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What would you do?
A recent 60-yr.-old retiree with a pension over $100K/yr. and rental income of ~$30K/yr. My expenses are ~$70K/yr. As you can see I have no need to withdraw any $ from my retirement accounts (~$1.09M in trad. IRA and $2.2K in Roth) or two brokerage accounts ($1.5M-a bunch of mutual funds (18) & $500K- Schwab Intelligent Portfolio-robo advisor; overall asset allocation of 85% stocks & 15% bonds.) Seriously considering doing Roth conversions before reaching RMD at 75.
I have a checking account and some emergency cash held in MM muni funds in the four accounts mentioned. All of my assets are held at Schwab. I am a DIY, “buy-and-hold” investor who likes to manage a portfolio with no/low fees and expenses, and I’ve had the mutual funds (index funds from Vanguards, T. Lowe Price, and some mid & small cap funds) for a long time and they have appreciated greatly over the years with serious tax consequences; it appears that some/many of them are not tax-efficient!
Due to large distributions and gains from the mutual funds, last year my taxes were very high (tail end of 32% fed. & 9.3% CA brackets). I was recommended to gradually sell the mutual funds and invest in a direct-indexing product, such as Schwab Personalized Indexing or Fidelity’s “SMA- Direct Indexing, both of which have 0.4% advisory fee. Tax-loss harvesting was the major reason these products were recommended.
What are your thoughts on these products? There are pros and cons of this strategy, but directly owning hundreds of stocks will create a nightmare when unloading or discontinuing in the future. Also, pages of 1099 to upload during tax preparation!
How about robo advisors (Betterment, M1, Wealthfront) that do tax-loss harvesting automatically for a fee (~0.25%) or direct indexing, like Wealthfront’s S&P 500 Direct Indexing with .09% fee?
Any feedback, thoughts or recommendations would be deeply appreciated, for I’m having a hard time making a decision on how to invest in tax-efficient products that cost very little or have no/low fees.
For those of us in the upper middle class (barely) with maybe a couple to several million of total savings, I don’t believe direct indexing to save maybe a few tax bucks is worth the effort for the complexity added.
Also, despite being one of Humble Dollar’s hugest Roth proponents, I’d say at a 41+ percent marginal tax rate, Roth converting is not likely to deliver huge tax savings.
With your $1.1 million tax deferred account today, RMDs on today’s basis would add about 4% (at age 75) or $44k to your annual income of $130k plus Social Security (say $50K? but SS may even be exempted from taxes under Trump proposals). I’m also going to presume your tax-deferred accounts at least double between now and age 75, so let’s presume RMDs double to $88K. Still, today’s income plus SS plus doubled RMDs are going to place you in the middle of the 24% tax bracket. All this says that Roth may not be a huge winner in your situation. If you moved to a lower tax state or if your tax-deferred accounts grow bigger, it may be more beneficial, especially when tax-deferred accounts get into the $2-3 million range which start pushing RMD plus other income more toward the top of the 24% income bracket.
Last year, as a single filer, my taxable income ($242K) was at the top of the 32% ($243,725) income bracket, nowhere near top of 24% ($191,950). Due to a very strong bull market in 2024, my investment income (1099s) of over $150K pushed me into the top 32% bracket. Unless I get a part-time job that contributes to SS, currently I don’t have enough credits to earn SS benefits, but modest increase (~2%) in pension and rental income with a decent investment gains both in taxable and tax-deferred accounts will definitely put me in 32% bracket with or without Roth conversion, I think. Thus, considering doing conversions up to the top of the 32% if it’s worth doing it. That’s the $64K question I have and uncertainty I’m facing. Or am I overlooking something here?
Just a heads-up: to get premium-free Medicare Part A, you need 40 quarters (10 years) of work where Medicare taxes were paid. If you’re missing this, you might still qualify for Medicare, but you’d pay a premium for Part A. Don’t let this catch you off guard—double-check your work history to be sure!
