Tax Efficient Sale of Stocks/Funds

[ENT Doc]

So I've got a family member who, for decades, has been investing much more in specific stocks than in mutual funds.  As this individual nears retirement I am suggesting to transition the stock holdings in a tax-efficient way into mutual funds.  They don't need the dividends or need to draw down from the taxable account for living expenses.  They have enough from social security, RMDs, and partnership income (FLP) to support their lifestyle.  If you can all poke holes in the following plan and/or suggest alternatives I would greatly appreciate it:

1.  Turn off dividend re-investment, buy mutual fund shares with the cash

2.  Sell lots with no gains

3.  Sell off lots with gains with other lots with matching losses

4.  Sell off lots with gains in the future (which will decrease as the effects of #1 take effect) with offsetting losses from TLH or from other stocks still held

5.  Sell off lots with gains, take the tax hit as a cost of minimizing risk and improving diversification

Some additional pieces of information.  Current stocks probably average a yield of 3.5-4%, mutual fund would probably be ~2%.  Cap gains and dividends taxed at a marginal rate of 15%.  25% marginal income tax rate.  Assume current tax law holds, for now.

Thanks everyone!

[FIREshrink]

Sounds like your friend has plenty of money and diversification. What problem are you trying to fix?

[ENT Doc]

The efficiency of the portfolio.  This person doesn't need the extra dividend income, so all this does is generate more tax for them to pay.  And the current holdings are NOT diversified - quite the opposite.  They have a small handful of stocks, which tend to be repeated across multiple accounts.  Consolidation under one roof is also a goal, but not pertinent to the tax/risk optimization I'm seeking for them.

[Donnie]

Would need more specifics to determine whether this makes sense. At least a general idea of concentration per asset, assets in retirement accounts versus taxable, embedded gains in taxable, expected use of the taxable account, whether person is still contributing to taxable, etc.

If the person is still contributing to taxable, easiest way to diversify would be to invest new capital in index funds and doing 1-4 above. Not sure if paying taxes to diversify is worth it. Time horizon for using funds would be an important consideration.

[FIREshrink]

Paying capital gains taxes to avoid dividend taxes is probably not worthwhile, obviously depending on the specifics. The larger the gain, the less worthwhile. You could certainly turn off reinvesting of distributions and sell anything with a loss. After that, I’d generally recommend donating these stocks to charity if charitable giving is already part of your friend’s plan. That’s how I got rid of all our individual stocks when we converted to pure indexing.

[ENT Doc]

They'll be contributing to taxable with whatever funds are not used from the RMDs and other income.  Time horizon probably 15-20 years.  Planned use is probably to pass on to their kids.  Embedded gains, probably $550k.  Not sure the other info (concentration per asset, assets in retirement accounts) is pertinent.  Also, whether contributing now or now, wouldn't #1-4 make sense anyway from an efficiency/risk perspective?

I know they donate to charity every year.  Wondering if they could just set up a fund for this instead of doing #5 and save them from having to spend after-tax money in the future for that purpose.  Don't itemize.

[Hatton]

Really unless the stocks are all in one sector the tax hit may not be worth it.  I own just one individual stock (Apple) which I will either donate or die with because I bought it 2008.  The tax hit is significant so I plan to keep it.  It also pays a dividend.  I also own some mutual funds that I started investing in 1989 they have a higher expense ratio than I would consider now but I don't want the tax hit.  I do not reinvest them and just donated some to start a Donor advised Fund.  I would look at the tax your relative pays on the dividend income versus the capital gains tax on selling the positions.  I bet the dividend tax is less than LTCG.  Now if there is a problem with one of the companies then that is a different ball of wax.

[Hatton]

They could donate appreciated shares for giving.  Right now their heirs (you?) will love individual stocks with a step up basis.  You can sell.

[FIREshrink]

selling off losers always makes sense, but under current law those offset regular income up to $3000 per year, so that much at least is not a net gain. If they have embedded losses of say $50k, I’d realize those in 2017 and carry them forward for the next 17 or so years without necessarily offsetting them with gains. I’m not explaining myself well - but basically, why waste a $3000 loss against a $3000 LTCG when instead it could offset regular income in the 33, 35, or 39.6% bracket (or whatever your friend is)?

1-2 make sense in general.

I’m thinking this is what DAFs are for but depends how charitable your friend wants to be.

[Donnie]

I agree that this looks like a great DAF candidate if they are making charitable donations anyway.

[ENT Doc]

So not me (heir), just trying to help some non-immediate family members.  Funny how they come to you when you show a shred of competence in this realm.  I like the DAF as an option and will look into this further for them.

FIREshrink, I like using the 3k of capital losses to carry forward and reduce income tax vs offset capital gains at a 15% rate.  Will need to run a few spreadsheets on these options.

Thanks for the pointers so far!

[StarTrekDoc]

Agree with Donnie --  perfect candidate for Donor Advised Fund --  donate highly gained stocks and double savings.  With 550k+ in gains, would make some very happy charities to receive these over time or in single bolus as your friend desires --this is the highest efficiency pass through you'll get.

All future taxable goes to index/diversified funds. Roth as much as possible as RMDs appear to be an issue.  Even 529 and pay the tax on the back end--hard to tell the inheritance/generation ramifications of those funds.