The Advanced Portfolio Modeling -> Growth Taxation form has me confused.
I am primarily an index investor. Let's say I own a S&P mutual fund in a taxable account (asset class of "Stocks"). Each year it will have some distributions, primarily qualified dividends.
What percentages would I use for "Growth Taxed as Qualified Dividends", "Growth Taxed as Realized LTCG" and "Growth taxed as LTCG When Withdrawn"? And why?
Thanks.
@jeffanddawnjefframin-org I cannot give you a specific answer but I can clarify what those categories are referring to and, hopefully, that'll help. "Growth taxed as QD" refers to the QD generated by the stocks held within the index fund. "Growth taxed as realized LTCG" refers to the LTCG generated by the sale of stocks held by the mutual fund and over which you have no control (it's a function of what the fund manager elects to sell each year). Finally, "Growth taxed as LTCG when withdrawn" refers to the annual appreciation of the fund minus any amounts thrown off each year as dividends. Pralana keeps track of the capital appreciation of the account and computes LTCG taxes accordingly whenever withdrawals are made from the taxable account to cover negative cash flows.
Stuart
@jeffanddawnjefframin-org I cannot give you a specific answer but I can clarify what those categories are referring to and, hopefully, that'll help. "Growth taxed as QD" refers to the QD generated by the stocks held within the index fund. "Growth taxed as realized LTCG" refers to the LTCG generated by the sale of stocks held by the mutual fund and over which you have no control (it's a function of what the fund manager elects to sell each year). Finally, "Growth taxed as LTCG when withdrawn" refers to the annual appreciation of the fund minus any amounts thrown off each year as dividends. Pralana keeps track of the capital appreciation of the account and computes LTCG taxes accordingly whenever withdrawals are made from the taxable account to cover negative cash flows.
Stuart
Thanks Stuart.
After I posted my question, I found a similar question in one of the Pralana online forums, which I think explains things pretty well.
The method in which this information is gathered is pretty confusing. A suggestion - perhaps ask the user what percentage of the value of an account is distributed as dividends each year, and what percentage of those that are qualified.
No doubt this is a tricky bit, just remember that Pralana is the only consumer program (at least that I know of) that tracks the capital gains taxes on asset sales which is a really important number and this is part of that calculation. Here's what I do.
I go to my 1099 from last year and work out what percent of the account value were qualified dividends and non-qualified dividends. Let's say it was 1.6% total dividends with 1.2% qualified and 0.4% non-qualified. My wild guess of future stock returns is about 8%/year (we want to work in nominal, not inflation adjusted, here, as we are talking about how taxes apportion in any given year). So the percentage that will be taxed as simple interest is 0.4/8.0 = 5%, the percentage that will be taxed as LTCG will be 1.2/8.0 = 15% and the remaining 80% will be taxed as LTCG when withdrawn.
I happen to own some international and that has higher dividends, with less as qualified, so my own dividend numbers are a bit higher.
Common area that confuses people. The key thing to remember is the tool is asking what percentage of the annual *growth* is in each category. @ricke example shows the math to figure it out. It's tougher with managed accounts or complex portfolios in the taxable brokerage (the only type of account this applies to).
The example from @ricke is very helpful. I would never have figured this out on my own, even after reading the help section about it. I would strongly recommend including his example in the help section for growth taxation. An example is worth 1000 words.
@benhirashima Good idea; I'll add Richard's example to the manual which will then be incorporated into the help section of the tool.
@benhirashima Good idea; I'll add Richard's example to the manual which will then be incorporated into the help section of the tool.
That would be helpful, however finding a more intuitive manner to gather that information would be even better. Don't make users calculate these values, even if it is just simple division.
@ricke Since you took your QD from one particular year, why wouldn't your denominator be the growth in your equity last year (e.g. 38%) rather than your long term estimate of growth?
We are trying to apportion the total return among the different tax categories for an average year, so the denominator has to be equal to the projected total return rate for an average year.
To illustrate how using recent equity returns would mess that up, if we used 38% equity returns in the denominator for predicting dividend income but used 8% for total equity returns, then Pralana would predict 1.6% dividend/38% last year's growth X 8% average future growth = 0.34% for this year's dividend estimate. Also think about what would happen if there had been a market downturn last year, then using last year's number would predict a negative dividend.
In general, I feel OK about using actual last year's numbers for dividends since those are based on companies' predicted ability to pay out money, that's more closely tied to the average than market prices.
The link below shows historical dividends vs total return for the S&P 500 and if I only invested in the S&P 500, then using historical data might be better than the approach I suggested. However, I have some other stuff that pays more dividend than the S&P (and has managed to grow less ☹️ ), so using S&P data isn't helpful.
So the percentage that will be taxed as simple interest is 0.4/8.0 = 5%, the percentage that will be taxed as LTCG will be 1.2/8.0 = 15% and the remaining 80% will be taxed as LTCG when withdrawn.
@ricke - After your 1099 calculations to which Asset Class (Stock, Bonds, etc) do you assign the percentages? And when the Growth Taxation table is fully configured according to your method does PRC "Tax Forms" entries (Interest, Dividends, etc) match actual, eg reported Federal IRS filing?
Couldn't you just tweak the ""Growth Taxed as Qualified Dividends" so the Qualified Dividends in Expenses->Taxes matches the 1099 value?
My 1099 shows qualified dividends and non-qualified dividends for each fund, so I follow those breakdowns. Bond dividends are non-qualified.
If dividends change, then it will deviate some, but it takes something like the 2008 meltdown for them to change drastically. Since I am generally projecting stocks will grow 8%/year nominal, effectively I'm using the same 8% nominal for dividend growth. I wouldn't expect it to be an exact projection in any given year of course.
Yes, if you made no changes in your holdings, you could look up the qualified dividends and non-qualified dividends and make guesses at the percentages until you find the right numbers, not sure why you would though when it's just division.
