Would it be better to invest my cash in VMFXX or VMSXX ?

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Topic Author
Shaneman
Posts: 8
Joined: Sun Apr 14, 2019 8:14 pm

Would it be better to invest my cash in VMFXX or VMSXX ?

Post by Shaneman » Sun Apr 14, 2019 8:34 pm

Hello Bogleheads,

Thank you in advance for reading this and offering some advice and perspective.

Would it be better to invest my cash in VMFXX or VMSXX ?

VMFXX 7-day SEC yield as of 04/12/2019 is 2.35%

VMSXX 7-day SEC yield as of 04/12/2019 is 1.47%

My tax situation
35% marginal federal tax bracket
5.1% state income tax
3.8% Net Investment Income Tax
0.9% High-Income Earner so I need to pay Obamacare Tax

I presently have cash invested in both funds but the majority is in VMSXX.

So there is no question how the returns are reported to the IRS I took a look at my 2018 Form 1099-DIV Dividends and Distributions

Vanguard Federal Money Market Fund (VMFXX) is reported as ordinary dividends (Box 1a) example for illustrative purposes $100.00

Vanguard Municipal Money Market Fund (VMSXX) ) is reported as Exempt-interest dividends(Box 11) and Specified private activity bond interest dividends (Box 12)

Example for illustrative purposes Exempt-interest dividends (Box 11) $1000.00 and
Specified private activity bond interest dividends (Box 12) $131.00

So if I had VMFXX with $100.00 reported this is taxed as ordinary dividends, thus treated as ordinary income and I will pay
35% marginal federal tax bracket
5.1% state income tax
0.9% High-Income Earner so I need to pay Obamacare Tax
41.9% Total taxes

So the after tax equivalent for VMFXX 2.35 - 41.9% = 1.365%
-----
For VMSXX yield is 1.47% and this is free of federal and state tax.

Yes VMSXX does have Specified private activity bond interest dividends reported in box 11 of 1099-DIV is the portion of tax-exempt interest dividends reported in Box 10 that may be subject to an Alternative Minimum Tax (AMT). Looking over my tax returns I did pay AMT but it was very little.

My conclusion is after considering taxes I am better off parking my cash in VMSXX resulting in a yield of 1.47% versus VMFXX which yields me an effective after tax yield of 1.365%

Do you agree with this conclusion?


I like to keep 7 years worth of living expenses in cash. I would be classified as very-high-net-worth. The cash holding is $1M. My other investments are 93% equities and 7% bonds. I know many people would say $1M in cash is too much to be holding but with a correction in equities and/or bonds holding 7 years worth of living expenses I don’t need to worry about selling assets in a down market. I am open to other ideas for parking the cash but please consider the high tax rates.

ofckrupke
Posts: 612
Joined: Mon Jan 10, 2011 2:26 pm

Re: Would it be better to invest my cash in VMFXX or VMSXX ?

Post by ofckrupke » Sun Apr 14, 2019 9:11 pm

Shaneman wrote:
Sun Apr 14, 2019 8:34 pm

Yes VMSXX does have Specified private activity bond interest dividends reported in box 11 of 1099-DIV is the portion of tax-exempt interest dividends reported in Box 10 that may be subject to an Alternative Minimum Tax (AMT). Looking over my tax returns I did pay AMT but it was very little.

My conclusion is after considering taxes I am better off parking my cash in VMSXX resulting in a yield of 1.47% versus VMFXX which yields me an effective after tax yield of 1.365%

Do you agree with this conclusion?
Three points:

1) you pay the 0.9% medicare surtax only on earned income, so it doesn't factor into tax adjustment of investment income yield. You pay the 3.8% NIIT on income that is not exempt from the regular federal tax.

2) only the portion of VMFXX income from US Govt Obligations (principally treasury, US Farm Credit bank, Federal Home Loan Bank, but not GNMA/fannie/freddie macs) is state tax exempt. In 2018 that was 77.79%.

3) You pay nonzero AMT for tax year 2018? That puts you in a select group since a) the TCJA's reset of the threshold for the exemption phaseout to 500k/1M released many from the annual snare and b) the SALT limitation drastically reduced some of the most common sources of deductions leading to AMT burden on the mass affluent in the first place. But if so, it means your marginal federal rate (exclusive of the 3.8% NIIT) may only be 28%, depending upon whether your income puts you beyond the AMT personal exemption phaseout aka bump zone.

However, taking your federal net rate (regular plus AMT exposures) at face value yes VMSXX rather than VMFXX or VUSXX or VMMXX. If your income puts you beyond the AMT bump zone then the method is the same but sub 28% for 35% on VMFXX. For VMSXX you'd apply some fraction of the 28% or 35% according to the fraction of the VMSXX income subject to the private activity AMT exposure.

venkman
Posts: 898
Joined: Tue Mar 14, 2017 10:33 pm

Re: Would it be better to invest my cash in VMFXX or VMSXX ?

Post by venkman » Sun Apr 14, 2019 10:30 pm

Shaneman wrote:
Sun Apr 14, 2019 8:34 pm
Would it be better to invest my cash in VMFXX or VMSXX ?
VMFXX 7-day SEC yield as of 04/12/2019 is 2.35%
VMSXX 7-day SEC yield as of 04/12/2019 is 1.47%
The SEC yield of VMSXX tends to fluctuate throughout the year, independent of changes in the Fed rate. While VMFXX's yield has remained stable since January, VMSXX started the year at 1.63%, went down to 1.30%, went back up to 1.67%, and is currently at 1.47%. There are apparently seasonal variations in demand for very short muni bonds, but I don't know enough to explain it more than that.

