Top tax bracket in CA - Bonds all muni?

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frankc29
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Top tax bracket in CA - Bonds all muni?

Post by frankc29 » Tue Nov 07, 2017 9:00 pm

Assuming an investor is in the top tax bracket in California and will be for the foreseeable future, does it make sense to have his/her complete bond portion of a portfolio in a CA Muni fund like VCADX? Or should some bond diversification still be present? I'm no expert in this, but VCADX has a higher yield (taxes notwithstanding) than something like BND as it is.

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Re: Top tax bracket in CA - Bonds all muni?

Post by DSInvestor » Tue Nov 07, 2017 9:06 pm

If you have tax advantaged space like 401(k), 403(b), 457(b), IRA, you can hold taxable bond funds. Use your tax advantaged space for taxable bonds and then complete the bond allocation in taxable accounts with a mix of a national tax exempt bond fund (VWIUX) and your CA tax exempt bond fund. This will give you much better diversification in your bond holdings than just VCADX.
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frankc29
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Re: Top tax bracket in CA - Bonds all muni?

Post by frankc29 » Tue Nov 07, 2017 9:08 pm

Thanks for the advice. I forgot to mention that this was a taxable portfolio.

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Re: Top tax bracket in CA - Bonds all muni?

Post by PFInterest » Tue Nov 07, 2017 9:14 pm

I personally vote no. I'll pay a little extra tax to diversify over all 50 states. You could do something like 50:50.

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Re: Top tax bracket in CA - Bonds all muni?

Post by GMT-8 » Tue Nov 07, 2017 9:40 pm

I vote yes. The yield is high; I can still sleep at night.
About 10% of my total portfolio is in Calif Interm & Long Term.
That’s 2/3 of my taxable but I have been spending it down the last few years.

GMT-8

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Re: Top tax bracket in CA - Bonds all muni?

Post by randomizer » Tue Nov 07, 2017 10:22 pm

50 percent state-specific muni, 50 percent short-term tax-exempt (federal). Bonds are for safety, stocks are for growth.
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Re: Top tax bracket in CA - Bonds all muni?

Post by Noobvestor » Wed Nov 08, 2017 12:42 am

Let's not forget that if op ends up with long-term gains in this tax-exempt fund that they'll have to pay those to sell.

Meanwhile, from another thread (TL;DR I use national muni funds): viewtopic.php?f=1&t=230543&p=3601487#p3601487
I can't figure out who would want CA tax-exempt over regular tax-exempt. I've considered it but rejected it personally. Consider these four funds and their yields (I'm using Vanguard's SEC yields):

CA intermediate yield: 1.67%
National intermediate yield: 1.74%

CA long yield: 2.14%
National long yield: 2.29%

I plugged in 33% for fed, 10% for state taxes and get tax-equivalent yields as follows:

CA intermediate yield: 2.77%
National intermediate yield: 2.60%

CA long yield: 3.55%
National long yield: 3.42%

But wait - there's more! The CA funds have slightly longer duration and lower-quality holdings. CA intermediate is only 6% AAA and regular intermediate is 23% AAA. There's also state-specific risk. Basically, on a risk-adjusted basis, the CA funds look to me to come out behind.

So you get up to a .17% yield increase for taking on state-specific concentration risk, a bit of duration/quality risk too. Is that really worth it?
"In the absence of clarity, diversification is the only logical strategy" -= Larry Swedroe

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Cyclesafe
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Re: Top tax bracket in CA - Bonds all muni?

Post by Cyclesafe » Wed Nov 08, 2017 11:31 am

In taxable, other than my money market emergency fund, I am 43% VCADX, 57% VWIUX. The latter is 12% non-deductible-for-state-tax Cali bonds, hence the odd allocation. (The net result is 50/50.)

In tax deferred, I am 100% VBTLX.

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Re: Top tax bracket in CA - Bonds all muni?

