Tax-Exempt Bonds for Lower Tax Brackets

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Kintora
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Tax-Exempt Bonds for Lower Tax Brackets

Post by Kintora » Sun May 10, 2020 7:04 pm

I have no more room in tax advantaged accounts for bonds, so I need to hold some in my taxable account to meet my desired AA. My tax bracket is 22%.

I currently hold Total Bond Market (VBTLX) in taxable, but thinking about switching my bond holdings there to Intermediate-Term Tax-Exempt (VWITX).

Everything I have read on this forum suggests that, generally speaking, muni funds are not worth it in taxable unless you are in a higher tax bracket (e.g., 32%+). However, it seems that the current SEC yield on TBM (1.58%) is actually lower than that of ITTE (1.74%), so regardless of tax bracket, ITTE is the current yield winner. TBM yield being lower than ITTE is maybe only due to the "unusual times" that we are in, and maybe a "return to normal" will see it going higher again. Then again, maybe not. We cannot predict the future.

Hypothetical growth of $10,000 over the last 10 years is almost identical according to Vanguard for the two funds.

I consider myself a buy-and-hold investor, and I don't want to be frequently chasing yield. That being said, I am still setting up and optimizing my accounts after a recent escape and conversion from Edward Jones to Vanguard. So, for me, now is the time to decide between TBM and ITTE in my taxable account. I should also note that I already have approximately 2/3 of my bond holdings in tax advantaged which is TBM, so I will have good TBM exposure regardless of what I decide to do in my taxable account.

I should also note there are no state-specific muni funds available to me. I am in North Dakota with state tax bracket of approximately 2%.

So, what would you do? ITTE seems like a no-brainer at current yields, but maybe TBM is better for the long term for lower tax brackets?

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Re: Tax-Exempt Bonds for Lower Tax Brackets

Post by fabdog » Sun May 10, 2020 7:23 pm

I think going with Int term tax exempt would be fine... as you note, yield currently above TBM... and even if/when TBM starts coming back up, it still has to be > 22% higher than TBM before you are losing out... who knows how long that will be

Mike

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Re: Tax-Exempt Bonds for Lower Tax Brackets

Post by petulant » Sun May 10, 2020 8:37 pm

TBM has lots of treasuries, and the muni fund holds, well, munis. This is a stress period where treasury yields have fallen (prices up) and spreads of other debtors have gone up (meaning munis and corps have higher premiums than normal). It is not surprising that the tax equivalent yield of munis would look more attractive than usual. The market is telling you it thinks they're a bit more risky than usual. That's probably not wrong when you think of sales tax and income tax impacts on state and local governments from COVID19. So, you're probably fine, but caveat emptor.

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Re: Tax-Exempt Bonds for Lower Tax Brackets

Post by hudson » Sun May 10, 2020 8:49 pm

Kintora wrote:
Sun May 10, 2020 7:04 pm

[b]Everything I have read on this forum suggests that, generally speaking, muni funds are not worth it in taxable unless you are in a higher tax bracket (e.g., 32%+).[/b]
Intermediate munis can work in the 22% tax bracket.
Do the math. Compare the after tax payout for total bond and Vang. Intermed Muni. Use distribution yield...that's what you actually get.

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Re: Tax-Exempt Bonds for Lower Tax Brackets

Post by Kintora » Sun May 10, 2020 11:40 pm

hudson wrote:
Sun May 10, 2020 8:49 pm
Kintora wrote:
Sun May 10, 2020 7:04 pm

Everything I have read on this forum suggests that, generally speaking, muni funds are not worth it in taxable unless you are in a higher tax bracket. (e.g., 32%+)
Intermediate munis can work in the 22% tax bracket.
Do the math. Compare the after tax payout for total bond and Vang. Intermed Muni. Use distribution yield...that's what you actually get.
Thanks for pointing out to use the distribution yield. I was not looking at that, but now I am. For 5/1/2020, VBTLX was 2.45% and VWITX was 2.48%.

So, tax-equivalent yield for VWITX would be 3.18% for me if I am calculating correctly.

Thank you all for your replies. It gives me more info to consider before deciding.

