What fixed income for taxable account?

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MechEngOSU
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What fixed income for taxable account?

Post by MechEngOSU » Sun Sep 30, 2018 3:13 pm

My wife and I are late 30’s with kids. Looking for advice on what should we do for the bond/fixed income part of our taxable account.
Quick details: Previously 33% marginal rate. For the taxable account, we envision saving the fixed income portion for things needed in the 10-20 year time from such as cars, kids college, weddings, etc

Currently we just use a 1.85% online savings account since it’s about six months expenses. For future monthly savings, I see the options as:

1)add to online savings every month. Easy to track and easy for my wife to remember/implement if something were to happen to me, but not necessarily tax efficient.

2)buy 6 month or 1 yr individual treasuries every time 10k or 20k accumulates. Slightly better interest rates and state tax efficiency, but more of a record keeping and tracking hassle.

3)Something else like MUB - National AMT Free Bond Fund (4.89 yr duration). We’ve been in AMT range but with new tax laws, I’m not sure this is relevant to have an AMT tax free fund now?
Would love any thoughts or real world examples!

livesoft
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Re: What fixed income for taxable account?

Post by livesoft » Sun Sep 30, 2018 3:28 pm

I have been very happy not having any fixed income in my taxable account. That way, the top half of my Form 1040 Schedule B has no income shown and I don't pay any income tax on the earnings of my fixed income that shows up in my 401(k) and rollover IRAs.

Instead of fixed income in my taxable account, I just put tax-efficient stock index funds such as Total US Stock Market Index fund and Total International Stock Market Index fund. The dividends are taxed at a much lower rate than a money market fund interest would be taxed.

If I need to buy a car, pay for a wedding, or have an emergency, I simply sell shares that have the least tax consequences to pay for those things. I don't care if the shares are up or down or sideways, but I prefer to sell shares with a loss since there will be no taxes. At the same time, in my 401(k) or rollover IRA, I exchange fixed income shares into equity shares that are similar to the one's I sold in taxable, so that my asset allocation remains the same.

There is even a bogleheads.org wiki article about what I do: https://www.bogleheads.org/wiki/Placing ... ed_account

Quite a few people cannot wrap their brains around this technique to avoid income taxes.

Another advantage of all this is that one can have more tax-loss harvesting opportunities where one gets other taxpayers to help pay for their losses in the stock funds. That cannot happen for stock funds in 401(k)s, IRAs, and Roth IRAs.
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grabiner
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Re: What fixed income for taxable account?

Post by grabiner » Sun Sep 30, 2018 3:45 pm

First, you should buy I-Bonds, as the income from them is tax-deferred. (Even if you are still in a high tax bracket when they mature in 30 years, you have benefited from tax-deferral of the interest.)

Then, which O is your OSU? If it is Ohio, Vanguard has an Ohio long-term tax-exempt fund. Thus, to reduce your Ohio taxes without taking too much risk, you might put half the money in OH Long-Term Tax-Exempt and half in Limited-Term Tax-Exempt, which gives an overall intermediate duration with more than half the income exempt from OH tax. If it is Oregon, the available Oregon funds cost more than they save in taxes, so a low-cost national intermediate fund such as MUB or Vanguard's VTEB or Intermediate-Term Tax-Exempt makes sense.

All of Vanguard's muni funds except High-Yield Tax-Exempt are AMT-free. But you are right that this probably won't matter under the new tax laws; one of the biggest triggers of AMT used to be the deduction for state income tax, and that is capped at $10K now.
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Spirit Rider
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Re: What fixed income for taxable account?

Post by Spirit Rider » Sun Sep 30, 2018 5:06 pm

What may also not be apparent from @livesoft's strategy. Is that if/when you have money to replenish/increase taxable assets. They will be purchased at current prices and will quite likely present additional future tax-loss harvesting opportunities.

MechEngOSU
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Re: What fixed income for taxable account?

