Bonds in HSA vs. Taxable

[LightStache]

I currently have most of my retirement savings in tax-deferred accounts with only $12K in my HSA and $80K in taxable. Currently looking at a five year glidepath to FIRE (or at least a sabbatical). I'll continue to max my HSA during that time and estimate the after tax accounts to grow to around $225K. I'll need to rely partly on these accounts to start my Roth ladder, so I plan to gradually increase my bond allocation to at least 50% by 2027.

My sense is that, when looking at HSA and taxable together, I should carry 100% bonds in my HSA and the minimum amount in taxable to hit my desired target. My only concern is that because of the low HSA contribution limits, the taxable will grow so much larger over the years. If I were to withdrawal anything from my HSA, it would be depleted rather quickly. I'm not sure that really matters in terms of overall strategy? Is there any good reason why I'd want to carry the same percentage of bonds in both HSA and taxable?

[EvenSteven]

I think the best place for bonds is in tax-deferred, so you should have enough space there for all your bonds. Treat the investment strategy for your HSA just as you would a Roth IRA.

[mistymoney]

I think the best place for bonds is in tax-deferred, so you should have enough space there for all your bonds. Treat the investment strategy for your HSA just as you would a Roth IRA.

I would add if you are pretty healthy and don't expect to need any medical care of great $$...

[Radagast]

Bonds worth keeping in taxable are series I savings bonds, and I recommend them either way, so I suggest stocking up on those first. VWALX may also be a worthwhile addition to a taxable account for some credit and interest rate risk, which does not generally have drawbacks relative to other options. Then you could add long term government bonds to your HSA until you get the average duration you are looking for. For example, say saving bonds have 0 duration, TLT has 15 years, and VWALX has 6 years. If you hold equal amounts you have an average 7 year duration with similar risk and better yield than BND, and take up minimal taxable space. Use a little less TLT to precisely match BND.

Otherwise yes, bonds go in tax deferred.

[LightStache]

Bonds worth keeping in taxable are series I savings bonds, and I recommend them either way, so I suggest stocking up on those first. VWALX may also be a worthwhile addition to a taxable account for some credit and interest rate risk, which does not generally have drawbacks relative to other options. Then you could add long term government bonds to your HSA until you get the average duration you are looking for. For example, say saving bonds have 0 duration, TLT has 15 years, and VWALX has 6 years. If you hold equal amounts you have an average 7 year duration with similar risk and better yield than BND, and take up minimal taxable space. Use a little less TLT to precisely match BND.

Otherwise yes, bonds go in tax deferred.

Interesting... since I'm in CA, what are your thoughts about something like CMF compared to TLT and VWALX?

[Tigerpine]

Just be sure not to buy any muni's in you tax-deferred accounts.  Especially if the interest is tax exempt for you at both the federal and state level.

[LightStache]

Just be sure not to buy any muni's in you tax-deferred accounts.  Especially if the interest is tax exempt for you at both the federal and state level.

Right, I wouldn't do that. I guess my original post is a little confusing. I'm just talking about allocation across taxable and HSA. If I shift to munis then it wouldn't matter, at least while I'm still living in CA.

[Radagast]

Bonds worth keeping in taxable are series I savings bonds, and I recommend them either way, so I suggest stocking up on those first. VWALX may also be a worthwhile addition to a taxable account for some credit and interest rate risk, which does not generally have drawbacks relative to other options. Then you could add long term government bonds to your HSA until you get the average duration you are looking for. For example, say saving bonds have 0 duration, TLT has 15 years, and VWALX has 6 years. If you hold equal amounts you have an average 7 year duration with similar risk and better yield than BND, and take up minimal taxable space. Use a little less TLT to precisely match BND.

Otherwise yes, bonds go in tax deferred.

Interesting... since I'm in CA, what are your thoughts about something like CMF compared to TLT and VWALX?

Municipal bonds generally have poorer performance than regular bonds do, they are typically bid to break even with taxable bonds in the 32% bracket or so, and high tax states are even worse. You'd have to do your own assessment based on your own situation. I have followed VWALX and in the past it has done very well, to the point that it is competitive with non-tax exempt bond funds eg it would not have been bad to hold in a tax-deferred account (pointless though). I haven't looked at CMF or other California mutual funds. I think VCLAX is be a little closer to VWALX in terms of yield and duration.