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Re: Tax-Exempt Bonds for Lower Tax Brackets

Post by hudson » Mon May 11, 2020 5:50 am

Kintora,

When I'm trying to decide, I don't use percentage; I use dollars and try to estimate the amount each fund will payout per year.
I look at the VWITX..Vang. Intermed Muni's Distribution tab and try to project say the next year. Last May 1st, VWIUX was paying 2.71%; now it's paying 2.48%. My speculative, uneducated and wild projection would be 2.3% on May 1st 2021.

Maybe look at the definition of distribution yield and the actual payouts on the distribution tab and watch it...especially if you own it.

SEC yield is a most useful number...but it's a future projection used for comparing funds. It also gives a fair estimate of long term future distribution yields.

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Re: Tax-Exempt Bonds for Lower Tax Brackets

Post by Kintora » Mon May 11, 2020 7:41 pm

hudson wrote:
Mon May 11, 2020 5:50 am
Kintora,

When I'm trying to decide, I don't use percentage; I use dollars and try to estimate the amount each fund will payout per year.
I look at the VWITX..Vang. Intermed Muni's Distribution tab and try to project say the next year. Last May 1st, VWIUX was paying 2.71%; now it's paying 2.48%. My speculative, uneducated and wild projection would be 2.3% on May 1st 2021.

Maybe look at the definition of distribution yield and the actual payouts on the distribution tab and watch it...especially if you own it.

SEC yield is a most useful number...but it's a future projection used for comparing funds. It also gives a fair estimate of long term future distribution yields.
Thanks again. I have a much better understanding of SEC yield and distribution yield now from your replies and some additional reading. :sharebeer

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Re: Tax-Exempt Bonds for Lower Tax Brackets

Post by Kintora » Tue May 26, 2020 10:00 pm

One last question on this before I pull the trigger on exchanging my Total Bond Market (VBTLX) for tax-exempt muni bonds in my taxable account.

For the tax-exempt muni bonds, I am looking at Intermediate-Term Tax-Exempt (VWITX/VWIUX) versus Tax-Exempt Bond Index Fund (VTEAX).

I am looking at around $30k in bonds here for this account, so I could not take advantage of the lower ER of VWIUX, so would be looking at 0.17% ER for VWITX versus 0.09% for VTEAX. VTEAX also looks like it might currently have a slight yield advantage and slightly lower credit risk, although it has slightly higher duration risk. This is my understanding of it anyway. I am still new to all this.

Overall, they look fairly similar, and this may be splitting hairs, but I am leaning towards VTEAX.

My main question to the community before I move forward, is there any reason to steer away from VTEAX in favor of VWITX, or are they so similar that it is just a matter of personal perference?

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Re: Tax-Exempt Bonds for Lower Tax Brackets

Post by hudson » Tue May 26, 2020 10:10 pm

VWITX is daily accrual so thats a big plus if need to tax loss harvest.

VTEAX and its ETF pair are not.

I’ll take another look on Wed.

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Re: Tax-Exempt Bonds for Lower Tax Brackets

Post by Toons » Tue May 26, 2020 10:14 pm

I hold Vanguard intermediate term tax exempt VWIUX
In a taxable account.
Yes I am in a lower tax bracket.
No I am not chasing yield,,taxable bond ,taxfree ,distribution yield,,etc
Satisfied.
For years.
:happy
"One does not accumulate but eliminate. It is not daily increase but daily decrease. The height of cultivation always runs to simplicity" –Bruce Lee

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Kintora
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Re: Tax-Exempt Bonds for Lower Tax Brackets

Post by Kintora » Tue May 26, 2020 10:34 pm

hudson wrote:
Tue May 26, 2020 10:10 pm
VWITX is daily accrual so thats a big plus if need to tax loss harvest.

VTEAX and its ETF pair are not.

I’ll take another look on Wed.
Thanks for pointing this out, and I am reading more about this and the 6-month rule, etc.