Post by MechEngOSU » Mon Oct 01, 2018 5:26 am

Really great advice all. It has led me down a totally different line of thinking than where I thought this thread would go! That is great.
If I go the livesoft route, and I wanted to keep my overall asset allocation static, I would keep adding more to stock funds in taxable and then increase my monthly contributions to bond funds in the retirement accounts. The funny thing is, going through this thought experiment, I find that I don't like the thought of going even more in bonds (and giving up stock fund space) in the tax deferred accounts. Behavioral finance is so interesting!

Grabiner, thanks for the thoughts on Vanguard funds...I'll take a look there. I think at one point I avoided opening up a taxable account at Vanguard because they would not allow a beneficiary (or just not a trust beneficiary?) on a joint account, and that was a deal breaker for me. I would have to check this again.
Last edited by MechEngOSU on Mon Oct 01, 2018 6:50 am, edited 1 time in total.

international001
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Re: What fixed income for taxable account?

Post by international001 » Mon Oct 01, 2018 5:53 am

livesoft wrote:
Sun Sep 30, 2018 3:28 pm
I have been very happy not having any fixed income in my taxable account. That way, the top half of my Form 1040 Schedule B has no income shown and I don't pay any income tax on the earnings of my fixed income that shows up in my 401(k) and rollover IRAs.

Instead of fixed income in my taxable account, I just put tax-efficient stock index funds such as Total US Stock Market Index fund and Total International Stock Market Index fund. The dividends are taxed at a much lower rate than a money market fund interest would be taxed.

If I need to buy a car, pay for a wedding, or have an emergency, I simply sell shares that have the least tax consequences to pay for those things. I don't care if the shares are up or down or sideways, but I prefer to sell shares with a loss since there will be no taxes. At the same time, in my 401(k) or rollover IRA, I exchange fixed income shares into equity shares that are similar to the one's I sold in taxable, so that my asset allocation remains the same.

There is even a bogleheads.org wiki article about what I do: https://www.bogleheads.org/wiki/Placing ... ed_account

Quite a few people cannot wrap their brains around this technique to avoid income taxes.

Another advantage of all this is that one can have more tax-loss harvesting opportunities where one gets other taxpayers to help pay for their losses in the stock funds. That cannot happen for stock funds in 401(k)s, IRAs, and Roth IRAs.
This would work as long as most of the taxable account is expected to be used for retirement.
If you had any expectation that you may need a big chunk of your taxable in a few years, it's better to have some bonds on the mix, or when you need the money you may see that you only have 50% of it (like after a recession)

international001
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Re: What fixed income for taxable account?

Post by international001 » Mon Oct 01, 2018 6:23 am

Actually, as discussed in other threads, in most cases having stocks on taxable is counterproductive. Most cases, the lower taxes paid does not compensate the tax-free compounding effects you have with stocks in taxable (because stocks give a higher return)

rkhusky
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Re: What fixed income for taxable account?

Post by rkhusky » Mon Oct 01, 2018 6:33 am

MechEngOSU wrote:
Mon Oct 01, 2018 5:26 am
The funny thing is, going through this thought experiment, I find that I don't like the thought of going even more in bonds (and giving up stock fund space) in the tax deferred accounts.
Having bonds in tax deferred is a good thing, if you expect to withdraw from those accounts and pay income tax rates. I want tax deferred to grow slower than taxable and tax exempt.

livesoft
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Re: What fixed income for taxable account?

Post by livesoft » Mon Oct 01, 2018 6:34 am

international001 wrote:
Mon Oct 01, 2018 5:53 am
This would work as long as most of the taxable account is expected to be used for retirement.
If you had any expectation that you may need a big chunk of your taxable in a few years, it's better to have some bonds on the mix, or when you need the money you may see that you only have 50% of it (like after a recession)
You have to start somewhere. If one wants to use a big chunk of one's taxable, yes, it is true that one should have a double-chunk of taxable. Since equities have a higher expected return, one can expect to reach a double-chunk by using equities as much as possible.
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livesoft
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Re: What fixed income for taxable account?

