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Interaction of Withdrawal/Taxation settings

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(@ilovemybeagles)
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I’m a little uncertain as to the interplay between a couple of withdrawal/taxation settings in PRC2023, even after a good-faith attempt at perusing the manual. I don’t have a fully functional model yet to divine the answer by poring over the detailed data output so I am hoping for a little upfront clarification from a wiser head.

The settings are:

  • Financial Assets > Management > Regular Savings Withdrawal Controls > Distribute withdrawals evenly across all growth areas
  • Financial Assets > Asset Class Taxation > Check if interest and dividends are to be reinvested

My first source of retirement funding is the passive income generated by my taxable account in the form of dividends, both ordinary and qualified, so I untick that reinvest setting on the Asset Class Taxation page. (I am extremely appreciative the option not to force reinvestment of these dividends was implemented in the PRC2022 version. Thank you, Mr. Matthews, very much for responding to that need! This is an awesome tool.)

So all taxable dividends from my Regular Investment Account are automatically dumped into the Cash Account. I figure that 85% of my Regular Investment Account growth is from capital appreciation and 15% from dividends, with 76% of those dividends (~11% of overall account growth) being qualified and, therefore, taxed at the preferred LTCG rate. That leads me to the following specifications on the Asset Class Taxation page: Growth taxed as simple interest 4% (Ordinary dividends), Growth Taxed Annually as Qualified Dividends 11%, Growth Taxed at LTCG When Withdrawn 85% (Capital appreciation).

First of all, I am not absolutely certain I am defining those taxation percentages correctly (cautiously confident I’d say). Most of all, though, I am unclear how PRC reconciles my shunting my dividends into the Cash Account on the Taxation page with the Regular Savings Withdrawal Controls on the Management page. It would seem I am overriding the Withdrawal Controls option by electing not to reinvest my dividends already so that the option to “Distribute withdrawals evenly over all growth areas” is just not applicable in this scenario. Correct? So my only real option concerning Regular Savings Withdrawal/Taxation is whether to withdraw Capital Gains First or Last? That one also leads me to scratch my head a little bit since you can’t sell a single share without realizing some capital gain (hopefully) so I’m not sure how one would even go about withdrawing capital gains first or last or in between. Not being critical - I know PRC is not meant to be tax software - but it just seems not to be a very realistic setting. I assume the idea behind it is that the user is electing the SpecID cost basis method in their brokerage account and then actively selecting which tax lots to sell that will result in realizing the most capital gains sooner rather later, or vice versa. Or selling taxable bonds first/last since capital appreciation makes up so little of their total return.

If anyone has any insight or practical advice as to how they are defining a similar spend-taxable-dividends-first scenario in their models - withdrawal method and taxation - I would greatly appreciate it and offer my thanks in advance. Bonus points for any insight on the capital gains first/last rationale.


   
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(@hines202)
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Hi @ilovemybeagles. I love my Bichon 🙂 I think you want to set that "Harvest LTCG when withdrawing to "Withdraw capital gains first". I don't have PRC or the manual up at the moment, but from memory I believe that means that when taking draws from your brokerage account, PRC will look to the qualified/LTCG dividends first.

On the taxation, keep in mind the default setting for bonds of 100% growth taxed as simple interest is not correct unless you have regular bonds that you bought. If you're in a bond fund in your brokerage, like most people, you have to break that up between the interest/dividend it throws off as income, a very small each year that may be capital gains (due to trading within the account by the managers), and then when you're selling shares, it's actually more like equities since this is technically an equity fund - you are selling shares of an asset. So if you sell shares owned less than a year, it's income. Anything longer than a year, those are LTCG.

You have to look at your withdrawal strategy over the years and do the math to get that right. You can also force distributions on a schedule by using the scheduled withdrawals.


   
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(@ilovemybeagles)
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Mr. @hines202, well anyone who loves their dog, of any stripe, is A-OK in my book! Bichons are beautiful little animals. Thank you very much for taking the time to reply.

Since I have told PRC not to reinvest my dividends (on the Asset Class Taxation page), I am taking that to mean that my qualified/LTCG dividends are withdrawn first, regardless, so that the "Withdraw capital gains first" setting (on the Management page) is just redundant. That's not a problem of course, just redundant, if my assumption is correct. I think I am trying to overthink the Capital Gains First/Last directive. Rather than trying to separate out the proportion of cost basis vs. capital gain of a given withdrawal, I think probably the intent in PRC is simply instead to withdraw 100% for-sure capital gains taxed at the preferred rate (qualified dividends & LTCG distributions by the funds/ETFs themselves), first or last.