Don't forget savings bonds! Single-state bonds are riskier than a national Muni fund. Bill Bernstein would have suggested 1/3 state specific muni, 1/3 national muni, 1/3 treasury because of the credit risk of munis and concentration risk of a single state.

[LightStache]

Bonds worth keeping in taxable are series I savings bonds, and I recommend them either way, so I suggest stocking up on those first. VWALX may also be a worthwhile addition to a taxable account for some credit and interest rate risk, which does not generally have drawbacks relative to other options. Then you could add long term government bonds to your HSA until you get the average duration you are looking for. For example, say saving bonds have 0 duration, TLT has 15 years, and VWALX has 6 years. If you hold equal amounts you have an average 7 year duration with similar risk and better yield than BND, and take up minimal taxable space. Use a little less TLT to precisely match BND.

Otherwise yes, bonds go in tax deferred.

Interesting... since I'm in CA, what are your thoughts about something like CMF compared to TLT and VWALX?

Municipal bonds generally have poorer performance than regular bonds do, they are typically bid to break even with taxable bonds in the 32% bracket or so, and high tax states are even worse. You'd have to do your own assessment based on your own situation. I have followed VWALX and in the past it has done very well, to the point that it is competitive with non-tax exempt bond funds eg it would not have been bad to hold in a tax-deferred account (pointless though). I haven't looked at CMF or other California mutual funds. I think VCLAX is be a little closer to VWALX in terms of yield and duration.

Don't forget savings bonds! Single-state bonds are riskier than a national Muni fund. Bill Bernstein would have suggested 1/3 state specific muni, 1/3 national muni, 1/3 treasury because of the credit risk of munis and concentration risk of a single state.

Great points! It probably makes sense to do something like HSA: 1/4 treasuries and 1/4 corporate, taxable: 1/4 national muni and 1/4 CA muni.

So with my current 80/20 target, $12K in HSA, and $80K in taxable:
- HSA $2.8K equities / $9.2k bonds
- Taxable: $70.8K equities / $9.2K bonds

That means the HSA will have lower overall returns and continue to have a balance only 10% - 15% compared to taxable. Is there any argument to shift more bond allocation from HSA to taxable to increase the relative balance of the HSA in the future? I can't think of one, but I'm naturally inclined to balance things out so it just feels a little weird.

[EvenSteven]

Bonds worth keeping in taxable are series I savings bonds, and I recommend them either way, so I suggest stocking up on those first. VWALX may also be a worthwhile addition to a taxable account for some credit and interest rate risk, which does not generally have drawbacks relative to other options. Then you could add long term government bonds to your HSA until you get the average duration you are looking for. For example, say saving bonds have 0 duration, TLT has 15 years, and VWALX has 6 years. If you hold equal amounts you have an average 7 year duration with similar risk and better yield than BND, and take up minimal taxable space. Use a little less TLT to precisely match BND.

Otherwise yes, bonds go in tax deferred.

Interesting... since I'm in CA, what are your thoughts about something like CMF compared to TLT and VWALX?

Municipal bonds generally have poorer performance than regular bonds do, they are typically bid to break even with taxable bonds in the 32% bracket or so, and high tax states are even worse. You'd have to do your own assessment based on your own situation. I have followed VWALX and in the past it has done very well, to the point that it is competitive with non-tax exempt bond funds eg it would not have been bad to hold in a tax-deferred account (pointless though). I haven't looked at CMF or other California mutual funds. I think VCLAX is be a little closer to VWALX in terms of yield and duration.

Don't forget savings bonds! Single-state bonds are riskier than a national Muni fund. Bill Bernstein would have suggested 1/3 state specific muni, 1/3 national muni, 1/3 treasury because of the credit risk of munis and concentration risk of a single state.

Great points! It probably makes sense to do something like HSA: 1/4 treasuries and 1/4 corporate, taxable: 1/4 national muni and 1/4 CA muni.

