Is BND the best bond ETF for tax free accounts

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rm
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Is BND the best bond ETF for tax free accounts

Post by rm »

Hi all,

BND also holds treasuries and maybe other tax exempt bonds. If I was to hold a bond fund in tax free, what is the recommendation.

Likewise for taxable account, what is the recommendation for bond ETF. I am in the 50% tax bracket (highest fed and highest state - CA). I couldn't find a great muni bond etf or mutual fund.

I have vanguard and fidelity.

Thank you!
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whodidntante
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Re: Is BND the best bond ETF for tax free accounts

Post by whodidntante »

I wouldn't put a bond ETF in a tax-free account, by which I assume you mean a Roth account. I would put the investments with the highest expected returns there.

There is no "best bond ETF" in my opinion. Many of the offerings are good if they fit your situation. Is the duration of BND suitable for you? Are you concerned about inflation protection?

Treasury bonds are exempt from California income taxes. You can also look at California muni bonds to see which you think would be better for your situation.
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retired@50
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Re: Is BND the best bond ETF for tax free accounts

Post by retired@50 »

rm wrote: Sun Jan 22, 2023 5:20 pm Hi all,

BND also holds treasuries and maybe other tax exempt bonds. If I was to hold a bond fund in tax free, what is the recommendation.

Likewise for taxable account, what is the recommendation for bond ETF. I am in the 50% tax bracket (highest fed and highest state - CA). I couldn't find a great muni bond etf or mutual fund.

I have vanguard and fidelity.

Thank you!
For CA residents, consider VCADX or VCLAX at Vanguard, which are suitable in taxable accounts.

If it has to be an ETF, then as far as I know, Vanguard doesn't offer state-specific ETFs, but does have a nationally focused ETF called VTEB.

Regards,
This is one person's opinion. Nothing more.
KlangFool
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Re: Is BND the best bond ETF for tax free accounts

Post by KlangFool »

OP,

What is a tax-free account?

We have Roth 401K and Roth IRA. Then, tax-deferred accounts like Trad 401K and Trad IRA. So, what do you actually mean by tax-free account?

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grabiner
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Re: Is BND the best bond ETF for tax free accounts

Post by grabiner »

If you are in the highest federal and CA tax bracket, then you pay higher taxes on stock dividends and long-term gains than any other investor (23.8% federal and 12.3% CA is a total rate of 36.1%), but no more taxes on CA municipal bonds than anyone else. Thus CA municipal bonds are especially attractive to you, and I would recommend holding CA munis in your taxable account and stocks in an IRA/401(K) in preference to holding taxable bonds in an IRA/401(k) and stocks in a taxable account.

There is no low-cost CA muni ETF, but you can use Vanguard's CA Intermediate-Term and Long-Term Tax-Exempt mutual funds at 0.09% expenses for the Admiral shares.

Normally, I recommend Total Bond Market Index (mutual fund or ETF) in an IRA/401(k) as a bond holding; this is the best-diversified, lowest-cost bond fund. But your situation is special because of your tax situation.
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Phaedrus
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Re: Is BND the best bond ETF for tax free accounts

Post by Phaedrus »

grabiner wrote: Sun Jan 22, 2023 8:04 pm There is no low-cost CA muni ETF, but you can use Vanguard's CA Intermediate-Term and Long-Term Tax-Exempt mutual funds at 0.09% expenses for the Admiral shares.
I have seen you recommend before using a 50/50 split between Vanguard Limited-Term Tax-Exempt and Vanguard CA Long-Term Tax-Exempt (so that it puts only half of bonds in CA, but more than half of bond interest exempt from CA tax). Do you recommend any of the equivalent Fidelity funds, or are there any low-cost national limited-term muni ETFs that could be used for the first half?
grabiner wrote: Sun Jan 22, 2023 8:04 pm Normally, I recommend Total Bond Market Index (mutual fund or ETF) in an IRA/401(k) as a bond holding; this is the best-diversified, lowest-cost bond fund. But your situation is special because of your tax situation.
Interesting. I have heard people recommend using traditional 401ks/IRA for bond allocations in part in order to slow the growth of the tax-deferred space and minimize RMDs. For a high tax bracket earner, do you think this makes sense or not? As context, I'm also in a near!y 50% marginal Fed/CA bracket, with 10% of my portfolio in Roth (all stock), 2.5% in traditional pre-tax (thinking of allocating all to Total Bond), and using munis in my taxable account to fill out the rest of my bond allocation. Your comment is making me wonder if that makes sense, or if I should just be using the 2.5% pre-tax for stocks as well and using munis in taxable for 100% of my bonds. Appreciate any thoughts you may have or guidelines about how to think about this tradeoff.