Thank you for the very insightful observations concerning bond funds in a taxable account. My bonds are actually all in tax-deferred so I was just using them as an example in my question. But your comments are certainly a helpful reminder as we do tend to think of bond return as strictly ordinary income when LTCG distributions & capital appreciation are definitely factors as well. I would likely overlook that if I were actually specifying bond return taxation in the PRC Regular Investment Account.

Thanks again!


   
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(@ilovemybeagles)
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For anyone following this topic in the future, I just wanted to correct what I believe is an incorrect conclusion on my part in my previous reply. I indicated a belief that when we indicate to PRC to "Withdraw capital gains first" that this means to withdraw any growth categorized as qualified dividends or LTCG fund distributions. I just noticed in the PRC documentation that this is plainly incorrect, or at best only partially true. It states "If Withdraw capital gains first is selected, all withdrawals will be made from the unrealized capital gains category". Now in the real world I don't know of any practical way to realize purely capital gain income except for "harvesting" those gains, a term also used by PRC, i.e. selling the asset then immediately repurchasing it, realizing the capital gain income while preserving ownership of the asset. Regular sales of shares would, of course, be comprised of the return of cost basis plus the capital gain (or loss). While a common thing to do, true harvesting of capital gains was not something that I was even considering before when evaluating this setting. I was thinking to devise a proportional percentage of cost basis-to-capital gain for any withdrawal and model that ratio in the Taxation page. I guess such a ratio of basis-to-gain would still be a valid thing to define in the model if one wanted to do that, but that's likely not a complication that was envisioned in the design. For my own sanity, I've got to stop over-complicating these things!


   
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(@hines202)
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@ilovemybeagles If you tell PRC to not reinvest your dividends/interest payments, I believe it just lets them to go cash in the brokerage asset location. In Management, telling PRC to draw capital gains first will tell PRC to sell any unrealized capital gains when drawing from the account.

Often retirees will let dividends/interest payments go to cash rather than reinvest and then either transfer those to checking for a stream of retirement income, or use that cash to refill their cash bucket at the end of the year, if using a bucket system. I'll have to retest and fire up the manual to double-check PRC acts that way, depending on settings.

To my knowledge, harvesting means to just sell the shares, "realizing" the unrealized gains at that point. I do not believe that harvesting entails having to reinvest after selling, although sometimes people certainly do that if they don't need the cash.


   
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(@ilovemybeagles)
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@hines202 Understood. Thank you. I guess "harvesting" does indeed have dual meanings. In my mind I was thinking of "harvesting capital gains" in the context of its being the other side of the coin of "tax loss harvesting", wherein in each maneuver you sell the asset and them immediately repurchase it (or a similar but not substantially identical asset in the case of tax loss harvesting). In the case of harvesting the gain, you would just be selling/repurchasing an asset to realize the income while raising your cost basis, say in a low tax year, so that selling the asset in a future high tax year could net you some cash with little-to-no taxation in that year. I know each December, if I have room left in my current marginal bracket, I always cogitate on whether to fill the headroom with ordinary income via a Roth conversion or capital gain income via gain harvesting. I usually Roth convert unless I know I have a need for some cheap cash in the next year and then harvest the capital gain (sell and immediately repurchase shares until I want to sell them later) - just a matter of how to fill up a tax bracket with the kind of income most beneficial in that particular low-tax year. But I certainly recognize "harvesting" is also the generic term for selling shares, "realizing" the gain, and then accessing the cash immediately. I think my error was in conflating PRC's use of the term "harvesting" with my thinking of it as the "gain harvesting" twin of "loss harvesting". I suppose it doesn't matter all that much except that, in my idea of "harvesting", the income is 100% capital gain with a corresponding PRC reduction of Unrealized Gains dollar-for-dollar. In the context of the generic term of "harvesting" for "sell and spend", PRC would have to reduce Unrealized Gains only by the proportion of the sale that was not comprised of the return of capital, the cost basis. I suspect that, in fact, PRC is reducing Unrealized Gains dollar-for-dollar per withdrawal (if you ask it to), which is not technically accurate since a big chunk of the withdrawal would not be capital gains but instead cost basis. As mentioned earlier, I realize PRC is not TurboTax - and shouldn't even try to be - and I am completely satisfied with it, just muddling my way though understanding exactly how it's doing its thing. Once I get my model all fleshed out and can dig into the data output hopefully I can observe what's going on. I really shouldn't be imposing on the kindness of others for insight until I do my utmost first so thanks much for your contribution.

ETA: Changed "different but substantially identical" to "similar but not substantially identical" - keyboard equivalent of a tongue twister

This post was modified 1 week ago 2 times by David Justice

   
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