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Reasons to Hold Bonds in Taxable Account?

Posted: Tue Jan 12, 2021 3:15 pm
by rapido
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Would there any reason I should hold bonds in my taxable (non-qualified) account?

I planned to hold Vanguard Total Stock Market USA (VTSAX) in my taxable (non-qualified) account. I've been reading about the possibility of having bonds in a taxable account. I'm now confused. (A few good reference posts are linked below.)

We'll need funds for retirement in about 15 years. We are in our early 50s.
- Married Filing Jointly. 24% Federal, 6.8% State
- We plan to be in a lower federal and state bracket in retirement.

Just over a million dollars in investments.
- 25% in a beneficiary IRA that we have 9 years left to distribute.
- 60% in taxable (non-qualified)
- 15% in pre-tax (qualified)

Future yearly contributions:
-$50,000-$70,000 in pre-tax (qualified). We try to max out our qualified accounts each year. 401K and Backdoor Roth
-$25,000 taxable (non-qualified) From the beneficiary IRA distribution, spread out equally over 9 years.

Asset Allocation:
53% Vanguard Total Stock Market USA (VTSAX)
17% International: Vanguard Developed Markets International (VTMGX) & Vanguard Emerging Markets International (VEMAX)
30% Vanguard Total Bond USA (VBTLX)



Posts about Bonds in Taxable Accounts:
The Tax-efficient fund placement talks about bond in taxable.
https://www.bogleheads.org/wiki/Tax-eff ... _placement

Asset allocation in multiple accounts also discusses bonds in taxable.
https://www.bogleheads.org/wiki/Asset_a ... e_accounts

This post also raises some good points about bonds in taxable.
viewtopic.php?f=10&t=97509

Re: Reasons to Hold Bonds in Taxable Account?

Posted: Tue Jan 12, 2021 4:20 pm
by sycamore
The main reason to have bonds in taxable is your AA says to hold so much in bonds but tax-advantaged account isn't big enough for that.

Some back of the envelope math...

Your desired AA is 70/30 stocks/bonds. Your accounts are currently split 60% taxable / 40% tax-advantaged.
So initially you can fit all your bonds in tax-advantaged.

You plan to decrease tax-advantaged space at the rate of 25%/9 years = ~3% year (withdraw from inherited IRA)
You plan to increase tax-advantaged space by $50K/year, which appears to be ~6%/year (confirm this)

Your tax-advantaged space will be growing with net ~3% contributions/year, so it should remain big enough to hold all your bonds.

The wildcard is how fast your taxable account grows relative to tax-advantaged... if stocks in taxable greatly outperforms bonds, your taxable account will be more than 70% of your portfolio, which means your tax-advantaged won't be big enough to hold the 30% you want in bonds.

If that happens, consider it a good problem to have :) Buying some bonds in taxable really isn't as bad as it might sound, just slightly tax-inefficient...you would just buy a basic low-cost taxable bond fund (like VBTLX) or a low-cost muni bond fund (like Vanguard Tax-Exempt Bond Index) if your tax bracket is 28% or more.

Re: Reasons to Hold Bonds in Taxable Account?

Posted: Tue Jan 12, 2021 4:25 pm
by retired@50
Depending on which state you live in, Vanguard may have a state-specific municipal bond fund that could be of interest.

See link: https://investor.vanguard.com/mutual-fu ... nd-returns

Regards,

Re: Reasons to Hold Bonds in Taxable Account?

Posted: Wed Jan 13, 2021 8:40 am
by rapido
sycamore wrote: Tue Jan 12, 2021 4:20 pm The main reason to have bonds in taxable is your AA says to hold so much in bonds but tax-advantaged account isn't big enough for that.

Some back of the envelope math...

Your desired AA is 70/30 stocks/bonds. Your accounts are currently split 60% taxable / 40% tax-advantaged.
So initially you can fit all your bonds in tax-advantaged.

You plan to decrease tax-advantaged space at the rate of 25%/9 years = ~3% year (withdraw from inherited IRA)
You plan to increase tax-advantaged space by $50K/year, which appears to be ~6%/year (confirm this)

Your tax-advantaged space will be growing with net ~3% contributions/year, so it should remain big enough to hold all your bonds.

The wildcard is how fast your taxable account grows relative to tax-advantaged... if stocks in taxable greatly outperforms bonds, your taxable account will be more than 70% of your portfolio, which means your tax-advantaged won't be big enough to hold the 30% you want in bonds.

If that happens, consider it a good problem to have :) Buying some bonds in taxable really isn't as bad as it might sound, just slightly tax-inefficient...you would just buy a basic low-cost taxable bond fund (like VBTLX) or a low-cost muni bond fund (like Vanguard Tax-Exempt Bond Index) if your tax bracket is 28% or more.
Thank you for your insights. It is always a good thing to have "good problems!"

Re: Reasons to Hold Bonds in Taxable Account?

Posted: Wed Jan 13, 2021 9:55 am
by aristotelian
There are more reasons not to, in my opinion. The primary being that capital gains and qualified dividends enjoy favorable taxation in taxable accounts while they are taxed as income in Traditional accounts. In any bracket, income tax is higher than capital gains tax.

It may make sense to have a small amount in taxable for liquidity purposes, similar to an emergency fund but with a little higher return. Also I Bonds and EE Bonds have favorable characteristics and can only be bought direct from Treasury, not in retirement accounts.

Certainly if you run out of space in your pretax accounts, taxable may be the next best alternative.

Re: Reasons to Hold Bonds in Taxable Account?

Posted: Wed Jan 13, 2021 9:58 am
by rapido
aristotelian wrote: Wed Jan 13, 2021 9:55 am It may make sense to have a small amount in taxable for liquidity purposes, similar to an emergency fund but with a little higher return.
That is a good point that I overlooked. Thanks.

Re: Reasons to Hold Bonds in Taxable Account?

Posted: Wed Jan 13, 2021 10:09 am
by livesoft
rapido wrote: Wed Jan 13, 2021 9:58 am
aristotelian wrote: Wed Jan 13, 2021 9:55 am It may make sense to have a small amount in taxable for liquidity purposes, similar to an emergency fund but with a little higher return.
That is a good point that I overlooked. Thanks.
A stock fund such as VTSAX has exactly the same liquidity as a bond fund like VBTLX in a taxable account. So liquidity purposes is not a valid reason.

Re: Reasons to Hold Bonds in Taxable Account?

Posted: Wed Jan 13, 2021 10:27 am
by jrbdmb
livesoft wrote: Wed Jan 13, 2021 10:09 am
rapido wrote: Wed Jan 13, 2021 9:58 am
aristotelian wrote: Wed Jan 13, 2021 9:55 am It may make sense to have a small amount in taxable for liquidity purposes, similar to an emergency fund but with a little higher return.
That is a good point that I overlooked. Thanks.
A stock fund such as VTSAX has exactly the same liquidity as a bond fund like VBTLX in a taxable account. So liquidity purposes is not a valid reason.
"Liquidity" is not the correct term, but perhaps "volatility" is. I have a taxable account that is partly an emergency fund, partly a savings account for potential future expenses (car, vacation, etc.). It doesn't make sense to me to have this money sitting in a bank earning 0.1%, but at the same time I don't want it 100% in stocks just to see the account take a 50% haircut right before I decide to make a withdrawal. So I invest with a conservative AA that includes stocks and bonds - similar to Vanguard's Lifestrategy Conservative Growth Fund.

Re: Reasons to Hold Bonds in Taxable Account?

Posted: Wed Jan 13, 2021 10:31 am
by rapido
OP here. Thanks. Every comment I'm gaining new knowledge and insights.