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Re: Tax-Exempt Bonds for Lower Tax Brackets

Post by Kintora » Tue May 26, 2020 10:42 pm

Toons wrote:
Tue May 26, 2020 10:14 pm
I hold Vanguard intermediate term tax exempt VWIUX
In a taxable account.
Yes I am in a lower tax bracket.
No I am not chasing yield,,taxable bond ,taxfree ,distribution yield,,etc
Satisfied.
For years.
:happy
Thanks for your feedback, Toons. If I go with VWITX, I guess I could eventually convert to VWIUX if I ever build up my position to $50k+ bonds in that taxable account. Not sure if that will ever happen though, since most of my new bond purchases going forward will be in my 401k. On the other hand, an extra .08% ER probably isn't the end of the world, but I am getting so spoiled with these low Vanguard ERs :happy

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Re: Tax-Exempt Bonds for Lower Tax Brackets

Post by hudson » Wed May 27, 2020 6:49 am

Kintora wrote:
Tue May 26, 2020 10:34 pm
hudson wrote:
Tue May 26, 2020 10:10 pm
VWITX is daily accrual so thats a big plus if need to tax loss harvest.

VTEAX and its ETF pair are not.

I’ll take another look on Wed.
Thanks for pointing this out, and I am reading more about this and the 6-month rule, etc.
I just took a quick look.
VTEAX is an index fund VWITX is not...my preference is VWITX...because VWITX has more latitude and doesn't have to follow the index. There are times when that's a plus. I'm not sure that I'm firm ground here.
VTEAX has a longer duration...I think that you said that....not by much.
VWITX is daily accrual...there are several good discussions on this that made me a daily accrual only person: viewtopic.php?p=4117185#p4117185

VWIUX...no hurry to get up there. VWITX will help you learn the ropes. Sometimes you have to own something to learn it.

I didn't confirm that VTEAX is or isn't daily accrual....I'm going by memory.

I like distribution yield....MikeG62 discusses holes in my theory. He's 100% right in what he says, but I think that my method on using distribution yield works....you just have to understand everything about Vanguard's definition of distribution yield and you have to keep an eye on the VWITX's distribution table....and internalize it viewtopic.php?p=5263588#p5263588

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Re: Tax-Exempt Bonds for Lower Tax Brackets

Post by retiredjg » Wed May 27, 2020 7:04 am

If you intend to switch back and forth between the total bond and a tax-exempt bond depending on the yields, remember that selling a bond fund can result in capital gains taxes which might wipe out the small benefit you have gotten.

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Re: Tax-Exempt Bonds for Lower Tax Brackets

Post by sycamore » Wed May 27, 2020 7:04 am

VTEAX is monthly accrual.

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Re: Tax-Exempt Bonds for Lower Tax Brackets

Post by grabiner » Wed May 27, 2020 9:05 pm

retiredjg wrote:
Wed May 27, 2020 7:04 am
If you intend to switch back and forth between the total bond and a tax-exempt bond depending on the yields, remember that selling a bond fund can result in capital gains taxes which might wipe out the small benefit you have gotten.
And while this can also result in losses, your strategy is more likely to result in capital gains rather than losses. If you buy a muni fund because it has a high yield, and sell it after muni yields have declined, you will have a capital gain.

But a more serious issue is that the yield on a type of bonds will be higher when the risk has increased; by holding whichever of muni or corporate bonds is riskier, you will be taking more risk than if you stuck with either one.
Wiki David Grabiner

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Re: Tax-Exempt Bonds for Lower Tax Brackets

Post by Kintora » Wed May 27, 2020 10:33 pm

grabiner wrote:
Wed May 27, 2020 9:05 pm
retiredjg wrote:
Wed May 27, 2020 7:04 am
If you intend to switch back and forth between the total bond and a tax-exempt bond depending on the yields, remember that selling a bond fund can result in capital gains taxes which might wipe out the small benefit you have gotten.
And while this can also result in losses, your strategy is more likely to result in capital gains rather than losses. If you buy a muni fund because it has a high yield, and sell it after muni yields have declined, you will have a capital gain.

