Author Topic: What to do with bonds in taxable investment account?  (Read 3456 times)

Olive Branch

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What to do with bonds in taxable investment account?
« on: February 17, 2016, 07:18:18 PM »
Hey folks, another newbie question. I have a TFSA, RRSP, and individual margin (taxable) account with Questrade that I opened two years ago. Back when I started I didn't treat my three accounts as part of one entire portfolio so that my three accounts had different funds and allocations in each. That has been mostly fixed with my RRSP and TFSA, as both hold the same funds and allocation percentages. However, my margin account, being taxable, has remained the same.

My taxable margin account has three Vanguard funds, VXC, VCN, and VAB. That's my international stock index, Canadian stock index, and Canadian bond index. My problem rises out of the fact that I learned only recently that bonds are not taxable account-friendly, given that their dividends are taxable. I really don't want to pay more in taxes if I can help it.

So my question is, what do I do with these bonds? Do I sell them off to trigger a taxable sale in 2016's tax return in March or April or whenever the 2016 tax season starts and never hold bonds in my margin account again? Or do I just grin and bear it and deal with the taxable dividends for the short term and deal with it in the long term, never buying any more bonds? The market value of my bonds is around $4,300 so we're not talking huge amounts of dividends here, for what it's worth.

Heckler

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Re: What to do with bonds in taxable investment account?
« Reply #1 on: February 17, 2016, 10:08:38 PM »
VAB has barely gained a buck in price per unit in two years - not much cspitsl gain.  Sell them and buy Canadian Dividend stocks (VDY?) in your taxable account, as dividends get a tax credit where capitsl gains doesnt. 


Caveat : I'm just a guy who reads a lot in the internet.  I don't have a taxable account. 

Heckler

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Interest Compound

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Re: What to do with bonds in taxable investment account?
« Reply #3 on: February 17, 2016, 10:55:18 PM »
Sell them. Bond funds don't appreciate much, so you'll have minimal capital gains taxes. Then you can buy more bond funds in your non-taxable accounts.

Remember dividend stocks are not a replacement for bonds. Don't treat them as such.

Olive Branch

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Re: What to do with bonds in taxable investment account?
« Reply #4 on: February 18, 2016, 04:58:00 PM »
Thanks for the advice, folks. I sold the bond ETFs earlier this morning and replaced them by buying a bunch more VXC. If they get lumped into my 2015 tax report, it's all good. From now on, bonds are verbotten in my taxable account! :)

MustacheAndaHalf

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Re: What to do with bonds in taxable investment account?
« Reply #5 on: February 18, 2016, 07:49:11 PM »
I'm ignorant of Canada's tax system, so let me start with 1 caveat:
1. I think capital gains in Canada are taxed less (50%?) than income from bonds

If so, you should keep stocks in taxable.  Stocks seem to have a Canadian tax advantage that bonds don't.  So if you own both, get the most tax benefit by putting the bonds in the retirement account and letting the stock fund get taxed at an advantageous rate.

Kaspian

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Re: What to do with bonds in taxable investment account?
« Reply #6 on: February 23, 2016, 08:31:45 AM »
Thanks for the advice, folks. I sold the bond ETFs earlier this morning and replaced them by buying a bunch more VXC. If they get lumped into my 2015 tax report, it's all good. From now on, bonds are verbotten in my taxable account! :)

Any capital gains you will report on your 2016 taxes.  The 2016 tax year starts January 1st, it's not a fiscal year-end type of company situation.  (Even though we file our taxes in February and RRSP cutoff is in March.)

Unfortunately, I do have some bonds in my taxable account.  I don't get much RRSP room ($3400/year) because I have a pension.  So both that and my TFSA are maxed to the hilt with bonds and international index funds and I have some overflow to keep things balanced.  CCP says we should avoid bonds outside as much as possible and that GICs might even be better a better solution.  ....But he never said which GICs and (after dealing with them for years) I really hate GICs.

Retire-Canada

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Re: What to do with bonds in taxable investment account?
« Reply #7 on: February 23, 2016, 08:45:16 AM »
Are the dividends from VCN [CDN companies] given preferential tax treatment over dividends from VXC?

http://canadiancouchpotato.com/2014/05/01/the-high-cost-of-high-dividends/
« Last Edit: February 23, 2016, 08:51:22 AM by Retire-Canada »

acanthurus

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Re: What to do with bonds in taxable investment account?
« Reply #8 on: February 23, 2016, 09:59:07 AM »
Quote
My problem rises out of the fact that I learned only recently that bonds are not taxable account-friendly, given that their dividends are taxable.

