Personal Investments • Roth IRA or leave it in Taxable? A Wonky Thought Experiment

I can imagine someone who has a lot more money invested and has access to a Roth 401K at work where he can funnel something like 38K into a Roth each years (IRA + 30K). But that someone better watch out for 986racer's NIIT tax or generating enough capital gains to push them into a higher capital gains bracket (although that would take a LOT).

To make it a bit more challenging for your calculations...

The NIIT tax is not adjusted for inflation but the tax brackets are. So, in about 10 years, it's quite likely that your son may be in the 22% bracket but will be hit by that tax if you leave the money in your taxable account.

quite likely?

I'm glad you brought NIIT to my attention as I've never heard of it before. Still, I'm confused why you think it's an issue at all. First, once he inherited the taxable fund, it would reset its cost basis to zero, so selling 100% of it would generate $0 realized gain.

But even if he did have to pay the tax on the gain it would be $5,000 of realized gain ($10,000 x 50% unrealized gain = $5,000 x15% = $750). I know you know all of this. Just laying it out to see if I'm missing something.

So, what kind of situation are you imagining where NIIT tax could trigger? If he was single making... what? $196,000, then the capital gains take would put him over the 200k? I know it's magi not raw income so there would be deductions, gains from his own investments, etc, but I just don't see him making near enough in income to have to worry about NIIT. Even if he made 100k, he'd be well over the median household income for the US, but still nowhere close to the 200k ceiling to trigger NIIT. What am I missing?

Please lay out your thinking on this. What income would he need such that an extra $5,000 in realized gains could trigger the extra tax?

Finally, and I should hope it's not breaking the boglehead rules about speculating on tax structure to simply state that, whatever party is in charge of our government, issues that affect the affluent tend to get addressed, so I would imagine the NIIT will eventually get adjusted if not indexed they way they do with estate taxes. If I'm out of bounds with this statement, someone say so and I'll immediately edit/delete it.

In your example, you had him holding onto the inherited asset for 10 more years and then selling. Assuming that it appreciates during those ten years, he would have capital gains taxes to pay between the final price and the reset basis. He'd also be paying taxes on the dividends along the way.

Fair enough. Dividends should have been less that $1,000/year in realized gain even in the last 10 years. I got $40,110 tax free for the son 10 years after I die when the basis reset. 10 years later, he'd be at $77,258 with about half that in unrealized gains, or $34,792 in realized gain to 100% cash out of the fund (after 20 years).

Just so I understand you right, you were thinking that that $34,792, added to his income might exceed the cap which (at the moment) is 200k for a single filer. Is that about it? There's no cumulative effect to NIIT or anything like there is for the the inheritance tax if you gift over the allowed amount each year, right? The NIIT tax is just something you either trigger annually, or don't, right?

Just curious about how it works. Thanks for bringing it to my attention and thanks again for playing with the numbers on your own time for my benefit.

I don't know how old your son is, but 20 years of inflation alone is going to be somewhere between a 50%-75% increase in incomes. Additionally, I'm hoping it's quite likely he would have a raise that is above COLA during those 20 years.

Again, I would think the NIIT cap would follow suit and be raised. I appreciate you following my scenarios rigorously, but in the real world, if I didn't give my son the Roth option, he'd just inherit the fund on my death with zero cost basis. After that, even if he kept the fund, he'd set it to spec ID and at that point it would be like any other investment started with new money and he'd be under no obligation to cash out all or any of it in 10 years. Still, you raise a good point to consider.

I think the speculation about what will happen with NIIT is probably out of bounds but I don't see any evidence so far that there is appetite to inflation adjust it. It hasn't happened yet and it's been around for over a decade.

Oh, okay, I'll go back and delete. Maybe you're right. There may be political reasons to support that, but I will not speculate. Image may be NSFW.
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Statistics: Posted by bobsmith — Tue Sep 03, 2024 4:00 pm — Replies 64 — Views 6000

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