Post by mega317 » Wed Nov 08, 2017 11:56 am

Cyclesafe wrote:
Wed Nov 08, 2017 11:31 am
In taxable, other than my money market emergency fund, I am 43% VCADX, 57% VWIUX. The latter is 12% non-deductible-for-state-tax Cali bonds, hence the odd allocation. (The net result is 50/50.)
What is the purpose of doing this math?

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Re: Top tax bracket in CA - Bonds all muni?

Post by ofckrupke » Wed Nov 08, 2017 12:18 pm

mega317 wrote:
Wed Nov 08, 2017 11:56 am
What is the purpose of doing this math?
Balancing single-state credit risk against the slight after-tax yield advantage of same-state munis.
Cyclesafe prefers to limit CA bonds to 50% of holdings, and has realized that the often suggested 50:50 split between national and CA funds doesn't deliver this, because about 12% of the bonds in the national fund are issued by CA.
By splitting the funds not-quite-equally, the targeted partition of holdings is met.
[eta: I think 47:53 might be the correct ratio though.]

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Re: Top tax bracket in CA - Bonds all muni?

Post by mega317 » Wed Nov 08, 2017 12:36 pm

Got it. Clever.

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Re: Top tax bracket in CA - Bonds all muni?

Post by grabiner » Fri Nov 10, 2017 11:18 am

frankc29 wrote:
Tue Nov 07, 2017 9:00 pm
Assuming an investor is in the top tax bracket in California and will be for the foreseeable future, does it make sense to have his/her complete bond portion of a portfolio in a CA Muni fund like VCADX? Or should some bond diversification still be present? I'm no expert in this, but VCADX has a higher yield (taxes notwithstanding) than something like BND as it is.
In the top CA tax bracket, you might want to diversify your bonds, but I wouldn't suggest Total Bond Market. You could put half your bonds in a non-CA muni fund; if you put half in Limited-Term Tax-Exempt and half in CA Long-Term Tax-Exempt, you have an intermediate duration with much more than half your bonds exempt from CA tax. Another alternative would be to use TIPS, which are exempt from CA tax but subject to federal tax, and which tend to have low yields because they are low-risk bonds.

You should also buy $10,000 annually in I-Bonds, which are exempt from state tax and defer federal tax until cashed in, but that won't have much effect on your overall allocation if you have the large portfolios which are typical for investors in the top tax bracket.
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Re: Top tax bracket in CA - Bonds all muni?

Post by decapod10 » Tue Mar 06, 2018 5:46 pm

grabiner wrote:
Fri Nov 10, 2017 11:18 am
frankc29 wrote:
Tue Nov 07, 2017 9:00 pm
Assuming an investor is in the top tax bracket in California and will be for the foreseeable future, does it make sense to have his/her complete bond portion of a portfolio in a CA Muni fund like VCADX? Or should some bond diversification still be present? I'm no expert in this, but VCADX has a higher yield (taxes notwithstanding) than something like BND as it is.
In the top CA tax bracket, you might want to diversify your bonds, but I wouldn't suggest Total Bond Market. You could put half your bonds in a non-CA muni fund; if you put half in Limited-Term Tax-Exempt and half in CA Long-Term Tax-Exempt, you have an intermediate duration with much more than half your bonds exempt from CA tax. Another alternative would be to use TIPS, which are exempt from CA tax but subject to federal tax, and which tend to have low yields because they are low-risk bonds.

You should also buy $10,000 annually in I-Bonds, which are exempt from state tax and defer federal tax until cashed in, but that won't have much effect on your overall allocation if you have the large portfolios which are typical for investors in the top tax bracket.
Sorry for resurrecting an old thread, but I was wondering if you could explain a little bit of the reasoning of using Limited Term Tax Exempt and CA Long-Term Tax Exempt, as compared to using Intermediate Term for both (Intermediate Term Tax Exempt and CA Intermediate Term Tax Exempt). Thanks!

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Re: Top tax bracket in CA - Bonds all muni?

