Author Topic: Bonds in a taxable account  (Read 8294 times)

spokey doke

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Bonds in a taxable account
« on: November 06, 2015, 08:04:20 AM »
We've been working on tuning up our investments, including finally maxing out our retirement accounts (401K, 403b, 457b, IRA).  Previously, we had also worked to reduce both fees and taxes in our taxable account at Fidelity.  So we are now looking at our taxable income at or below the 15% tax bracket threshold moving forward, and we have about 25% of our taxable account split between intermediate and short-term tax free bond funds. 

The thread on the relative advantages of municipal bond funds for different tax brackets has me thinking that we might consider a different strategy for our bond holdings, including moving from Fidelity to Vanguard for that portion, since Fidelity bond funds don't seem to compete well on fees.  But once it is with Vanguard, I'm a bit uncertain what to do with that couple hundred K for bonds.  I was thinking of the analogous tax exempt bond funds (Admiralty shares), but would love to get some critical perspectives from the forum...

Interest Compound

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Re: Bonds in a taxable account
« Reply #1 on: November 06, 2015, 08:16:40 AM »
Two questions:

1. Why hold any bonds in taxable at all?

2. If holding bonds in taxable, why choose tax exempt bonds?

Moby32

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Re: Bonds in a taxable account
« Reply #2 on: November 06, 2015, 08:41:26 AM »
1.  You are more likely to use income from your taxable (non-qualified) accounts before drawing income from your IRA to avoid income taxes and continue tax deferred growth.  Because of this, I would argue your taxable accounts should be more conservative (more bonds) than qualified accounts because of the shorter time horizon.

2 A.Tax exempt bonds should only be held in taxable account.

2 B. Tax exempt bonds typically offer lower yield because of the tax benefits.  In order to compare taxable vs tax exempt, you can take the yield/(1-your highest marginal tax rate).  This will give you the "taxable equivalent yield".  Usually someone in a very low federal bracket will not benefit enough from the tax savings to justify buying them vs corporates, but not always.  Lastly, to make matters more confusing muni's and corporates are not rated on the same scale.  "A" rated muni's are safer than "A" rated corporates, so comparing apples to apples for risk vs net return on taxable vs muni is very hard.


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Interest Compound

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Re: Bonds in a taxable account
« Reply #3 on: November 06, 2015, 08:53:47 AM »
1.  You are more likely to use income from your taxable (non-qualified) accounts before drawing income from your IRA to avoid income taxes and continue tax deferred growth.  Because of this, I would argue your taxable accounts should be more conservative (more bonds) than qualified accounts because of the shorter time horizon.

2 A.Tax exempt bonds should only be held in taxable account.

2 B. Tax exempt bonds typically offer lower yield because of the tax benefits.  In order to compare taxable vs tax exempt, you can take the yield/(1-your highest marginal tax rate).  This will give you the "taxable equivalent yield".  Usually someone in a very low federal bracket will not benefit enough from the tax savings to justify buying them vs corporates, but not always.  Lastly, to make matters more confusing muni's and corporates are not rated on the same scale.  "A" rated muni's are safer than "A" rated corporates, so comparing apples to apples for risk vs net return on taxable vs muni is very hard.


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I wanted to know what spokey doke's reasoning was :)

I'll reply to this once spokey doke responds.

spokey doke

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Re: Bonds in a taxable account
« Reply #4 on: November 06, 2015, 11:55:50 AM »
Two questions:

1. Why hold any bonds in taxable at all?

2. If holding bonds in taxable, why choose tax exempt bonds?

1. Basic diversification.  Particularly given the taxable account is much larger than our tax advantaged accounts, and the rates on bond funds are not so good in the options we have in the latter.  We are also being more conservative being a few years from FIRE, so more bonds.

2. Tax efficiency

Interest Compound

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Re: Bonds in a taxable account
« Reply #5 on: November 06, 2015, 12:15:27 PM »
Two questions:

1. Why hold any bonds in taxable at all?

2. If holding bonds in taxable, why choose tax exempt bonds?

1. Basic diversification.  Particularly given the taxable account is much larger than our tax advantaged accounts, and the rates on bond funds are not so good in the options we have in the latter.  We are also being more conservative being a few years from FIRE, so more bonds.

2. Tax efficiency

1. The general rule, is to fill up tax advantaged space with bonds, before putting any bonds in taxable. It's more efficient (meaning you'll make more money) this way. If your 401ks don't have good bond options, then you can fill up your IRAs with bonds...etc. If the bond options in your current 401k are truly horrible (I'm assuming any old 401ks have already been rolled over into IRAs), and your IRAs are already filled with bonds, it can make sense to put bonds in taxable.

2. I'm asking this because you saw my thread showing municipal bonds aren't worth it until you're at the 35% tax bracket or above, but you're still leaning towards them despite being in the 15% tax bracket. So I'm wondering if I didn't do a good job of communicating this in my thread, or if you have some mitigating circumstances I didn't account for.

Interest Compound

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Re: Bonds in a taxable account
« Reply #6 on: November 06, 2015, 12:31:20 PM »
1.  You are more likely to use income from your taxable (non-qualified) accounts before drawing income from your IRA to avoid income taxes and continue tax deferred growth.  Because of this, I would argue your taxable accounts should be more conservative (more bonds) than qualified accounts because of the shorter time horizon.