So with my current 80/20 target, $12K in HSA, and $80K in taxable:
- HSA $2.8K equities / $9.2k bonds
- Taxable: $70.8K equities / $9.2K bonds

That means the HSA will have lower overall returns and continue to have a balance only 10% - 15% compared to taxable. Is there any argument to shift more bond allocation from HSA to taxable to increase the relative balance of the HSA in the future? I can't think of one, but I'm naturally inclined to balance things out so it just feels a little weird.

What is you reasoning for keeping any bonds at all in your taxable and tax free accounts? You can keep your asset allocation where you want it while keeping all your bonds in tax deferred if you wanted.

[Radagast]

Bonds worth keeping in taxable are series I savings bonds, and I recommend them either way, so I suggest stocking up on those first. VWALX may also be a worthwhile addition to a taxable account for some credit and interest rate risk, which does not generally have drawbacks relative to other options. Then you could add long term government bonds to your HSA until you get the average duration you are looking for. For example, say saving bonds have 0 duration, TLT has 15 years, and VWALX has 6 years. If you hold equal amounts you have an average 7 year duration with similar risk and better yield than BND, and take up minimal taxable space. Use a little less TLT to precisely match BND.

Otherwise yes, bonds go in tax deferred.

Interesting... since I'm in CA, what are your thoughts about something like CMF compared to TLT and VWALX?

Municipal bonds generally have poorer performance than regular bonds do, they are typically bid to break even with taxable bonds in the 32% bracket or so, and high tax states are even worse. You'd have to do your own assessment based on your own situation. I have followed VWALX and in the past it has done very well, to the point that it is competitive with non-tax exempt bond funds eg it would not have been bad to hold in a tax-deferred account (pointless though). I haven't looked at CMF or other California mutual funds. I think VCLAX is be a little closer to VWALX in terms of yield and duration.

Don't forget savings bonds! Single-state bonds are riskier than a national Muni fund. Bill Bernstein would have suggested 1/3 state specific muni, 1/3 national muni, 1/3 treasury because of the credit risk of munis and concentration risk of a single state.

Great points! It probably makes sense to do something like HSA: 1/4 treasuries and 1/4 corporate, taxable: 1/4 national muni and 1/4 CA muni.

So with my current 80/20 target, $12K in HSA, and $80K in taxable:
- HSA $2.8K equities / $9.2k bonds
- Taxable: $70.8K equities / $9.2K bonds

That means the HSA will have lower overall returns and continue to have a balance only 10% - 15% compared to taxable. Is there any argument to shift more bond allocation from HSA to taxable to increase the relative balance of the HSA in the future? I can't think of one, but I'm naturally inclined to balance things out so it just feels a little weird.

What is you reasoning for keeping any bonds at all in your taxable and tax free accounts? You can keep your asset allocation where you want it while keeping all your bonds in tax deferred if you wanted.

Mostly agreed. In a state like CA, bonds are going to return on average about 40% less yield than they should regardless of whether you use tax exempt or taxable bonds, depending on your situation. Savings bonds pay no taxes on interest until redeemed (likely at a lower tax rate) and no state taxes (I think) so are a good choice. After that, it's probably best not to keep any bonds in taxable unless necessary. I keep VWALX, but I pay no state taxes and find it a worthwhile addition.

If you use municipal bonds, just avoid corporate bonds. They add nothing you don't get from municipal bonds and would be a detriment by taking up space better used on other things.

[LightStache]

Bonds worth keeping in taxable are series I savings bonds, and I recommend them either way, so I suggest stocking up on those first. VWALX may also be a worthwhile addition to a taxable account for some credit and interest rate risk, which does not generally have drawbacks relative to other options. Then you could add long term government bonds to your HSA until you get the average duration you are looking for. For example, say saving bonds have 0 duration, TLT has 15 years, and VWALX has 6 years. If you hold equal amounts you have an average 7 year duration with similar risk and better yield than BND, and take up minimal taxable space. Use a little less TLT to precisely match BND.

Otherwise yes, bonds go in tax deferred.

Interesting... since I'm in CA, what are your thoughts about something like CMF compared to TLT and VWALX?

