Taxable fixed-income options for investing a windfall

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Topic Author
Grogs
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Joined: Tue Mar 24, 2015 4:55 pm

Taxable fixed-income options for investing a windfall

Post by Grogs » Sat Apr 13, 2019 11:18 am

Hi all,

I'm expecting a windfall in the next few months that will approximately double the size of my current investment accounts. I have a couple of questions about this for you. I'll put them up front, then post my details below for those with more patience to read it.

- All of my bonds are currently in my pre-tax 401k. Assuming I invest everything, my 401k will be too small to hold all the bonds (65:35 AA) I would need. Any suggestions on the best way to add bonds/CDs to taxable accounts for my situation?
- I'm considering using some (~1/3) of the windfall to pay off my mortgage. I know this comes down to personal preference for most, but is this a better idea in light of the fact I need more fixed-income space?
- To add a wrinkle, I was going to open a DAF and bunch deductions this year. Paying off the mortgage will lose most of the deduction on that. Would it make more sense to put the money in a CD for a year or more and then pay it off when I'll be taking the standard deduction again?
- Would paying off the mortgage hurt my credit rating? It's my only current recurring payment. I have no plans to move, but who knows. Someday I might need another mortgage at least until the current house sells.


Here are my details:

Emergency funds: ~ 1 yr expenses
Debt: $90k mortgage @ 2.99%, 10.5 yrs remaining on a 20-yr note.
Tax Filing Status: Single, no dependents
Tax Rate: 24% Federal, 0% State*
State of Residence: TN
Age: 46
Desired Asset allocation: 65% stocks / 35% bonds**
Desired International allocation: 33% of stocks

* There is a small (1-2%) state tax on dividend (but not CD interest or cap. gain) income for the next two years until the law sunsets.
** My AA target is based on the size of my investments. Right now it's 73%, but if I invested the entire windfall it would go down to 65%.

Taxable (32% of total)
100% VTSAX, total stock market

Roth (20% of total)
50% VTSAX, total stock market
50% VTIAX, total international stock market

401k (43.5% of total) - These are Blackrock funds with no tickers, all low (0.03-0.10%) ERs.
18.5% S&P 500 fund
5.0% Russell 2000 fund
29.0% total international stock fund
47.5% U.S. total bond index

HSA (4.5% of total)
15% cash (required minimum $ value in savings for provider)
85% VTSAX total stock market

For my deductions, they would look something like this:

- $10k to open a DAF (This is ~ 2.5 yrs. of cash donations)
- 1k donations through payroll (UW, etc. to be a "good team player" at work)
- $1200 property tax
- $2800 mortgage interest
- $1800 for the standard sales tax deduction
- TOTAL: $16.8k / $12.4k standard deduction

- For the mortgage, my P&I is $10,900/yr. I've been adding another $3k/yr principal to that, so paying it off would free up $13.9k/yr in cash flow.
- At 2.99% x (100-24%), the after-tax rate is 2.27%.
- Ally has a 2.75% 1-yr CD. 2.75% x (100-24%) = 2.09%, which is a little worse.
- I could also do a 5-yr/3.0% which just beat the mortgage initially (2.28% after tax). Next year when I revert to the standard deduction I'll be paying the full 2.99% on the mortgage though. OTOH, it seems like the CD might still come out slightly ahead since the mortgage principal is falling each year.

Thanks for your help,

Grogs

22twain
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Re: Taxable fixed-income options for investing a windfall

Post by 22twain » Sat Apr 13, 2019 12:11 pm

Grogs wrote:
Sat Apr 13, 2019 11:18 am
- Would paying off the mortgage hurt my credit rating? It's my only current recurring payment.
Not even any credit cards? :shock:

Our house has been paid off for more than ten years. Our only other credit usage has ever been credit cards that we pay off at the end of each month. Last time I looked, probably a couple of years ago, my credit score was around 820.
My investing princiPLEs do not include absolutely preserving princiPAL.

livesoft
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Re: Taxable fixed-income options for investing a windfall

