Re-investing dividends

Research on Safe Withdrawal Rates

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peteyperson
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Re-investing dividends

Post by peteyperson » Thu Jul 24, 2003 10:11 am

Do you avoid dividends being considered new income for tax purposes if you have them automatically reinvested instead of distributed from an index fund?

I'm thinking about the w/d rate and the fact that dividends paid out by companies like GE owned within the index fund would be taxed, where as if they are used to buy new share units then you might only pay capital gains taxes on the realised gain when you sell the new shares (paid for from dividends not taken but reinvested).

How does the sequence work in the US? I've no experience of dividends and how it works.

Petey

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BenSolar
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Re: Re-investing dividends

Post by BenSolar » Thu Jul 24, 2003 10:17 am

peteyperson wrote:Do you avoid dividends being considered new income for tax purposes if you have them automatically reinvested instead of distributed from an index fund?

No, you don't avoid them, unless it is in a tax-sheltered account. Uncle Sam will take his cut even though you have reinvested the dividends.

BenS
"Do not spoil what you have by desiring what you have not; remember that what you now have was once among the things only hoped for." - Epicurus

peteyperson
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Re: Re-investing dividends

Post by peteyperson » Thu Jul 24, 2003 10:25 am

DAMN ! <cue: heavy booming drums>

The IRS. Just when you think you're out... they pull you back in!

BenSolar wrote:
peteyperson wrote:Do you avoid dividends being considered new income for tax purposes if you have them automatically reinvested instead of distributed from an index fund?

No, you don't avoid them, unless it is in a tax-sheltered account. Uncle Sam will take his cut even though you have reinvested the dividends.

BenS

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FMO
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Re: Re-investing dividends

Post by FMO » Sat Jul 26, 2003 2:13 am

peteyperson wrote:Do you avoid dividends being considered new income for tax purposes if you have them automatically reinvested instead of distributed from an index fund?

I'm thinking about the w/d rate and the fact that dividends paid out by companies like GE owned within the index fund would be taxed, where as if they are used to buy new share units then you might only pay capital gains taxes on the realised gain when you sell the new shares (paid for from dividends not taken but reinvested).

How does the sequence work in the US? I've no experience of dividends and how it works.

Petey

Consider the ramifications of the fact that you can't avoid taxation of dividends held in taxable accounts. Most SWR models assume that no taxation occurs until funds are withdrawn to fund living expenses. Consider further that the average dividend payout of the S&P 500 exceeds the rates of safe withdrawal commonly calculated for prospective early retirees. Consider further that few people hold 100% of their retirement portfolio in tax-deferred vehicles. This tells me that the SWR models fail to address the effects of taxation on the compounding of retirement funds. There have been many years when the dividend rate of the S&P 500 has exceeded 7%. Even if 4% is withdrawn from the portfolio, 3% of the dividends cannot avoid taxation, yet are assumed to compound tax-free for long periods. Few people want to talk about this and while I can't quantify the impact, the impact is real and will reduce SWRs. Perhaps the issue is too difficult to address. Does that mean it should be ignored?
FMO

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peteyperson
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Re: Re-investing dividends

Post by peteyperson » Sat Jul 26, 2003 11:15 am

I will have to give this issue more thought. I think John R would find this issue interesting too.

At the moment my plan is to avoid tax-deferred pension investing altogether due to the unknown payout percentage, financial instability of the main insurers and other issues. I fully expect the majority of investments to fully incur taxes. One of my concerns with real estate investing was the same year taxation of revenue, but dividends have similar liability issues here in the UK.

Petey

FMO wrote:
peteyperson wrote:Do you avoid dividends being considered new income for tax purposes if you have them automatically reinvested instead of distributed from an index fund?

I'm thinking about the w/d rate and the fact that dividends paid out by companies like GE owned within the index fund would be taxed, where as if they are used to buy new share units then you might only pay capital gains taxes on the realised gain when you sell the new shares (paid for from dividends not taken but reinvested).

