Bonds go in taxable/

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Mark2614
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Bonds go in taxable/

Post by Mark2614 » Mon Jan 02, 2017 9:31 pm

The Bogleheads wiki says that bond funds should be placed into tax advantaged accounts first (such as 401K).

Why does this website suggest the opposite?
http://whitecoatinvestor.com/asset-loca ... /#comments

Am I missing something?

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arcticpineapplecorp.
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Re: Bonds go in taxable/

Post by arcticpineapplecorp. » Mon Jan 02, 2017 9:40 pm

Mark2614 wrote:The Bogleheads wiki says that bond funds should be placed into tax advantaged accounts first (such as 401K).

Why does this website suggest the opposite?
http://whitecoatinvestor.com/asset-loca ... /#comments

Am I missing something?

Actually in Dr. Dahle's (who is a boglehead and frequent and well respected poster here) blog that you linked he says:
Even the Bogleheads just recently revised their Wiki on this subject to show that stocks in taxable isn’t always right. Put your bonds in taxable and let proper asset location give your portfolio a boost.


If you look at the boglehead link he provided (https://www.bogleheads.org/wiki/Tax-eff ... _placement) it says:
The advantages for holding bonds in a taxable account include:

Bonds have a lower expected return than stocks, and hence sometimes a lower tax cost.
Switching placement when necessary does not incur a large capital gains tax. If you hold stocks in a taxable account instead, large built-up unrealized capital gains makes it very difficult to switch even if switching would otherwise be beneficial.
Nominal treasury bonds, TIPS, and in-state muni bonds are not subject to the state income tax.
The effective tax rate on muni bonds is usually much lower than the highest marginal tax rate on ordinary income.
Interest from muni bonds is not included in Adjusted Gross Income (AGI), which determines eligibility for many income tax deductions and credits, whereas dividends and capital gains are included in AGI.

So I don't see any inconsistency. The conventional wisdom used to be that since bonds throw off income, you're paying taxes on that so it was better to shield it in a tax deferred account. As Dr. Dahle has shown, the math doesn't always support that, especially during times of low interest rates (in which low income from bonds are being received, and thereby, less taxes owed). And the bogleheads wiki has been updated to reflect that change in conventional wisdom.
"Invest we must." -- Jack Bogle | “The purpose of investing is not to simply optimise returns and make yourself rich. The purpose is not to die poor.” -- William Bernstein

Saphomd
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Re: Bonds go in taxable/

Post by Saphomd » Mon Jan 02, 2017 9:59 pm

Interesting. I wonder if Balanced funds with 60%stocks/40%bonds also would benefit in a taxable account. :|

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cookymonster
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Re: Bonds go in taxable/

Post by cookymonster » Mon Jan 02, 2017 10:01 pm

Roth IRA
$100K Bonds grows at 2.69% for 30 years to $221,740 =FV(2.69%,30,,-100000,1)=221,740

Taxable
$100K Stocks grows at 8% -(15% * the 1.86% yield) = 7.72% to $930,873 over 30 years. =FV(7.72%,30,,-100000,1)

You don’t pay capital gains on the original $100K, nor on the $183,177 in dividends received. So capital gains taxes on the $647,696 in gains are $97,154, leaving you with $930,873-$97,154 = $833,718.

Total = $1,055,459

Now, put the stocks in the Roth, and you’ll get this.

Roth IRA
$100K Stocks grows at 8% for 30 years to $1,006,266

Taxable
$100K Municipal Bonds grows at 2.16% for 30 years to $189,857

Total = $1,196,123

You get $140,664 or 13% MORE by putting the stocks into the Roth

The problem with this is that if you substitute a traditional 401k into a Roth IRA, the difference in how 1 million is taxed and 221k is taxed on withdrawal will probably eat away at a huge chunk of the putative $140k gain you make by investing in bonds in taxable. How much is very difficult to calculate and estimate. And most high income professionals who have utility for municipal bonds are going to have a lot more tax-deferred space than Roth space.