Post by livesoft » Sat Apr 13, 2019 12:15 pm

I can say that Yes, paying off the mortgage will hurt your credit rating. I think mine dropped by 20 to 30 points from a high value to another high value that was lower.
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welderwannabe
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Re: Taxable fixed-income options for investing a windfall

Post by welderwannabe » Sat Apr 13, 2019 12:31 pm

livesoft wrote:
Sat Apr 13, 2019 12:15 pm
I can say that Yes, paying off the mortgage will hurt your credit rating. I think mine dropped by 20 to 30 points from a high value to another high value that was lower.
Same here. I was bounding between 820s and 830s before I paid off my house early last year. I still use credit cards and pay them off every month, but thats it for payments. My credit score is in the mid 700's. Primary reason stated it isn't higher, according to the little tips it gives you when you pull your credit, is 'poor mix of credit types'.
I am not an investment professional, but I did stay at a Holiday Inn Express last night.

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Tycoon
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Re: Taxable fixed-income options for investing a windfall

Post by Tycoon » Sat Apr 13, 2019 12:45 pm

Alternately, we have no mortgage and the only credit accounts we have are cards. Both of our credit scores are in the 812 to 820 range.
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BL
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Re: Taxable fixed-income options for investing a windfall

Post by BL » Sat Apr 13, 2019 12:48 pm

You could use municipal bonds/money market for fixed income. Also I-Bonds at 10k/year unless you also get some paper bonds as a tax return.

Your itemized deductions are so small, I wouldn't spend much effort on that. If you did 5 years worth of DAF maybe that would make more sense. Maybe make a decision next year on paying off such a low-cost mortgage. I don't think I would pay it off at that rate, but if the satisfaction is great, so be it.

livesoft
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Re: Taxable fixed-income options for investing a windfall

Post by livesoft » Sat Apr 13, 2019 1:48 pm

Tycoon wrote:
Sat Apr 13, 2019 12:45 pm
Alternately, we have no mortgage and the only credit accounts we have are cards. Both of our credit scores are in the 812 to 820 range.
Yes, our score has increased since paying off the mortgage several years ago.
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Topic Author
Grogs
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Re: Taxable fixed-income options for investing a windfall

Post by Grogs » Sat Apr 13, 2019 6:04 pm

22twain wrote:
Sat Apr 13, 2019 12:11 pm
Grogs wrote:
Sat Apr 13, 2019 11:18 am
- Would paying off the mortgage hurt my credit rating? It's my only current recurring payment.
Not even any credit cards? :shock:

Our house has been paid off for more than ten years. Our only other credit usage has ever been credit cards that we pay off at the end of each month. Last time I looked, probably a couple of years ago, my credit score was around 820.
Credit cards, sure, but I mean debt service with a fixed monthly payment like a car, house, etc. I'm pretty sure those fall into a special category.
BL wrote:
Sat Apr 13, 2019 12:48 pm
You could use municipal bonds/money market for fixed income. Also I-Bonds at 10k/year unless you also get some paper bonds as a tax return.

Your itemized deductions are so small, I wouldn't spend much effort on that. If you did 5 years worth of DAF maybe that would make more sense. Maybe make a decision next year on paying off such a low-cost mortgage. I don't think I would pay it off at that rate, but if the satisfaction is great, so be it.
I thought munis were more attractive to high tax bracket / high state tax folks.

And I agree that paying the mortgage off at 3% isn't super attractive compared to investing in something with a higher expected return. OTOH, I'm not sure it makes sense to keep it if I'm going to be buying a lot of bonds making about the same rate of interest.

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Re: Taxable fixed-income options for investing a windfall

Post by grabiner » Sat Apr 13, 2019 8:41 pm

Grogs wrote:
Sat Apr 13, 2019 6:04 pm
And I agree that paying the mortgage off at 3% isn't super attractive compared to investing in something with a higher expected return. OTOH, I'm not sure it makes sense to keep it if I'm going to be buying a lot of bonds making about the same rate of interest.
If you don't itemize deductions, then paying off the mortgage is a risk-free 2.99% return, and low-risk bonds don't earn 3% after tax.