Thank you for the heads-up. I did pay Medicare taxes when I was working so I should be good to go for premium-free Medicare Part A. I suppose it doesn’t hurt to check with the SS administration to be 100% sure. Medicare Part B on the other hand is a entirely different story and very likely I’d be facing IRMAA just with my ordinary income (pension + rental). It’s a matter of which IRMAA bracket I’d be in with MAGI that includes Roth conversions and investment income. Now I see why health care cost is one of the highest expenses during retirement.
Oops – single filing, my bad – I don’t think you are overlooking anything. Yes – Rothing to the top of any bracket in which you’ll likely forever remain in, is beneficial especially from an estate and RMD standpoint, but the additional 9.3 percent state tax is a tough additional tax pill to swallow along the way. We used to live in MD with 8.3% marginal state and local tax rates on Roths, but we moved to NH 3 years ago to be close to our children and NH happens to have 0% state taxes on Roths.
You’ve done fantastic with your pension, investment income and savings, but all these are well taxed – good problems to have. If you can Roth sufficiently to reduce RMD’s to the extent to reduce future marginal taxes from 32% to 24%, it could be a bigger winner. But in the 15 years until RMDs, tax brackets or account balances (markets) could change significantly.
Adam Grossman has written at least one article on direct indexing.
Here are three pieces where Adam discusses direct indexing:
https://humbledollar.com/2025/02/one-stock-at-a-time/
https://humbledollar.com/2024/04/no-big-loss/
https://humbledollar.com/2021/07/how-to-lose-less/
Being high net worth is a remarkable position—it likely means you have more than enough to meet your needs. So my question is:
Is the juice really worth the squeeze?
Or would simplifying your life, even if it costs a bit more, bring you greater peace?
I’d definitely like to have an answer to that very wise question. It may not be “worth the squeeze,” but I’d like to know for sure so I don’t regret not trying at least. I’m considering consulting professionals, like CFP, EA, CPA, etc., to confirm.
Does “simplifying” my life mean simply not doing anything about it, just keep whatever I have in my brokerage accounts (18 mutual funds & a robo advisor) and no Roth conversions? Hmm…very tempting, but don’t know if it’s wise to face very high tax bills year after year with large capital gains/distributions, RMD and IRMMA….these may cost more than “a bit more,” I’d think.
You certainly gave me some food for thoughts. Appreciate it!
“Tax-loss harvesting was the major reason these products were recommended.”
So the recommendation is to invest in order to intentionally lose money? That is simply nonsensical.
I think quan nguyen’s advice below is well reasoned.
Of course, achieving investment growth with tax-loss harvesting as a tax-smart investing strategy would be the objective of DI, but as Quan N. stated that no one can “…reliably predict…the good year or bad year for tax loss harvesting.” Thus, DI can be very risky and may not be beneficial in the long run. Thanks for your comments!
Since you don’t need the income, when you attain RMD age, you will just be moving assets from tax-deferred to taxable. Unless you spend it, gift it to relatives, or donate it, it will just accumulate and increase the amount of your taxes. The is the challenge/result of good financial habits and thrift. There is no magic pill that will make things different, including direct indexing. Things are what they are, being wealthy is better than being poor!
For Roth conversions, I was thinking it’d be much more tax-efficient for my heirs when they inherit my Roth since I assume their tax brackets would be higher than mine now. I’m also thinking about doing both charitable giving through Donor Advise Funds (DAF) and Roth conversions during the years near the RMD age. This will mitigate paying too much taxes while doing good deeds:) Your last three sentences are so wise and true!! Of course, having this “challenge” is better than being broke or in red financially! Thanks!
I have a really off the wall suggestion for you. Contact your pension administrator and ask about suspending your pension benefit for say 10 years. (Perhaps less after you play with the numbers on the conversions) During these ten years, you do Roth conversions. You should have plenty of $$ in taxable accounts to pay the tax on the conversions. I would aim for a $500k ending balance in the IRA. This balance could be used to pay for long term care if the need arose. When you do conversions see if you can just transfer assets instead of selling and reinvesting. Transfer equities as your goal should be to have 100% equities in the Roth. When your pension benefit is released, the benefit should be substantially larger, but you will have reduced future taxes for your heirs.