Municipal bonds generally have poorer performance than regular bonds do, they are typically bid to break even with taxable bonds in the 32% bracket or so, and high tax states are even worse. You'd have to do your own assessment based on your own situation. I have followed VWALX and in the past it has done very well, to the point that it is competitive with non-tax exempt bond funds eg it would not have been bad to hold in a tax-deferred account (pointless though). I haven't looked at CMF or other California mutual funds. I think VCLAX is be a little closer to VWALX in terms of yield and duration.

Don't forget savings bonds! Single-state bonds are riskier than a national Muni fund. Bill Bernstein would have suggested 1/3 state specific muni, 1/3 national muni, 1/3 treasury because of the credit risk of munis and concentration risk of a single state.

Great points! It probably makes sense to do something like HSA: 1/4 treasuries and 1/4 corporate, taxable: 1/4 national muni and 1/4 CA muni.

So with my current 80/20 target, $12K in HSA, and $80K in taxable:
- HSA $2.8K equities / $9.2k bonds
- Taxable: $70.8K equities / $9.2K bonds

That means the HSA will have lower overall returns and continue to have a balance only 10% - 15% compared to taxable. Is there any argument to shift more bond allocation from HSA to taxable to increase the relative balance of the HSA in the future? I can't think of one, but I'm naturally inclined to balance things out so it just feels a little weird.

What is you reasoning for keeping any bonds at all in your taxable and tax free accounts? You can keep your asset allocation where you want it while keeping all your bonds in tax deferred if you wanted.

When I RE, taxable and HSA will only have enough for me to live for five years and start a Roth ladder. They won't have enough to outlast a severe bear market with a 100% equity allocation. Of course I could shift more savings from tax deferred to these accounts, but at 33% combined marginal rate, I don't think that would be more efficient in the long run.

[LightStache]

^^^ Is that sound or should I be taking another approach?

[EvenSteven]

^^^ Is that sound or should I be taking another approach?

If you are right on the line for having the necessary 5 years in available funds for a Roth ladder, it probably makes sense to keep a more conservative allocation for those 5 years. It ends up being like paying for insurance, where the cost is the tax inefficiency of your bond placement.

[LightStache]

^^^ Is that sound or should I be taking another approach?

If you are right on the line for having the necessary 5 years in available funds for a Roth ladder, it probably makes sense to keep a more conservative allocation for those 5 years. It ends up being like paying for insurance, where the cost is the tax inefficiency of your bond placement.

I project having an extra 33%, so there's some buffer but it would be difficult to watch it dip that low. But maybe I need to plan for more risk in that part of my portfolio. If markets plunge and I'm not working to cover my spend, I can always start 72t distributions from tax deferred, just take the penalty, move somewhere cheap, liquidate some real estate, or try to bring in extra income. So many fallback options.

[secondcor521]

I think you realize this, and I might be missing something.

In order to be able to make tax-efficient withdrawals from your HSA to fund your 5 year Roth ladder seasoning period, you'd need to have qualified medical expenses to substantiate the withdrawal.  In particular, those medical expenses, in order to qualify, would need to have been incurred after your first HSA funding. (*)

You sound younger, so if you're healthy, and you probably are, you might not have enough qualified medical expenses.  You could still withdraw from the HSA if you wanted, but the federal tax penalties might make it not worth it / might make another option, like straight taxable, better.

(*) Technically depends on state trust law, but that's the rule in my state and is a common one.

[LightStache]

I think you realize this, and I might be missing something.

In order to be able to make tax-efficient withdrawals from your HSA to fund your 5 year Roth ladder seasoning period, you'd need to have qualified medical expenses to substantiate the withdrawal.  In particular, those medical expenses, in order to qualify, would need to have been incurred after your first HSA funding. (*)

You sound younger, so if you're healthy, and you probably are, you might not have enough qualified medical expenses.  You could still withdraw from the HSA if you wanted, but the federal tax penalties might make it not worth it / might make another option, like straight taxable, better.

(*) Technically depends on state trust law, but that's the rule in my state and is a common one.

Appreciate the reminder. I'm 37 and have had just enough medical expenses to keep up with my HSA contributions over the past three years of contributing.

Given the relatively small size of the HSA, I don't plan to make regular withdrawals from it. But I'll need to rely on it to cover any unexpected medical expenses, like a medical expense emergency account. I might also use it to fine tune taxable income at some point.