above, assumes that the first payment will be due at the end of the first period immediately following the loan origination.

I've made available a Mortgage Comparison Template.ods file that implements the calculations referred to in this post.