How does the sequence work in the US? I've no experience of dividends and how it works.

Petey

Consider the ramifications of the fact that you can't avoid taxation of dividends held in taxable accounts. Most SWR models assume that no taxation occurs until funds are withdrawn to fund living expenses. Consider further that the average dividend payout of the S&P 500 exceeds the rates of safe withdrawal commonly calculated for prospective early retirees. Consider further that few people hold 100% of their retirement portfolio in tax-deferred vehicles. This tells me that the SWR models fail to address the effects of taxation on the compounding of retirement funds. There have been many years when the dividend rate of the S&P 500 has exceeded 7%. Even if 4% is withdrawn from the portfolio, 3% of the dividends cannot avoid taxation, yet are assumed to compound tax-free for long periods. Few people want to talk about this and while I can't quantify the impact, the impact is real and will reduce SWRs. Perhaps the issue is too difficult to address. Does that mean it should be ignored?
Last edited by peteyperson on Sat Jul 26, 2003 11:21 am, edited 1 time in total.

therealchips
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Income Tax and SWRs

Post by therealchips » Sat Jul 26, 2003 11:20 am

FMO wrote:Most SWR models assume that no taxation occurs until funds are withdrawn to fund living expenses. Consider further that the average dividend payout of the S&P 500 exceeds the rates of safe withdrawal commonly calculated for prospective early retirees. Consider further that few people hold 100% of their retirement portfolio in tax-deferred vehicles. This tells me that the SWR models fail to address the effects of taxation on the compounding of retirement funds. There have been many years when the dividend rate of the S&P 500 has exceeded 7%. Even if 4% is withdrawn from the portfolio, 3% of the dividends cannot avoid taxation, yet are assumed to compound tax-free for long periods. Few people want to talk about this and while I can't quantify the impact, the impact is real and will reduce SWRs. Perhaps the issue is too difficult to address. Does that mean it should be ignored?

I agree entirely with your statements, especially the one I emphasized in bold. My answer to your question is No, plans for retirement should not ignore taxation, even if SWR studies do not (yet?) include this issue. I have raised taxation as a factor in retirement planning in at least one recent post at NFB. It's an issue I am happy to talk about, not that I look forward to paying the taxes.

There are some ameliorating circumstances, however, in the taxation of dividends and realized capital gains. While few people have all the retirement stash in tax-deferred accounts, many of us have a significant part of our assets there. In my case, it is almost half. Further, with the new tax law, (most) dividends paid in taxable accounts are taxed at a maximum of 15%. (Under present law, the federal tax rate on dividends is zero for one year only, 2008 as I recall. As a citizen of Nevada, I happily ignore the state income tax problem, but other people may need to consider it. The tax-happy state of California, from which I only recently escaped, treats capital gains distributions from mutual funds as ordinary income, and therefore subject to a maximum tax rate of 9.3%.) Dividend and realized capital gains taxes are still a significant burden when compounded over years, as you said, but not so bad as formerly. Finally, the current dividend on the S&P 500 is only a little over 1%, so the problem of dividend taxation may not be urgent at the moment. Still, long range planning for taxation is important to me, difficult as it is. We cannot predict what the changes in tax law and regulations will be, just as we are not sure what inflation and stock market returns will be.

The problem that concerns me more than dividend taxation just now is this: I can see a doubling or tripling of my real income tax payments starting in about six years when I have to start making withdrawals from my IRA. Further, my analysis says that, for my purposes, I cannot reduce that tax problem by taking some optional IRA withdrawals before age 70 and a half when withdrawals become mandatory. That influences my assessment of a SWR since I don't plan on letting that predictable tax increase reduce my after-tax inflation-corrected standard of living in retirement.
He who has lived obscurely and quietly has lived well. [Latin: Bene qui latuit, bene vixit.]

Chips

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