Post by grabiner » Tue Mar 06, 2018 11:25 pm

decapod10 wrote:
Tue Mar 06, 2018 5:46 pm
grabiner wrote:
Fri Nov 10, 2017 11:18 am
In the top CA tax bracket, you might want to diversify your bonds, but I wouldn't suggest Total Bond Market. You could put half your bonds in a non-CA muni fund; if you put half in Limited-Term Tax-Exempt and half in CA Long-Term Tax-Exempt, you have an intermediate duration with much more than half your bonds exempt from CA tax. Another alternative would be to use TIPS, which are exempt from CA tax but subject to federal tax, and which tend to have low yields because they are low-risk bonds.
Sorry for resurrecting an old thread, but I was wondering if you could explain a little bit of the reasoning of using Limited Term Tax Exempt and CA Long-Term Tax Exempt, as compared to using Intermediate Term for both (Intermediate Term Tax Exempt and CA Intermediate Term Tax Exempt). Thanks!
If you use two intermediate-term funds, half your interest will be exempt from CA tax. If you use a long-term CA fund and a short-term national fund, more than half your interest will be exempt from CA tax, and you will still have an overall intermediate duration.
Wiki David Grabiner

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Re: Top tax bracket in CA - Bonds all muni?

Post by decapod10 » Wed Mar 07, 2018 2:39 am

grabiner wrote:
Tue Mar 06, 2018 11:25 pm
decapod10 wrote:
Tue Mar 06, 2018 5:46 pm
grabiner wrote:
Fri Nov 10, 2017 11:18 am
In the top CA tax bracket, you might want to diversify your bonds, but I wouldn't suggest Total Bond Market. You could put half your bonds in a non-CA muni fund; if you put half in Limited-Term Tax-Exempt and half in CA Long-Term Tax-Exempt, you have an intermediate duration with much more than half your bonds exempt from CA tax. Another alternative would be to use TIPS, which are exempt from CA tax but subject to federal tax, and which tend to have low yields because they are low-risk bonds.
Sorry for resurrecting an old thread, but I was wondering if you could explain a little bit of the reasoning of using Limited Term Tax Exempt and CA Long-Term Tax Exempt, as compared to using Intermediate Term for both (Intermediate Term Tax Exempt and CA Intermediate Term Tax Exempt). Thanks!
If you use two intermediate-term funds, half your interest will be exempt from CA tax. If you use a long-term CA fund and a short-term national fund, more than half your interest will be exempt from CA tax, and you will still have an overall intermediate duration.
Thank you very much for your reply

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Re: Top tax bracket in CA - Bonds all muni?

Post by manedark » Sat May 05, 2018 1:47 am

Noobvestor wrote:
Wed Nov 08, 2017 12:42 am
Let's not forget that if op ends up with long-term gains in this tax-exempt fund that they'll have to pay those to sell.
Reviving an old thread, can somebody explain what is meant by the above statement?

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Re: Top tax bracket in CA - Bonds all muni?

Post by manedark » Sat May 05, 2018 1:50 am

I have a related question - I have around 100K to invest for a 5-10 time horizon, for which I am thinking a 50-50 stock vs bond allocation.
I am in 22% Federal and 9.4% CA tax brackets, so for the Bond Allocation does it make sense for doing a 50-50 in VCAIX and VWITX?

Or to get a lower ER (1/2 of the funds I started) go for the Admiral Shares of the California Intermediate Tax Exempt i.e. VCADX?

Thanks a lot in advance!

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Re: Top tax bracket in CA - Bonds all muni?

Post by inbox788 » Sat May 05, 2018 4:31 am

frankc29 wrote:
Tue Nov 07, 2017 9:08 pm
Thanks for the advice. I forgot to mention that this was a taxable portfolio.
Stocks are more tax efficient and should go in taxable as much as possible. Have you exhausted bonds in tax advantaged accounts? I know it's an old thread, but it might help to re-evaluate or someone reading this.
https://www.bogleheads.org/wiki/Tax-eff ... _placement

A new corporate bond ETF option just became available. ProShares S&P 500 Bond ETF SPXB. It may not be exactly what you think it is, so take a close look at the details (e.g. from what I can tell, it's not even weighed or market cap weighted, but loan size weighted).
The First S&P 500 Bond ETF Is Here
https://www.marketwatch.com/story/the-f ... 04-8464727

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Re: Top tax bracket in CA - Bonds all muni?