Tax efficiency is one of the few free lunches you get in investing. I don't like to give it up easily.

sambb
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Re: Bonds go in taxable/

Post by sambb » Mon Jan 02, 2017 10:01 pm

until someone can also predict the future capital gains tax rate, it is hard to agree with several statements about bond placement
I think the issue is sometimes unclear, esp in high tax brackets and with munis

Mark2614
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Re: Bonds go in taxable/

Post by Mark2614 » Mon Jan 02, 2017 10:02 pm

How does one determine then if bonds should go into 401K or Taxable? I'm in the 33% tax bracket this year and have TBM fund in 401K.
Last edited by Mark2614 on Mon Jan 02, 2017 10:04 pm, edited 1 time in total.

sambb
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Re: Bonds go in taxable/

Post by sambb » Mon Jan 02, 2017 10:04 pm

Mark2614 wrote:How does one determine then if bonds should go into 401K or Taxable? I'm in the 33% tax bracket this year and have bonds in 401K.



I would hedge all bets and keep allocations the same on both sides
Lets say you are 70/30
Make the same allocation in tax deferred, that you have in taxable (of course use munis in taxable)
Best of both worlds, and hedge the bets
You wont be 100% right, but you wont be 100% wrong and your risk is thus mitigated

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cookymonster
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Re: Bonds go in taxable/

Post by cookymonster » Mon Jan 02, 2017 10:06 pm

Mark2614 wrote:How does one determine then if bonds should go into 401K or Taxable? I'm in the 33% tax bracket this year and have TBM fund in 401K.

I do exactly the same. Invest in SCHZ through my 401k. 33% fed, 5% state. This is much cheaper than any Muni fund I have available and I sleep like a champ.

Mark2614
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Re: Bonds go in taxable/

Post by Mark2614 » Mon Jan 02, 2017 10:09 pm

cookymonster wrote:
Mark2614 wrote:How does one determine then if bonds should go into 401K or Taxable? I'm in the 33% tax bracket this year and have TBM fund in 401K.

I do exactly the same. Invest in SCHZ through my 401k. 33% fed, 5% state. This is much cheaper than any Muni fund I have available and I sleep like a champ.


For someone that has access to low-cost tax exempt bond funds such as Vanguard's VWIUX -- and in a state with fairly low 4.35% state taxes, and currently in 33% federal bracket, is it worth considering bonds in taxable? Or better to stick with TBM fund in 401K like I have now?

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cookymonster
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Re: Bonds go in taxable/

Post by cookymonster » Mon Jan 02, 2017 10:21 pm

Mark2614 wrote:
cookymonster wrote:
Mark2614 wrote:How does one determine then if bonds should go into 401K or Taxable? I'm in the 33% tax bracket this year and have TBM fund in 401K.

I do exactly the same. Invest in SCHZ through my 401k. 33% fed, 5% state. This is much cheaper than any Muni fund I have available and I sleep like a champ.


For someone that has access to low-cost tax exempt bond funds such as Vanguard's VWIUX -- and in a state with fairly low 4.35% state taxes, and currently in 33% federal bracket, is it worth considering bonds in taxable? Or better to stick with TBM fund in 401K like I have now?

I don't think it makes much difference in the end. But another problem with VWIUX and other munis is that you're still stuck paying state tax on them unless they're issued by your state. So I don't think they're really that great a deal. It's important to factor that in when you run the numbers. The linked blog post doesn't seem to do that.

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Dale_G
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Re: Bonds go in taxable/

Post by Dale_G » Tue Jan 03, 2017 12:48 am

the whitecoatinvestor is comparing a Roth account to a taxable account. That is not the same situation as comparing a traditional IRA or 401k account to a taxable account. Yes, if you can stuff your equities into a Roth IRA or Roth 401k, it is ok, but not so if you are using a traditional IRA or tax-deferred 401k.

