RetireJapan

While its raining cats and dogs outside, I've been doing some thinking...

When choosing funds or ETFs for my asset allocation I was preferring the 配当込み ones, that is funds with dividends reinvested internally, in order to save on taxes on dividends (outside of NISA).
However, recently I started thinking, that if I'm going to live off dividends after retirement, then after retirement I will have to switch do funds distributing dividends, and pay taxes on capital gains when doing so. Which basically means, that I will probably have to pay even more taxes than if I paid taxes on dividends now, because 1) those reinvested dividends will grow in price, 2) taxes in general might be higher then, and my own tax bracket might be higher.
Therefore, it looks like it is better to invest in dividend paying funds, and reinvest dividends after taxes.

But, thinking further, currently I'm investing in broad market indexes like MSCI kokusai or TOPIX, which have low dividend yield, but in retirement I would probably have switch to high dividend yielding blue chip stocks instead, meaning that I would still have to sell the "old" funds, dividends reinvested or not, pay taxes on capital gains and buy the dividend yielding stocks instead.

So if the plan is to live off dividends in retirement, taxes on capital gains look inevitable in any case (unless, of course, the capital is large enough to not care about few percent difference in dividend yield ).

I was wondering what everyone else thinks about this?

It seems like reinvesting the dividends internally is more tax-efficient (if you are only going to reinvest them you'll pay taxes as well as fees to purchase more units). Personally I enjoy seeing my dividend income rise and hope to be able to live off it eventually.

So I guess it's a personal decision. My portfolio has a mix of:

1) non-dividend producing assets (iDeCo, THEO)
2) low-dividend producing assets (ETFs like VT, 1550)
3) high-dividend producing assets (individual shares)

I suspect 1 and 2 will provide a greater return over time, but 3 is more enjoyable to track year on year

Indeed, it is more tax efficient if dividends are reinvested internally by the fund before taxes.
But if dividends are reinvested internally, then there is no way to live off them.
In order to live off dividends after retirement, you would have to sell 1) and 2) and buy more of 3), no?
And when selling, you would have to pay even more taxes on capital gains, because those dividends reinvested in new shares have grown in price (hopefully ).
Of course, if 2) is big enough that even 1,5% dividend yield is providing financial freedom, then good for you.

Pretty sure dividends and capital gains are taxed at a flat rate around 20% in Japan, regardless of your income. So I'm not sure why you're bringing your tax bracket into it?

I think I read somewhere that all things being equal, the lump sum tax on a capital gain after internal reinvestment is less than the tax you would pay through multiple dividend payouts and reinvesting manually.

The idea of living off dividends sounds cool, but dividends are not guaranteed and the value of a portfolio of blue chips is more likely to take a dive than a portfolio of index funds.

I think a combination of the two may be the best option?

I'm bringing tax bracket because I read too much USA-originated information about investments
However, my concern about taxes raising in future still stands.

I think I read somewhere that all things being equal, the lump sum tax on a capital gain after internal reinvestment is less than the tax you would pay through multiple dividend payouts and reinvesting manually.

What would be ideal is to see the real numbers. I guess I'll have to google or try to calculate myself.
At the moment I cannot see how it can be true, because in case of lump sum tax on a capital gain you would eventually pay taxes on the compounded dividends + taxes on compounded principal growth. However, if there is no capital gain, then you would only pay taxes on the reinvested dividends. The crucial thing here is that if we don't switch to another asset allocation after retirement, then there is no capital gains, so only dividends are taxed.

Which leads to your question, what is the best asset allocation when retired? I don't know. I'm too far from the retirement, so I haven't given it much thought until today. However, my guess is that it is something paying dividends. Therefore, if I owned only funds with internal dividends reinvestment I would definitely had to switch.
But would/should I switch if I had index fund with dividends NOT reinvested? Are there better options for retirees? If not, then it looks like it is better to buy funds without reinvesting. But if there is, then reinvesting or not, one would have to switch anyway (provided, one plans to live off dividends, of course).

Regarding, whether living off dividends is feasible or not, I again, don't know. I mean, it looks feasible on paper and Investopedia says that blue-chip stocks "generally, they make increased and uninterrupted dividend payments over time" (and as long as they are paying dividends, I don't care how much dive the share price would take on paper). However, I haven't researched this topic well.
I'm just trying to come up with some funds for my portfolio, but every time I think that I got it all done, I find out something new and have to redo everything.

From what I have read, you will likely end up with more money by allowing the funds to compound without paying taxes, then selling them and paying capital gains.

Receiving dividends is less tax-efficient but more satisfying for some people (like me)

Ori wrote: ↑Sun Oct 22, 2017 4:05 pm What would be ideal is to see the real numbers. I guess I'll have to google or try to calculate myself.