My situation is somewhat similar to yours except that I don’t have a pension and I am much older. When I retired at 55, I had very little income allowing for large conversions.
Very interesting and intriguing suggestion! It’s never crossed my mind to suspend my pension in order to make room for higher Roth conversions. If I suspend pension, rental income would be the only source of income and I’d need to withdraw from my taxable account to cover the rest of my expenses. Most likely, I wouldn’t be able to cover for anything (i.e. travels) beyond basic living expenses. Of course, I’d be able to convert higher amount of Roth. Although I have “plenty of $$ in taxable” account, I’d be hit with 15% LT capital gain taxes when unloading the mutual funds to pay for the tax on conversions and source of income while paying ordinary income taxes for the conversions and the rental income.
This idea is definitely unique and thought-provoking, but I’d think I’d need to do deeper analysis and/or seek further consultations from various professionals, like CPA and CFP before executing, idea of which I’m not particularly in favor of as a DIYer, but might be necessary. Thank you so much for giving me something to ponder and think outside the box! Deeply appreciate your wisdom!
RL, Perhaps the question is; if you paused your pension, how could you fund your retirement?
First, I am just guessing, but I estimate you get between 25 and $35k in dividends from your taxable account, most of which are Qualified Dividends. Since you have a lot of mutual funds, no doubt you are currently reinvesting these dividends. If you stopped reinvesting during your pension pause, you could use these dividends for living expenses.
Second, since you are over 59 you can just withdraw funds from your IRA for living expenses. Doing this would help reduce your Traditional IRA balance.
Finally, ETFs are generally more tax friendly than MFs. Over time you might consider gradually switching.
Were I you, I might look for an hourly financial planner who could run some numbers to look at possible scenarios…..Maybe you don’t need to do more conversions, but instead, just live on your Traditional IRA for a while instead of your pension. Think outside the box….
As for dividends, your estimate of $25-$35K might be close, but I don’t know for sure since I don’t usually check on the total amount until tax preparation time. I have the reinvesting turned off currently after seeing the 1099s and learning how much taxes I needed to pay for the investment income earlier in the year. Of course, I earn both qualified and non-qualified dividends from the mutual funds each year, but more non-qualified than qualified last year. They are one of the incomes I can live off if I suspended my pension and they will lower the amount of withdrawal I’d need to take from my traditional IRA as well.
As suggested, I’m considering gradually moving the mutual funds to low-cost, index ETFs for tax efficiency purpose. Inevitably, this process will generate capital gains and thus I’d need to be more strategic in my implementation as much as possible.
I am seriously considering using the services of a flat-fee, project-based, or hourly CFP/CPA/EA (or use an online financial planning application, like Boldin/New Retirement?) to run the numbers and different, possible scenarios. Hopefully, the advisory fees are worth it and not too painful for the DIYer in me:) lol…
Again, deeply appreciate your outside-the-box, thoughtful and intelligent suggestions.
There is a national association of fee-only advisors: https://www.napfa.org/financial-planning/what-is-fee-only-advising.
You might check to see who is nearby and look for reviews.
Thank you for the resource. I shall look into that soon:)
Hi RL,
You have clearly been a great saver and as a buy and hold investor you are at a website where such virtuous habits are appreciated.
My opinion of direct indexing as a financial tool is that the usefulness is often limited to a select group of individuals whose life and investment profile match the problem that direct indexing is trying to solve. I am not one of that select group. You noted many of the pros and cons of direct indexing but I think there are other considerations.