Post by grabiner » Sat May 05, 2018 12:51 pm

manedark wrote:
Sat May 05, 2018 1:47 am
Noobvestor wrote:
Wed Nov 08, 2017 12:42 am
Let's not forget that if op ends up with long-term gains in this tax-exempt fund that they'll have to pay those to sell.
Reviving an old thread, can somebody explain what is meant by the above statement?
Interest on municipal bonds in tax-exempt. However, capital gains are taxable, and losses are usually tax-deductible.

Long-term municipal-bond funds usually sell bonds which are no longer long-term. If those bonds are sold for capital gains, there will be a small tax bill.
Wiki David Grabiner

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Re: Top tax bracket in CA - Bonds all muni?

Post by Clever_Username » Sat May 05, 2018 1:21 pm

grabiner wrote:
Sat May 05, 2018 12:51 pm
manedark wrote:
Sat May 05, 2018 1:47 am
Noobvestor wrote:
Wed Nov 08, 2017 12:42 am
Let's not forget that if op ends up with long-term gains in this tax-exempt fund that they'll have to pay those to sell.
Reviving an old thread, can somebody explain what is meant by the above statement?
Interest on municipal bonds in tax-exempt. However, capital gains are taxable, and losses are usually tax-deductible.

Long-term municipal-bond funds usually sell bonds which are no longer long-term. If those bonds are sold for capital gains, there will be a small tax bill.
Do other duration funds do this? I'm not in the top tax bracket (9.3% CA, barely in 32% federal and that's new to me) and that'd be a mild worry for me. I hold CA Intermediate Term Tax Exempt bonds in taxable (not yet in Admiral, only recently expanded into this space).

Alternately, is this even something I should worry about?
"What was true then is true now. Have a plan. Stick to it." -- XXXX, _Layer Cake_

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Re: Top tax bracket in CA - Bonds all muni?

Post by manedark » Sat May 05, 2018 1:21 pm

grabiner wrote:
Sat May 05, 2018 12:51 pm
Interest on municipal bonds in tax-exempt. However, capital gains are taxable, and losses are usually tax-deductible.
Long-term municipal-bond funds usually sell bonds which are no longer long-term. If those bonds are sold for capital gains, there will be a small tax bill.
Thanks Grabiner. Who pays the tax - the fund or the individual himself/herself. Are there funds that try to avoid the capital gains - is this part of the expertise they employ to manage the fund? How to calculate the potential of such taxes in a given fund - is there a history you can rely - i.e. over 10 years - interest generated was X and capital gains was Y.

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Re: Top tax bracket in CA - Bonds all muni?

Post by grabiner » Sat May 05, 2018 9:00 pm

Clever_Username wrote:
Sat May 05, 2018 1:21 pm
grabiner wrote:
Sat May 05, 2018 12:51 pm
manedark wrote:
Sat May 05, 2018 1:47 am
Noobvestor wrote:
Wed Nov 08, 2017 12:42 am
Let's not forget that if op ends up with long-term gains in this tax-exempt fund that they'll have to pay those to sell.
Reviving an old thread, can somebody explain what is meant by the above statement?
Interest on municipal bonds in tax-exempt. However, capital gains are taxable, and losses are usually tax-deductible.

Long-term municipal-bond funds usually sell bonds which are no longer long-term. If those bonds are sold for capital gains, there will be a small tax bill.
Do other duration funds do this? I'm not in the top tax bracket (9.3% CA, barely in 32% federal and that's new to me) and that'd be a mild worry for me. I hold CA Intermediate Term Tax Exempt bonds in taxable (not yet in Admiral, only recently expanded into this space).
Short-term funds are more likely to hold bonds to maturity.