This is the standard advice. In the US, it may actually be bad advice. For US investors concerned about taxable bond funds inside of taxable accounts, please read WhiteCoatInvestor's articles on "Bonds Go In Taxable".

The basic premise is that it's best to put the assets with the highest capital appreciation (stocks) in your tax-advantaged accounts. You want the most growth in the accounts that you'll never have to pay taxes on (Roth) or may be able to pay little to no taxes on (Trad IRA/401k).

Having bonds in your taxable account will increase your taxes, but we're not optimizing for low taxes - we should be optimizing for total after-tax return over an investing career. in any give year I would rather have 10% gains on a stock fund that I'll never pay taxes on than have to pay 25% taxes on a bond fund that's yielding 2.25%.

I don't know what the Canadian tax treatment is like, but read WhiteCoatInvestor's blog post about the topic, do the math with your country's tax policy and your long term goals, and do what is best for you. That could actually end up being bonds being in taxable, despite it going against the traditional wisdom.

Interest Compound

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Re: What to do with bonds in taxable investment account?
« Reply #9 on: February 23, 2016, 03:28:22 PM »
Quote
My problem rises out of the fact that I learned only recently that bonds are not taxable account-friendly, given that their dividends are taxable.

This is the standard advice. In the US, it may actually be bad advice. For US investors concerned about taxable bond funds inside of taxable accounts, please read WhiteCoatInvestor's articles on "Bonds Go In Taxable".

The basic premise is that it's best to put the assets with the highest capital appreciation (stocks) in your tax-advantaged accounts. You want the most growth in the accounts that you'll never have to pay taxes on (Roth) or may be able to pay little to no taxes on (Trad IRA/401k).

Having bonds in your taxable account will increase your taxes, but we're not optimizing for low taxes - we should be optimizing for total after-tax return over an investing career. in any give year I would rather have 10% gains on a stock fund that I'll never pay taxes on than have to pay 25% taxes on a bond fund that's yielding 2.25%.

I don't know what the Canadian tax treatment is like, but read WhiteCoatInvestor's blog post about the topic, do the math with your country's tax policy and your long term goals, and do what is best for you. That could actually end up being bonds being in taxable, despite it going against the traditional wisdom.

It's important to do the math for your specific situation. For the typical person retiring early on this site, bonds should not be in taxable. We stay in very low tax-brackets, we can pretty much avoid taxes altogether. This doesn't work for the typical doctor on WhiteCoatInvestor's blog, who might be in a high tax-bracket forever.

MustacheAndaHalf

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Re: What to do with bonds in taxable investment account?
« Reply #10 on: February 23, 2016, 11:59:51 PM »
For US investors concerned about taxable bond funds inside of taxable accounts, please read WhiteCoatInvestor's articles on "Bonds Go In Taxable".

The basic premise is that it's best to put the assets with the highest capital appreciation (stocks) in your tax-advantaged accounts. You want the most growth in the accounts that you'll never have to pay taxes on (Roth) or may be able to pay little to no taxes on (Trad IRA/401k).
...
in any give year I would rather have 10% gains on a stock fund that I'll never pay taxes on than have to pay 25% taxes on a bond fund that's yielding 2.25%.
That article and your post share the assumption of using a Roth IRA.  The main example is a Roth IRA, and here in your post you mention "a stock fund that [you'll] never pay taxes on".  Maybe for a Roth IRA in the US.

For Traditional IRA/401k/other tax deferred accounts (Canada?) I'd like to point a couple of problems with "bonds go in taxable".
1. You owe ordinary income on bonds, and a Traditional IRA or tax deferred account will eventually owe ordinary income tax.  You do not give up any advantage by putting bonds in tax deferred, you just delay the tax date.
2. Dividends in both Canada (I think) and U.S. have a tax advantage.  When stocks or stock funds are in taxable, you pay less taxes.  Move those stocks into a Traditional IRA or tax deferred account, and you pay ordinary income tax on the whole account in the future.  You lose the tax advantage of qualified dividends.
3. Not sure about Canada, but in U.S. long-term capital gains have a tax advantage.  Bonds don't get much of this, but stocks get a lot of gains from their long-term capital gains.  So another tax advantage that's lost when putting stocks in tax deferred, and converting the whole thing to ordinary tax rates.

It would be great if White Coat Investor did a non-Roth comparison between taxable and tax deferred - where to put stocks, where to put bonds.