By the way, your posts have been immensely helpful to me as I learn about how to handle my bond allocation. Many thanks for all of your time and efforts in posting here and answering people's questions.
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Re: Is BND the best bond ETF for tax free accounts

Post by livesoft »

KlangFool wrote: Sun Jan 22, 2023 5:39 pm What is a tax-free account?
Maybe their income is so low, they pay no income taxes, so even a taxable account would be tax-free, right?
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grabiner
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Re: Is BND the best bond ETF for tax free accounts

Post by grabiner »

Phaedrus wrote: Tue Jan 24, 2023 6:42 pm
grabiner wrote: Sun Jan 22, 2023 8:04 pm There is no low-cost CA muni ETF, but you can use Vanguard's CA Intermediate-Term and Long-Term Tax-Exempt mutual funds at 0.09% expenses for the Admiral shares.
I have seen you recommend before using a 50/50 split between Vanguard Limited-Term Tax-Exempt and Vanguard CA Long-Term Tax-Exempt (so that it puts only half of bonds in CA, but more than half of bond interest exempt from CA tax). Do you recommend any of the equivalent Fidelity funds, or are there any low-cost national limited-term muni ETFs that could be used for the first half?
Fidelity's muni funds are more expensive than Vanguard's. You can use iShares' SUB for short-term munis in a non-Vanguard account, but for CA munis, you either have to hold individual bonds or use the Vanguard fund.
grabiner wrote: Sun Jan 22, 2023 8:04 pm Normally, I recommend Total Bond Market Index (mutual fund or ETF) in an IRA/401(k) as a bond holding; this is the best-diversified, lowest-cost bond fund. But your situation is special because of your tax situation.
Interesting. I have heard people recommend using traditional 401ks/IRA for bond allocations in part in order to slow the growth of the tax-deferred space and minimize RMDs. For a high tax bracket earner, do you think this makes sense or not? As context, I'm also in a near!y 50% marginal Fed/CA bracket, with 10% of my portfolio in Roth (all stock), 2.5% in traditional pre-tax (thinking of allocating all to Total Bond), and using munis in my taxable account to fill out the rest of my bond allocation. Your comment is making me wonder if that makes sense, or if I should just be using the 2.5% pre-tax for stocks as well and using munis in taxable for 100% of my bonds. Appreciate any thoughts you may have or guidelines about how to think about this tradeoff.
I would recommend munis in your situation, despite the RMD issue. You can compare the tax cost of holding bonds in an IRA until the RMD, and stocks in taxable, versus stocks in an IRA until the RMD, and bonds in taxable. Once you have taken the RMD, you will have both bonds and stocks in taxable either way, so the RMD effectively shortens the time horizon slightly if it is money you would not otherwise spend. But given your very high tax rate on stock dividends, the total tax cost of holding stocks in the taxable account for the whole time is likely higher.
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Re: Is BND the best bond ETF for tax free accounts

Post by Phaedrus »

grabiner wrote: Tue Jan 24, 2023 9:07 pm I would recommend munis in your situation, despite the RMD issue. You can compare the tax cost of holding bonds in an IRA until the RMD, and stocks in taxable, versus stocks in an IRA until the RMD, and bonds in taxable. Once you have taken the RMD, you will have both bonds and stocks in taxable either way, so the RMD effectively shortens the time horizon slightly if it is money you would not otherwise spend. But given your very high tax rate on stock dividends, the total tax cost of holding stocks in the taxable account for the whole time is likely higher.
VTI's dividend yield is ~1.6%, and I believe I pay 33% on that (20% Fed + 3.8% NIIT + 9.3% CA), or about 0.5% in tax per year.

Vanguard Total Bond's SEC Yield is 4.02% vs. Vanguard California Long-Term Tax-Exempt's SEC yield is 3.32%, or nearly 0.7% higher.

So if I have some space in my tIRA, it seems like filling it with bonds lets me get an extra 0.2% of yield (0.7% more on the bonds, less the 0.5% extra tax cost for keeping VTI in a taxable account).

Does that make sense, or am I thinking about this the wrong way?
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William Million
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Re: Is BND the best bond ETF for tax free accounts

Post by William Million »

Always stocks 1st in accounts with no taxes on the way out (Roth) due to the higher long-term returns, and fixed income in acounts that tax at much higher regular rates when withdrawiing (trad IRA/401k) due to lower long-term returns.
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Re: Is BND the best bond ETF for tax free accounts

Post by NiceUnparticularMan »

I am a big believer in not letting the tax tail wag the asset allocation dog.

I also think when you really go through all the long-term implications and focus on risks around post-tax returns and not just minimizing short-term taxes, it turns out a lot of the conventional advice on tax efficient allocation of assets to various types of accounts is way less well-evidenced than some people suggest.

OK, so the first question I think you need to ask is what purpose are these bonds serving for you. This will tell you what general type of bond to use, and maybe in which account to hold them. And then you might tweak exactly which bonds depending on tax considerations, but to me that is the last step, not the first.

So, for example, I have determined that since we are looking at a possible early retirement we would plan to fund disproportionately from a taxable account, including possibly funding ACA health plans and some Roth conversions and ultimately deferring Social Security, such that we should really be building up a portfolio of IP bonds in that taxable account. The only realistic IP bonds for us are TIPS, but fortunately TIPS do have a little tax break (since we pay a flat state tax in our state). Muni bonds are not a substitute because they are not IP bonds.

We also use a stable value fund and a cash balance pension in 401Ks, and eventually we plan to use the TSP G Fund too.

Personally, I see no purpose for us holding the bonds in BND anywhere.
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