Post by livesoft » Mon Oct 01, 2018 6:35 am

international001 wrote:
Mon Oct 01, 2018 6:23 am
Actually, as discussed in other threads, in most cases having stocks on taxable is counterproductive. Most cases, the lower taxes paid does not compensate the tax-free compounding effects you have with stocks in taxable (because stocks give a higher return)
That's a gross misunderstanding of what has been discussed in other threads, but maybe you have a typo.
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international001
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Re: What fixed income for taxable account?

Post by international001 » Mon Oct 01, 2018 7:38 am

I guess we didn't read the same threads

Imagine you have to invest over many years (everything before inflation)

1. stocks, with a CAGR 9%
2. bonds, with a CAGR 5%

In taxable you have to pay every year some percentage of the fund (let's assume morningstar tax cost ratio)
for 1. 0.5%
for 2. 2%

You have to pay less taxes the first year if you put 1 in taxable. But over the long term 1 compounds as 8.5%, 2 as 5%

If you put 2 in taxable, 1 compounds as 9%, 2 as 3%

From the one in tax-sheltered, you have to take your marginal tax (retirement distribution). But over long enough time, compounding effect will have a dominating effect. Of course, you may want to put things on a spreadsheet and see how long this time really is

livesoft
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Re: What fixed income for taxable account?

Post by livesoft » Mon Oct 01, 2018 9:08 am

Wrong assumptions. I do not pay 0.5% a year on my taxable accounts. I pay 0% tax. Most people should be able to figure out how to pay 0.1% or less tax on the equity fund investments in their taxable account. And most people should be able to figure out how to tax-loss harvest and benefit by even more than 0.1% average each year. Indeed, when I look at it that way, I am paid extra to have stock index funds in my taxable account.

Someone with an actively managed moderate expense ratio stock mutual fund would be shooting themselves in the tax foot.
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international001
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Re: What fixed income for taxable account?

Post by international001 » Mon Oct 01, 2018 9:48 am

livesoft wrote:
Mon Oct 01, 2018 9:08 am
Wrong assumptions. I do not pay 0.5% a year on my taxable accounts. I pay 0% tax. Most people should be able to figure out how to pay 0.1% or less tax on the equity fund investments in their taxable account. And most people should be able to figure out how to tax-loss harvest and benefit by even more than 0.1% average each year. Indeed, when I look at it that way, I am paid extra to have stock index funds in my taxable account.

Someone with an actively managed moderate expense ratio stock mutual fund would be shooting themselves in the tax foot.
I'm assuming a standard etf like ETF. Vanilla. No tax loss harvest. Which is your investment?

PFInterest
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Re: What fixed income for taxable account?

Post by PFInterest » Mon Oct 01, 2018 9:57 am

international001 wrote:
Mon Oct 01, 2018 7:38 am
I guess we didn't read the same threads

Imagine you have to invest over many years (everything before inflation)

1. stocks, with a CAGR 9%
2. bonds, with a CAGR 5%

In taxable you have to pay every year some percentage of the fund (let's assume morningstar tax cost ratio)
for 1. 0.5%
for 2. 2%

You have to pay less taxes the first year if you put 1 in taxable. But over the long term 1 compounds as 8.5%, 2 as 5%

If you put 2 in taxable, 1 compounds as 9%, 2 as 3%

From the one in tax-sheltered, you have to take your marginal tax (retirement distribution). But over long enough time, compounding effect will have a dominating effect. Of course, you may want to put things on a spreadsheet and see how long this time really is
You also forget for tax sheltered it doesn't come out in 1 marginal bracket....you have to fill up the lower tiers first thus lowering the effective tax.
As per livesoft, one can lower their taxable target range through some easy processes such as TLH.

PFInterest
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Re: What fixed income for taxable account?

Post by PFInterest » Mon Oct 01, 2018 10:01 am

MechEngOSU wrote:
Sun Sep 30, 2018 3:13 pm
My wife and I are late 30’s with kids. Looking for advice on what should we do for the bond/fixed income part of our taxable account.
Quick details: Previously 33% marginal rate. For the taxable account, we envision saving the fixed income portion for things needed in the 10-20 year time from such as cars, kids college, weddings, etc

Currently we just use a 1.85% online savings account since it’s about six months expenses. For future monthly savings, I see the options as:

1)add to online savings every month. Easy to track and easy for my wife to remember/implement if something were to happen to me, but not necessarily tax efficient.