However, the tax cost isn't that great, and it only happens when your return exceeds the yield on the bond. Suppose that a fund buys a 10-year bond with a 4% yield, and sells the bond five years later. If the bond still has a 4% yield, there will be no capital gain, and you had a 4% return for those five years. If the bond has a 3% yield, there will be a 5% capital gain, so you will have had a 5% return for those five years, with 1% of the return taxable.
manedark wrote:
Sat May 05, 2018 1:21 pm
Who pays the tax - the fund or the individual himself/herself. Are there funds that try to avoid the capital gains - is this part of the expertise they employ to manage the fund? How to calculate the potential of such taxes in a given fund - is there a history you can rely - i.e. over 10 years - interest generated was X and capital gains was Y.
Investors pay tax on capital gains in two ways. If a fund sells something for a capital gain, it makes a capital gain distribution, and the investor must pay tax. If an investor sells a share of a fund for a capital gain, the investor pays the tax on that gain.

Stock funds can be run to minimize capital gains; Vanguard has a few explicitly tax-managed funds, and ETFs and large-cap indexes are inherently good at avoiding capital gains. But there is no way to avoid capital gains on a bond fund; when interest rates fall, the prices of all bonds rise, and all funds will distribute capital gains. (The ETF structure doesn't help much here; the ETF redemption process allows a fund to get rid of the highest-basis shares.)

You can check the historical distributions for a fund. For muni funds, you can also get an estimate of historical capital gains from Vanguard's reported after-tax returns, since the income from a muni fund is tax-exempt. For example, Vanguard Long-Term Tax-Exempt Admiral reports a 4.75% ten-year return before taxes, and 4.72% after taxes. Since the performance numbers assume the top 20% tax rate on capital gains, this implies that the average capital gain on the fund was 0.15%.
Wiki David Grabiner

manedark
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Re: Top tax bracket in CA - Bonds all muni?

Post by manedark » Sat May 05, 2018 9:57 pm

grabiner wrote:
Sat May 05, 2018 9:00 pm
You can check the historical distributions for a fund. For muni funds, you can also get an estimate of historical capital gains from Vanguard's reported after-tax returns, since the income from a muni fund is tax-exempt. For example, Vanguard Long-Term Tax-Exempt Admiral reports a 4.75% ten-year return before taxes, and 4.72% after taxes. Since the performance numbers assume the top 20% tax rate on capital gains, this implies that the average capital gain on the fund was 0.15%.
Thanks again for explaining. Can we broadly assume that the capital gains will not cause a more than 10 basis point change in returns roughly as in your example.

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Re: Top tax bracket in CA - Bonds all muni?

Post by grabiner » Sun May 06, 2018 7:31 pm

manedark wrote:
Sat May 05, 2018 9:57 pm
grabiner wrote:
Sat May 05, 2018 9:00 pm
You can check the historical distributions for a fund. For muni funds, you can also get an estimate of historical capital gains from Vanguard's reported after-tax returns, since the income from a muni fund is tax-exempt. For example, Vanguard Long-Term Tax-Exempt Admiral reports a 4.75% ten-year return before taxes, and 4.72% after taxes. Since the performance numbers assume the top 20% tax rate on capital gains, this implies that the average capital gain on the fund was 0.15%.
Thanks again for explaining. Can we broadly assume that the capital gains will not cause a more than 10 basis point change in returns roughly as in your example.
Even 10 basis points would be high; 3 basis points was all that this fund lost over 10 years, and it would be 2 basis points if you aren't in the top tax bracket.

And if rates rise, there will be capital losses, not capital gains. The fund may sell bonds for a loss to offset future capital gains, or you may be able to harvest your capital losses by selling shares of the fund.
Wiki David Grabiner

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Re: Top tax bracket in CA - Bonds all muni?

Post by manedark » Sun May 06, 2018 7:38 pm

Thanks Grabiner. Do you mind reviewing the post at viewtopic.php?f=1&t=248816

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