But a more serious issue is that the yield on a type of bonds will be higher when the risk has increased; by holding whichever of muni or corporate bonds is riskier, you will be taking more risk than if you stuck with either one.
Thank you for making these points. Just to clarify, it is not my intention to switch back and forth. I am hoping to buy and hold for the long term and only make a switch if there is a compelling reason to do so. As my Vanguard accounts are still relatively new, I am still tweaking my holdings a bit. Since I hold Total Bond Market (VBTLX) in my Traditional IRA and 401k, I just thought it might be nice to have a different bond fund such as tax-exempt in my taxable account. I didn't do that initially since at the time, my lower marginal tax rate seemed to favor having VBTLX for my taxable account bond fund holding. That being said, what is your opinion on staying the course with VBTLX in taxable versus switching to VWITX/VWIUX and holding that for the long term?

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Re: Tax-Exempt Bonds for Lower Tax Brackets

Post by retiredjg » Thu May 28, 2020 5:49 am

My understanding is that the taxable bond will return more than a tax-exempt bond more than half of the time for a person in the 22% tax bracket. The only reason to switch to the tax exempt bond now is to take advantage of a temporary reversal. When things go back to how they are most of the time, you would need to switch back to a taxable bond. That is why I suggested you would be switching back and forth.

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Re: Tax-Exempt Bonds for Lower Tax Brackets

Post by Triple digit golfer » Thu May 28, 2020 6:03 am

I would probably use the taxable bond for the simple fact that I don't want a lot tied up in municipal bonds. Total bond is much more diversified. But I may just be ignorant and maybe that isn't a valid reason.

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Total Bond in Taxable OR Vanguard Intermediate Muni in taxable

Post by hudson » Thu May 28, 2020 6:16 am

Kintora wrote:
Wed May 27, 2020 10:33 pm
what is your opinion on staying the course with VBTLX in taxable versus switching to VWITX/VWIUX and holding that for the long term?
Is your question total bond in taxable or Van. Intermed Muni VWITX in taxable?

If so, I may have already said, I'd do the after tax math using the distribution yield of each.
I would look at the history of distribution yield of each. I would estimate the future distribution yields.
I would compare SEC yields. I would decide which one is paying the best monthly rent...using distribution yields...after taxes.

I personally like VWITX better in taxable.
High quality muni funds like VWITX are considered (at least by me) safer than total bond.
BMBIX, Baird's intermed. very safe muni, and others are even safer but payout less per month.

I hold VWIUX...Van. Intermed muni. I wouldn't say that I hold for the long term...although I've owned it almost continually for over 10 years...and will likely stay for 10 more. I'm always looking for a better deal...either paying more, lower cost, or safer. Also, if VWIUX dropped below my purchase price, I would tax loss harvest into BMBIX. Therefore, I'm probably long term, unless there's a better deal. In other words if a five year 3.5% or higher CD became available, I might switch?

Bottom Line: VWITX/VWIUX would be where I would go depending on the after tax payout.

(Note: Make sure that you understand MikeG62 and Grabiner's thoughts on SEC Yield/Distribution Yield.)
viewtopic.php?p=5263588#p5263588

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Re: Tax-Exempt Bonds for Lower Tax Brackets

Post by Kintora » Thu May 28, 2020 9:56 am

retiredjg wrote:
Thu May 28, 2020 5:49 am
My understanding is that the taxable bond will return more than a tax-exempt bond more than half of the time for a person in the 22% tax bracket. The only reason to switch to the tax exempt bond now is to take advantage of a temporary reversal. When things go back to how they are most of the time, you would need to switch back to a taxable bond. That is why I suggested you would be switching back and forth.
Understood, and that is something I need to consider in this decision. Thanks again for your feedback.

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Re: Total Bond in Taxable OR Vanguard Intermediate Muni in taxable

Post by Kintora » Thu May 28, 2020 10:00 am

hudson wrote:
Thu May 28, 2020 6:16 am
Kintora wrote:
Wed May 27, 2020 10:33 pm
what is your opinion on staying the course with VBTLX in taxable versus switching to VWITX/VWIUX and holding that for the long term?
Is your question total bond in taxable or Van. Intermed Muni VWITX in taxable?
Yes, that is essentially where I am at now. Deciding between staying the course with VBTLX in taxable or switching to VWITX.

I will spend some time after work today looking at what you have suggested. Thanks again.

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