If you do itemize, then paying off the mortgage is a risk-free 2.99% taxable return, which is only 2.23% after tax. Even that might be worth doing, as it is equivalent to buying a bond portfolio with a 5-year duration, and a low-risk bond portfolio with a 5-year duration (Admiral shares of Vanguard Intermediate-Term Tax-Exempt) yields 2.13%. So you come out very slightly ahead by paying it off, and you lose some liquidity, but that is liquidity you don't seem to need.

Therefore, it seems that even if you want to open a DAF this year, it might be better to pay off the whole mortgage this year; check the yields on intermediate-term bonds when you actually have the option. If yields go up, you will probably want to wait until 2020 to pay off the mortgage.
Last edited by grabiner on Sat Apr 13, 2019 8:43 pm, edited 1 time in total.
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BL
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Re: Taxable fixed-income options for investing a windfall

Post by BL » Sat Apr 13, 2019 8:43 pm

Grogs wrote:
Sat Apr 13, 2019 6:04 pm
22twain wrote:
Sat Apr 13, 2019 12:11 pm
Grogs wrote:
Sat Apr 13, 2019 11:18 am
- Would paying off the mortgage hurt my credit rating? It's my only current recurring payment.
Not even any credit cards? :shock:

Our house has been paid off for more than ten years. Our only other credit usage has ever been credit cards that we pay off at the end of each month. Last time I looked, probably a couple of years ago, my credit score was around 820.
Credit cards, sure, but I mean debt service with a fixed monthly payment like a car, house, etc. I'm pretty sure those fall into a special category.
BL wrote:
Sat Apr 13, 2019 12:48 pm
You could use municipal bonds/money market for fixed income. Also I-Bonds at 10k/year unless you also get some paper bonds as a tax return.

Your itemized deductions are so small, I wouldn't spend much effort on that. If you did 5 years worth of DAF maybe that would make more sense. Maybe make a decision next year on paying off such a low-cost mortgage. I don't think I would pay it off at that rate, but if the satisfaction is great, so be it.
I thought munis were more attractive to high tax bracket / high state tax folks.

And I agree that paying the mortgage off at 3% isn't super attractive compared to investing in something with a higher expected return. OTOH, I'm not sure it makes sense to keep it if I'm going to be buying a lot of bonds making about the same rate of interest.
What is your tax-equivalent rate of Total Bond Market or other taxable bonds? No state tax? There has been several threads recently about calculating this. Your 24% may or may not be high enough to recommend munis.

Topic Author
Grogs
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Re: Taxable fixed-income options for investing a windfall

Post by Grogs » Sun Apr 14, 2019 10:06 pm

BL wrote:
Sat Apr 13, 2019 8:43 pm

What is your tax-equivalent rate of Total Bond Market or other taxable bonds? No state tax? There has been several threads recently about calculating this. Your 24% may or may not be high enough to recommend munis.
Here are the formulas I got from Kevin M's post:
Treasury: TEY = Yt * (1-f) / (1 - f - s)

Out-of-state Muni: TEY = Ym * (1 - s) / (1 - f - s)
State is 0%, so TEY on TBM (VBTLX) is just the 2.93% SEC yield.

TEY of a muni reduces to Ym / (1-f). Looking at a couple of national munis,

VWITX (intermediate term national muni) has 2.05% SEC yield -> 2.70% TEY

VWLTX (long-term national muni) is 2.51% SEC yield -> 3.30% TEY

Of course, VWLTX comes with more duration risk. Not sure how they rate on default risks, but VG gives a higher risk rating to VWLTX than the other two.

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BL
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Re: Taxable fixed-income options for investing a windfall

Post by BL » Mon Apr 15, 2019 12:56 am

I believe you would want to compare the long-term to a taxable long-term.
Intermediate might be somewhat comparable in length to total stock market.

I don't see anything that recommends munis here, unless there is something else that applies. No state tax makes a difference.

You could make your 401k 100% fixed income (not clear to me if it will be or not) and add some bonds to Roth. Some don't want any but I have seen it recommended that one should have some there rather than in taxable if no room in tIRA or 401k. Having some bonds in the Roth IRA would also give you a place to re-balance.

I guess pre-paying the mortgage by some amount would take care of the problem as well.

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