2)buy 6 month or 1 yr individual treasuries every time 10k or 20k accumulates. Slightly better interest rates and state tax efficiency, but more of a record keeping and tracking hassle.

3)Something else like MUB - National AMT Free Bond Fund (4.89 yr duration). We’ve been in AMT range but with new tax laws, I’m not sure this is relevant to have an AMT tax free fund now?
Would love any thoughts or real world examples!
In answer to your question, I would use munis such as VWIUX.

international001
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Re: What fixed income for taxable account?

Post by international001 » Mon Oct 01, 2018 11:10 am

PFInterest wrote:
Mon Oct 01, 2018 9:57 am


You also forget for tax sheltered it doesn't come out in 1 marginal bracket....you have to fill up the lower tiers first thus lowering the effective tax.
As per livesoft, one can lower their taxable target range through some easy processes such as TLH.
Sure.. but my model works whatever marginal tax bracket. It's just a question on how long do you keep the funds
So you are saying that with TLH you reduce the effective tax cost rate?
But w/o TLH I'm right and you should have bonds on taxable?

livesoft
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Re: What fixed income for taxable account?

Post by livesoft » Mon Oct 01, 2018 11:14 am

international001 wrote:
Mon Oct 01, 2018 9:48 am
I'm assuming a standard etf like ETF. Vanilla. No tax loss harvest. Which is your investment?
VV or VLCAX, but there are many others. You cannot get more vanilla than that. TLH is important, too, so please do not ignore it.

If I reinvest dividends, then I will have some short-term shares held less than a year, some long-term shares held say 1-3 years with fewer gains than longer-term shares held 3 to 40 years. I can choose which shares to sell when I need the money in order to make the tax bite essentially zero.

No, you are not right. For most people, they should NOT have bonds in taxable if they have room for bonds in tax-deferred accounts.

Try this as an exercise: What tax rate on a stock index fund would be the break-even point to NOT put a stock index fund in taxable?

I think we can say that the 0% tax rate that I pay is below the break-even point, right?

And for some realistic tax rates please see the spreadsheet linked in this thread: viewtopic.php?t=242137
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international001
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Re: What fixed income for taxable account?

Post by international001 » Mon Oct 01, 2018 1:47 pm

VV VLCAX tax cost is about 0.5% (from morningstar). I have read the thread you told me. But I'm simplifying.

Again in my simplification, assume you have them compounding forever and than the CAGR is constant over the years. So no TLH involved. This was my assumption from the beginning. Even if it's not realistic, just bear with me so we can have an understanding.

This 0.5% makes a difference. You have to pay evey year about 0.5% of your ETF total value if it's on taxable. How can you avoid it?

livesoft
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Re: What fixed income for taxable account?

Post by livesoft » Mon Oct 01, 2018 2:54 pm

It has been pointed out many times that the Morningstar.com tax cost information is bogus. Yes, the 0.5% per year would make a difference if it were true. It is false for me and is false for at least 90% of citizens of the USA.

I'll simplify for you: Unrealized capital gains are NOT taxed at all. And qualified dividend income like that paid by VLCAX is NOT taxed either for married couples with taxable income below about $75,000 annually. Note that I wrote "taxable income" which is NOT the same as income nor is it the same as Adjusted Gross Income.

There is an old thread explaining some of this: viewtopic.php?t=87471

So do you know how morningstar.com calculates a tax cost and what they define the tax cost to be? Do you know why it is wrong?
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international001
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Re: What fixed income for taxable account?

Post by international001 » Mon Oct 01, 2018 6:13 pm

I haven't looked on it for a while, but I thought it was considering the highest marginal tax possible.
But the exact number is beyond the point. That spreadsheet gives me around 0.4%

The point is that *any* tax cost will make stocks in taxable not worth it given enough time. The exact number of the tax cost or the CAGR will just change the exact amount of time. Make your numbers when time is less than infinite.

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