You'll probably have to calculate it yourself. Shouldn't be too difficult. The problem with reading on the net in English is that other countries have different tax treatment of dividends and capital gains to Japan. So comparison is difficult. E.g. short/long-term capital gain taxation (I don't think Japan differentiates?). Also, most countries treat dividends as part of income (Japan is a flat ~20%). Also, I don't know if Japanese dividends can be franked or not? Lots of variables...

Ori wrote: ↑Sun Oct 22, 2017 4:05 pm At the moment I cannot see how it can be true, because in case of lump sum tax on a capital gain you would eventually pay taxes on the compounded dividends + taxes on compounded principal growth. However, if there is no capital gain, then you would only pay taxes on the reinvested dividends. The crucial thing here is that if we don't switch to another asset allocation after retirement, then there is no capital gains, so only dividends are taxed.

So you don't ever plan on using your principal? It will get taxed at some point, as inheritance for example. Also, I'm not sure of the logic you're using above. That could be due to my limited knowledge on the matter though. Hopefully someone can clear it up for us, haha.

Ori wrote: ↑Sun Oct 22, 2017 4:05 pm Which leads to your question, what is the best asset allocation when retired? I don't know. I'm too far from the retirement, so I haven't given it much thought until today. However, my guess is that it is something paying dividends. Therefore, if I owned only funds with internal dividends reinvestment I would definitely had to switch.

By the way, I assume you are utilizing NISA and iDeco?

When choosing funds or ETFs for my asset allocation I was preferring the 配当込み ones, that is funds with dividends reinvested internally, in order to save on taxes on dividends (outside of NISA).
However, recently I started thinking, that if I'm going to live off dividends after retirement, then after retirement I will have to switch do funds distributing dividends, and pay taxes on capital gains when doing so. Which basically means, that I will probably have to pay even more taxes than if I paid taxes on dividends now, because 1) those reinvested dividends will grow in price, 2) taxes in general might be higher then, and my own tax bracket might be higher.
Therefore, it looks like it is better to invest in dividend paying funds, and reinvest dividends after taxes.

I'm pretty sure that it's better to let the dividends compound untaxed and pay capital gains when you sell.
Imagine a fund tracks an index which has a 2% dividend. Let's say it triples in value over 20 years.
If the index includes the dividend, then the dividend will be added to the assets of the fund untaxed. A 100,000 yen investment would yield 2,000 yen. In 20 years, that becomes 6,000 yen. All of this would be a capital gain, so you'd get 4,800 yen when you sell.

If the fund pays out a dividend and it's taxed then your receive 1,600 yen. Reinvest it and wait 20 years and it'll grow to 4,800 yen. When you sell, 3,200 yen of this would be a capital gain. So, you'd pay 640 yen tax. That means you end up with 4,160 yen.

I feel that I didn't make myself clear enough.
A second try

I see the following options on use of the accumulated investments after retirement:
1) Live off the dividends. Assuming that dividend yield is 2% (being pessimistic here) and married couple needs 20 man yen a month (30 man seem to be the number everyone uses in Japan, and we hope that at least 10 man will be from pension), then we would need to accumulate 1.2 oku yen (or roughly 1mln USD) until retirement. That's a lot, but not impossible for two income family spending reasonably.
2) Sell principal bit by bit.
3) Doing both.

It is obvious, that for 2) it is better to invest in funds which reinvest dividends before taxes.
However, what is best for 1)?
A. Invest in the index funds which reinvest dividends (FR) before taxes and then on retirement sell them off and buy index funds which pay dividends (FP). Capital gains occur.
B. Buy FP from the very beginning, reinvest dividends after taxes and then on retirement don't sell off anything, stop reinvest dividends and instead start live off those dividends. Capital gains don't occur.
C. Do same as A, but instead of buying FP on retirement buy blue chip stocks with high dividend yield. Capital gains occur.

In order to compare A and B, I made some calculations in Excel and it looks like if average return on investment is 4% and dividend yield is 2%, then we will end up with more money on retirement in case B than in case A after 30 years of investment (initial investment 10,000 yen, but it doesn't matter):
A: 57434 => 45947 (after taxes on capital gains because we sell off)
B: 51276 => 51276 (no taxes because we hold)

The situation reverses as soon as dividend yield reaches 4%, but I think it is unrealistic.
So, it looks if one plans to live off the dividends in future, it is better to buy funds not reinvesting dividends.

BUT, is it wise to buy index funds for living off dividends? Maybe, those who live off dividends buy blue chip stocks with high dividend yield or even something else?? This would be the case C then, and so it would be better to buy funds reinvesting dividends while before the retirement.

I guess, it boils down to the question of what to do with the investments after the retirement?
As to whether it would be possible for one accumulate enough to live off the dividends eventually depends on the individual circumstances of every investor )

P.S. This all is of course relevant only for investments outside NISA and ideco.

Got it! Still, from your calculations it looks like you'd be better off doing A and selling off 2% a year to live off rather than selling the whole lot and transferring it into other funds.

Index funds that follow the market in general don't have very high dividends. Dividend focused funds and ETFs give better dividends if you plan on living on the returns.