Rob Berger did a 15 minute YouTube video on this topic a couple of years ago which may be worth a watch. Just google, if you are interested –
Rob Berger Direct Indexing–Why the Tax Loss Harvesting Benefits Aren’t Worth the Cost
I suspect the main problems with direct indexing not noted by you above (cost and complexity when you stop using direct indexing) but noted in Mr. Berger’s video that you may want to consider are –
Will your benefit from tax loss harvesting (TLH) from direct indexing decrease quickly over time as losses in the direct index are realized and you are left with mostly investments with unrealized taxable gains which typically occurs after about five years?
As a long term buy and hold investor to fund the direct indexing account will you have to realize large taxable gains from selling mutual funds?
Will you have sufficient other capital gains to utilize the capital losses generated from TLH?
I will leave other questions and possible recommendations to other Humble Dollar commenters.
I hope this helps.
Best, Bill
Thank you, Bll, for your thoughtful comments. On my journey to learn more about direct indexing (DI) over the past two/three months, I did watch Bob Berger’s video on direct indexing and he and other resources have made me consider numerous questions to ponder. Needless to say, I’m currently skeptical about signing up for this strategy and seeking wisdom from HD on what steps to take if not DI. As many have said to me, “It’s a good problem to have.:)”
How do your distributions compare with, say, Vanguard Total Stock Market ETF (VTI)? I believe you can find this info on Morningstar. VTI distributes no capital gains.
Maybe you can move your Vanguard mutual funds in kind to Vanguard and then convert them to ETFs with no tax consequences, if that makes sense.
You’ve read my mind, Randy! I’ve been considering transferring the Vanguard mutual funds to Vanguard and convert them to equivalent ETFs without tax consequences. Luckily, six out of seven of my mutual funds have equivalent ETFs! Hopefully, the ETFs are more tax efficient than the mutual funds. I’ll investigate tax/distribution data of each ETF from Morningstar as you’ve suggested. Your comments and suggestions are deeply appreciated! Let me know if you have any further suggestions/ideas I can take instead of direct indexing.
I always think of tax loss harvesting as the least desirable decision to be taken at year end. Direct indexing is a strategy that places investment loss as the primary objective – the larger the losses, the more successful the strategy. And the investors pay advisors for help. It sounds counter intuitive to me. If the index is the total US stock market, then in a down year, more stocks will have losses and fewer stocks have gains – good for tax harvesting. In any up year, more stocks with gains and fewer stocks with losses – bad for tax harvesting. Can any advisor reliably predict 2025 as the good year or bad year for tax loss harvesting, not to consider the starting point of direct indexing or market timing?
A lot more about direct indexing at morningstar.com – what it is, when it pays, what questions to ask your advisors about direct indexing.
“It takes all kinds to make the world go around, though perhaps some shouldn’t go quite so far around it as others.” Bill Bryson
Interesting thoughts on the primary objective of direct indexing (DI) as gaining more investment loss to be successful! I have seen some of the data from the investment brokers that offer DI on how efficient and successful the strategy is on tax efficiency. Of course, their data results show more positive than negative in marketing the product. I’ll definitely check out more about direct indexing at morningstar.com as you suggested. Thank you so much for your thoughts and suggestions. Now, I’d need to look for alternatives to DI, maybe gradually and strategically unloading the mutual funds and buying a few (no more than 4 or 5) solid, tax-efficient, diversified ETFs as a long term goal.
Saying that the primary objective is to lose money is a snappy quote but probably not correct. I’ve investigated such “tax-smart” separate accounts before as well, and the fine print is clear that the primary objective is making the client money; reducing their tax is secondary.
For me, realizing gains up front to fund an account that may be more tax efficient going forward makes no sense. However, if I didn’t have to do that, perhaps because of an influx of cash or a rest in cost basis, then I can see it making sense.
The logic behind gradually unloading and taking the gains upfront and moving to more tax efficient ETFs is to avoid deeper appreciation of the fund basis and generate more taxes passively or actively when unloading it in the future. Of course, unloading the mutual funds will be done over many years, starting with the funds with the highest expense & tax ratios. No matter what there’s no avoiding the taxes, but I either pay them now or later just like doing Roth conversions, I suppose. Thanks for your insightful comments, Michael!