I am happy that I figured out that stocks belonged in taxable in the late 90's and bonds belonged in tax deferred. I pay about 18% in taxes on the equity dividends (partly qualified) in taxable - and zero % on the unrealized dividends capital gains. I pay 25/28% on the RMDs. Had I kept anything like an equal allocation in the taxable account and the deferred account, I would be paying about the same in taxes for the taxable account investments and twice the taxes on the RMD distributions.

Run your own numbers, but this year only counts for a little. It is when you begin forced RMDs that the chickens come home to roost.

Dale
Last edited by Dale_G on Tue Jan 03, 2017 1:47 pm, edited 1 time in total.
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livesoft
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Re: Bonds go in taxable/

Post by livesoft » Tue Jan 03, 2017 7:18 am

With current tax laws, for stocks in our taxable account we pay 0% taxes on long-term capital gains, 0% taxes on qualified divided income, and can do tax-loss harvesting. Under those conditions, there is no way I am putting bonds in taxable. WCI does not pay 0% taxes when his stocks are in his taxable accounts.

Your situation is different from mine, too, but when I was working, I was in the 33% marginal income tax brecket. Now that I am retired, I am in a much lower bracket. What brackets will you be in when you retire? That bracket might tell you whether you should use muni bonds in taxable and stocks in tax-deferred. But you also need to know future tax laws.

So WCI's tax situation is different from mine, too. His reasons are the same reasons that tfb did a better job of showing how bonds might go in taxable that were linked in the other thread you started:

livesoft wrote:It is OK to hold tax-efficient equity funds in a taxable account. Total stock [US or international] market index funds are generally tax-efficient. It is probably a better idea to hold Total Bond in the 401(k) (tax-deferred) and not in the Roth.

For help with taxation and some of the tax drag versus expected returns, you might take a look at The Finance Buff's 2012 article on the subject AND the associated calculator to help make decisions:

https://thefinancebuff.com/tax-efficien ... olute.html

https://thefinancebuff.com/tax-cost-calculator.html

For some people nowadays, it is OK to hold bonds in a taxable account, but make sure the assumptions apply to you. It is generally better for everybody to avoid more than about 0% to 20% bonds in a Roth account. That is, try to have a Roth account at least 80% equities and prefer to hold bonds in a tax-deferred account.


Also for completeness WCI presented ANOTHER ARTICLE with an update that touches on the subject last month:
http://whitecoatinvestor.com/my-two-ass ... et-peeves/

I guess none of these blog articles explained things well enough, so one has to step back and think about things until they figure it out for their own personal situation and their future situations, too. OTOH, the differences can so small for many people that they will not be able to decide, but so what? In that case, every decision is not a bad decision. :)

Oh, we have stocks in our Roths IRAs, too. And stocks in our tax-deferred accounts, too.
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inbox788
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Re: Bonds go in taxable/

Post by inbox788 » Tue Jan 03, 2017 1:47 pm

How can such a seemingly simple idea wind up so complicated? So far the only conclusion I've come to is don't put bonds in Roth. Between tIRA and taxable the differences depend on many factors and don't seem to be that big in the scheme of things, so I'll split the difference or just ignore it for now. Glad my IPA is fairly loose with the requirements (mainly out of laziness).

qwertyjazz
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Re: Bonds go in taxable/

Post by qwertyjazz » Tue Jan 03, 2017 2:35 pm

inbox788 wrote:How can such a seemingly simple idea wind up so complicated? So far the only conclusion I've come to is don't put bonds in Roth. Between tIRA and taxable the differences depend on many factors and don't seem to be that big in the scheme of things, so I'll split the difference or just ignore it for now. Glad my IPA is fairly loose with the requirements (mainly out of laziness).


It is not that complicated. If you know the exact future rates of return, future tax codes and your future income, then it is just a very complex dynamic programming problem.
G.E. Box "All models are wrong, but some are useful."

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