The upshot is that 1-year past performance might be a better comparison tool for these 2 particular funds than current SEC yield. (1 year performance for VMFXX was 2.03%, and VMSXX was 1.42%.)

Topic Author
Shaneman
Posts: 8
Joined: Sun Apr 14, 2019 8:14 pm

Re: Would it be better to invest my cash in VMFXX or VMSXX ?

Post by Shaneman » Mon Apr 15, 2019 6:55 pm

Thank you to both Ofckrupke and venkman for your insights and correcting me that the 0.9% medicare surtax only on earned income.

Reviewing my tax returns it looks like my accountant considered all of VMFXX has ordinary dividends and did not exempt any portion as state tax exempt.

Very keen eye on venkman to note the 1 year return since seasonal variations in demand for very short muni bonds can skew 7-day SEC yield.

Regardless it seems since my taxes are very high the best choice for my cash would be to have it in VMSXX over VMFXX.

dknightd
Posts: 1458
Joined: Wed Mar 07, 2018 11:57 am

Re: Would it be better to invest my cash in VMFXX or VMSXX ?

Post by dknightd » Mon Apr 15, 2019 6:59 pm

If I did not know what to do, and I don't, I'd split 50/50

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celia
Posts: 9168
Joined: Sun Mar 09, 2008 6:32 am
Location: SoCal

Re: Would it be better to invest my cash in VMFXX or VMSXX ?

Post by celia » Tue Apr 16, 2019 12:32 am

Shaneman wrote:
Sun Apr 14, 2019 8:34 pm
35% marginal federal tax bracket
5.1% state income tax
0.9% High-Income Earner so I need to pay Obamacare Tax
41.9% Total taxes
If this was meant to add up the 3 percentages, the sum is 41.0%, instead of 41.9%. But I would not have figured this out in the same way. I would have kept the federal and state tax percentages separate since they will apply to different amounts of “interest dividends”.

You should have received a U.S. government obligations information flyer for each 1099-DIV that reported on any fund that held U.S. government obligations. This is where it shows that Federal MM fund is 77.79% tax-free to the state.

You should have also received a Tax-Exempt interest dividends by state flyer for each 1099-DIV that reported on Municipal Money Market fund or any non-state-specific Tax-Exempt funds. It shows how much of each fund is tax-free for each state. (Many states have less than 1% being tax-exempt, but NY and TX munis appear to have the biggest holdings in the Muni MM fund. In addition, if there is a state-specific Municipal or Tax-Exempt fund, even managed by a different company than Vanguard, the fund will be 100% tax-exempt from both federal and state taxes if you are a resident of that state.)

When I get either of these (or any other notice with a tax form, I staple it to the tax form and highlight the fund(s) that will need adjustments. If you gave these to your tax preparer, they may have looked like junk or advertising, so she could have thrown them out. You may need to point them out in the future or put a post-it on the front of the applicable 1099s.

Your tax rates:
35% marginal federal tax bracket
5.1% state income tax
3.8% Net Investment Income Tax

Then for $1,000 invested in Federal MM, there will be a distribution of $23.50. The federal taxes would be (35% + 3.8% = 38.8%) and the state tax would be (5.1% * (1-77.79%) = 1.13%). After paying the taxes, you would be left with:
$23.50 - $9.12 - $0.27 = $14.11 (an effective gain of 1.41% on the $1,000).

For $1,000 invested in Municipal MM, there will be a distribution of $14.70. The federal taxes would be $0 and the state tax would depend on your state. Unless you live in NY or TX, let’s say you need to pay taxes on 99% of the distribution. Then 5.1% * 99% * $14.70 = $0.74 in taxes, leaving you with $13.96 (an effective gain of 1.40% on the $1,000).

Note 1: If your state has a Tax-Exempt fund, you should consider investing in that as it will be federal and state tax-free.

Note 2: YOUR state may have different rules. Some states may not allow tax-exempt income for its residents and some states may not care if you are a resident. Read the flyers that are linked above.

Topic Author
Shaneman
Posts: 8
Joined: Sun Apr 14, 2019 8:14 pm

Re: Would it be better to invest my cash in VMFXX or VMSXX ?

Post by Shaneman » Tue Apr 16, 2019 8:49 pm

Thank you celia. The member of bogleheads.org are just amazing.

So for my situation it is the VMFXX - Vanguard Federal Money Market Fund will provide the best return after taxes - aka what I keep for myself.

I did give to my accountant the a U.S. government obligations information flyer from Vanguard and even highlighted the fund and circled the 77.79% but my accountant just overlooked it.

Wow for the VMSXX it is 100% tax free on the federal return but only 3.17% of the ordinary dividend is Massachusetts state income tax exempt and the remaining 96.83% should be imposed the Massachusetts state income tax.

The accountant just took the dollar amount listed on the 2018 Form 1099-DIV for the VANGUARD FEDL MONEY MKT 09999100 that was listed under Total ordinary dividends (Box 1a) and paid the state tax on the entire amount.

On the VNGRD MUN MMKT 922907506 the accountant took the amount listed under Exempt-interest dividends (Box 11) and paid no state tax on this amount.

I guess it is probably a wash (over paid state taxes on dividends VMFXX and underpaid state taxes on VMSXX) but for the money my accountant charges I would think he would be on the ball and meticulous to get everything right.

Vanguard does offer a tax exempt fund for the state I have domicile in presently Massachusetts.

Vanguard Massachusetts Tax-Exempt Fund (VMATX)

30 day SEC yield as of 04/12/2019 2.46%

Average stated maturity 16.7 years

Average duration 6.7 years

The duration is just too long for me since there will be a day when the artificial low interest rates will revert to the present day economic market.

I also think I may change my domicle to Florida soon to get away from state taxes.

Thank you again for being so meticulous and detailed.

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