Isn’t it good to have some bond funds in taxable account?

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CoastalWinds
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Isn’t it good to have some bond funds in taxable account?

Post by CoastalWinds » Fri May 31, 2019 1:05 pm

I realize this goes against the conventional wisdom of asset location based on the goal of maximizing after-tax returns, but here is my thinking...

Let’s assume I fill up my pre-tax 401k and IRA space with bonds, and put stocks in my taxable account. Then let’s say stocks have a huge run-up, triggering they need to rebalance. Now I’m forced to sell stocks to buy bonds. This would force me to sell stocks in the taxable account, thus triggering capital gains tax. (and as an aside, it would also force me to buy bonds in the taxable, so I’d end up there anyway).

Or alternately, let’s say that my pre-tax space isn’t yet filled with bonds, but rather has mostly bonds but some stocks (so I could still re-balance there). But let’s assume that my taxable account is all stocks. And then let’s say I were to follow the advice of “unless you have a concrete plan to use the taxable money in X months to buy something (eg, house downpayment), keep it invested per your overall AA.” But then suddenly and unplanned, the house of my dreams becomes available and I need to sell taxable holdings to have the cash for the downpayment. Once again, this will trigger a capital gains tax.

In both scenarios, if I had held some bonds in the taxable account, I could: (a) re-balance in the tax-sheltered space; and (b) sell bonds with presumably little capital gains and thus stave off a large tax hit.

Given this, wouldn’t it make sense to keep some portion of bonds in a taxable account? Say 20%.

Please help me understand if this is illogical or flawed thinking. Thank you.

livesoft
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Re: Isn’t it good to have some bond funds in taxable account?

Post by livesoft » Fri May 31, 2019 1:12 pm

I think you exaggerate the capital gains tax hit. If you had gained the same amount in bond fund dividends, then you would have paid a higher tax rate. Also return-of-capital is not taxed. Also, if you had been tax-loss harvesting (as I have been), then you would not have any capital gains taxes to worry about.

But if one had no room anymore in their tax-deferred accounts and needed more bond funds, then there is no problem owning bond funds in a taxable account.
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Phineas J. Whoopee
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Re: Isn’t it good to have some bond funds in taxable account?

Post by Phineas J. Whoopee » Fri May 31, 2019 1:45 pm

It speaks of cash, and particularly an emergency fund, but the reasoning works equally well for any fixed income including bonds: our wiki article Placing cash needs in a tax-advantaged account.

If you're going to pay income tax soon anyway, the rate on capital gains is likely to be lower than on your other income.

PJW

bryanm
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Re: Isn’t it good to have some bond funds in taxable account?

Post by bryanm » Fri May 31, 2019 2:00 pm

Don't let the tax-tail wag the return-dog. Yes, it's okay to hold bonds in taxable if you run out of space for your AA in tax-advantaged accounts.

The problem with bonds in taxable isn't capital gains (or lack thereof) at the time of sale, it's "tax drag": the lowering of each year's return by the taxable amount in that year.

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Nate79
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Re: Isn’t it good to have some bond funds in taxable account?

Post by Nate79 » Fri May 31, 2019 2:03 pm

Yes there is no problem to have bond funds in taxable accounts. These can act as secondary emergency funds or savings account type vehicles for near term purchases.

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Earl Lemongrab
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Re: Isn’t it good to have some bond funds in taxable account?

Post by Earl Lemongrab » Fri May 31, 2019 3:40 pm

If you use new contributions and distributions to rebalance as you go, it's likely you won't really run into the need to sell anything.

thefirst100k
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Re: Isn’t it good to have some bond funds in taxable account?

Post by thefirst100k » Sat Jun 01, 2019 9:58 am

One solution is to buy tax-free municipal bonds and put them in your taxable account.

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JoMoney
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Re: Isn’t it good to have some bond funds in taxable account?

Post by JoMoney » Sat Jun 01, 2019 10:02 am

Another reason to have some bonds in taxable: That's the only place you can buy U.S. Savings Bonds, which can accrue their interest tax free for up to 30 years (effectively giving you additional tax sheltered savings space).
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grabiner
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Re: Isn’t it good to have some bond funds in taxable account?

Post by grabiner » Sat Jun 01, 2019 7:44 pm

thefirst100k wrote:
Sat Jun 01, 2019 9:58 am
One solution is to buy tax-free municipal bonds and put them in your taxable account.
There is a tax cost there as well; it is the cost you pay to avoid taxes, which is the difference between the yields of muni and corporate bonds of comparable risk.

This may still be a good deal, particularly if you are in a high federal tax bracket or there is a low-cost fund for your high-tax state. The tax cost of CA munis versus corporate bonds is the same for all CA residents, while the tax cost of anything else in a taxable account is significantly higher because of CA tax, and 3.8% Net Investment Income federal tax if you are above that limit.
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Noble Knight
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Re: Isn’t it good to have some bond funds in taxable account?

Post by Noble Knight » Sat Jun 01, 2019 8:30 pm

I hold bonds in my taxable, at my age holding bonds in my tax deferred accounts doesn’t make a lot of sense. I suspect the “conventional wisdom” applies best for people near or at the retirement stage or people in a high tax bracket.

sambb
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Re: Isn’t it good to have some bond funds in taxable account?

Post by sambb » Sat Jun 01, 2019 8:36 pm

in high tax bracket, munis make sense

thefirst100k
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Re: Isn’t it good to have some bond funds in taxable account?

Post by thefirst100k » Sat Jun 01, 2019 8:41 pm

grabiner wrote:
Sat Jun 01, 2019 7:44 pm
thefirst100k wrote:
Sat Jun 01, 2019 9:58 am
One solution is to buy tax-free municipal bonds and put them in your taxable account.
There is a tax cost there as well; it is the cost you pay to avoid taxes, which is the difference between the yields of muni and corporate bonds of comparable risk.

This may still be a good deal, particularly if you are in a high federal tax bracket or there is a low-cost fund for your high-tax state. The tax cost of CA munis versus corporate bonds is the same for all CA residents, while the tax cost of anything else in a taxable account is significantly higher because of CA tax, and 3.8% Net Investment Income federal tax if you are above that limit.
Excellent point. Furthermore, there are Muni vs Taxable bond calculators out there, for OP to look into. Like this one:
https://www.oppenheimerfunds.com/adviso ... calculator

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