2 A.Tax exempt bonds should only be held in taxable account.

2 B. Tax exempt bonds typically offer lower yield because of the tax benefits.  In order to compare taxable vs tax exempt, you can take the yield/(1-your highest marginal tax rate).  This will give you the "taxable equivalent yield".  Usually someone in a very low federal bracket will not benefit enough from the tax savings to justify buying them vs corporates, but not always.  Lastly, to make matters more confusing muni's and corporates are not rated on the same scale.  "A" rated muni's are safer than "A" rated corporates, so comparing apples to apples for risk vs net return on taxable vs muni is very hard.


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Check out Placing cash needs in a tax-advantaged account:

Suppose you have $15,000 in your portfolio with additional $5,000 as emergency fund. Then you could have:

Taxable
$10,000 tax-efficient stock index funds

Tax-advantaged account, such as 401(k)
$5,000 money market fund <- emergency fund
$5,000 bond fund

Asset Allocation: $10,000 stocks, $5,000 bonds, $5,000 emergency fund

Now let's say you need $5,000 in emergency. Then you sell $5,000 from the stock index funds in your taxable account and exchange the money market fund for similar stock funds in the money market fund in your tax-advantaged account. You are left with:

Taxable
$5,000 tax-efficient stock index funds (-$5,000)

Tax-advantaged account, such as 401(k)
$5,000 stock funds (converted from the money market fund)
$5,000 bond fund

Asset Allocation: $10,000 stocks, $5,000 bonds

Notice that you have not changed the asset allocation at all.

Full_Beard

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Re: Bonds in a taxable account
« Reply #7 on: November 06, 2015, 12:55:02 PM »
Seems like Moby's pt. 1 conflicts with Interest Compound's pt. 1 concerning whether bonds should be held in a taxable account or an IRA-type account. I tend to agree with Moby; that is, put them in the taxable account (if at all) because that's where you'll likely first draw money from and where you pay capital gains taxes. Is that wrong?

Interest Compound

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Re: Bonds in a taxable account
« Reply #8 on: November 06, 2015, 01:06:06 PM »
Seems like Moby's pt. 1 conflicts with Interest Compound's pt. 1 concerning whether bonds should be held in a taxable account or an IRA-type account. I tend to agree with Moby; that is, put them in the taxable account (if at all) because that's where you'll likely first draw money from and where you pay capital gains taxes. Is that wrong?

There's nothing to agree/disagree with. Mathematically you end up with more money by keeping bonds in a tax-advantaged account. If you deviate from this by putting bonds in taxable when you still have tax-advantaged space, even if the reasons make sense to you, you will end up with less money. Maybe the convenience/mental-accounting...etc is worth having less money, but it's important to be aware of the consequences of that decision.

Full_Beard

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Re: Bonds in a taxable account
« Reply #9 on: November 06, 2015, 01:23:12 PM »
I am operating under the assumption that, in both scenarios, you have maximized your contributions to tax-advantaged accounts and are also contributing to a tax account. The question then is where to hold the bonds if you want your overall allocation to be 85/15?

spokey doke

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Re: Bonds in a taxable account
« Reply #10 on: November 06, 2015, 05:38:46 PM »

2. I'm asking this because you saw my thread showing municipal bonds aren't worth it until you're at the 35% tax bracket or above, but you're still leaning towards them despite being in the 15% tax bracket. So I'm wondering if I didn't do a good job of communicating this in my thread, or if you have some mitigating circumstances I didn't account for.

Your thread has me rethinking things, but it isn't a solution.

And my 401k has not been been rolled into my IRA, and my IRA is still rather modest in size.

I am operating under the assumption that, in both scenarios, you have maximized your contributions to tax-advantaged accounts and are also contributing to a tax account. The question then is where to hold the bonds if you want your overall allocation to be 85/15?

I don't have large enough IRA's to have them do that much for my overall bond allocation, and my other tax advantaged accounts don't have good options....SO...I'm mostly interested in how best to hold bonds in my taxable account.
« Last Edit: November 06, 2015, 05:47:48 PM by spokey doke »

Interest Compound

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Re: Bonds in a taxable account
« Reply #11 on: November 06, 2015, 06:02:57 PM »

2. I'm asking this because you saw my thread showing municipal bonds aren't worth it until you're at the 35% tax bracket or above, but you're still leaning towards them despite being in the 15% tax bracket. So I'm wondering if I didn't do a good job of communicating this in my thread, or if you have some mitigating circumstances I didn't account for.

Your thread has me rethinking things, but it isn't a solution.

And my 401k has not been been rolled into my IRA, and my IRA is still rather modest in size.

I am operating under the assumption that, in both scenarios, you have maximized your contributions to tax-advantaged accounts and are also contributing to a tax account. The question then is where to hold the bonds if you want your overall allocation to be 85/15?

I don't have large enough IRA's to have them do that much for my overall bond allocation, and my other tax advantaged accounts don't have good options....SO...I'm mostly interested in how best to hold bonds in my taxable account.

In the 15% tax bracket, the best taxable bond holding at Vanguard is the standard Vanguard Total Bond Market Index Fund. Fidelity has an identical offering, SpartanŽ U.S. Bond Index Fund, which tracks the same index.