WSJ Article/what to do with inherited bonds in taxable

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hcs77135
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WSJ Article/what to do with inherited bonds in taxable

Post by hcs77135 »

Hi, i recently inherited about $100k of bonds in a taxable account (some corporates and some NY munis) - because of the step-up in basis the capital losses were erased. (This represents less than 2% of assets.). I was thinking about liquidating them and buying more Vanguard Total Stock (I have never bought individual bonds.). However right now I need to rebalance into bonds, not stocks, to keep my desired AA. I could sell them and buy VTI in taxable, and then sell VTI in tax-deferred and buy Vanguard intermediate ETF (BIV). However there was a very interesting article in the WSJ on 2/2/24 by Jason Zweig advocating for buying long bonds in taxable, because deep losses are now embedded in inter- and long-term bond ETFs, enabling future gains to be taxed at the capital-gains rates. The nickname of the article was “Bonds - the New Tax Haven.” (The article doesn’t mention the taxabilty of the income at ordinary rates.). I was then looking at Vanguard Long Term Treasury ETF (VGLT) - which had unrealized losses equal to about 12% of NAV as of year end, and it’s down another 4.5% so far this year. 17 year duration! I have never looked at longer than a 6-7 year duration on a bond fund/ETF. I realize there is an element of market timing and gambling, would anyone on boggleheads follow this article’s advice? If not what would you do with those mostly taxable inherited bonds, with durations between 8 months and 18 years?). Thank you!
stan1
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Re: WSJ Article/what to do with inherited bonds in taxable

Post by stan1 »

Personally I would sell what you inherited and buy what's right for your asset allocation. What are your needs: age, asset allocation, tax rate now, tax rate in retirement? Do you have bonds in IRA accounts? Other taxable investments?

It is seldom the case where I would recommend just keeping what someone inherits in a taxable account. Almost always a person should choose what's best for them, except in the coincidental case where the person who passed away just happened to own exactly what is right for their heir. It is a one time opportunity with the reset in cost basis to set up the taxable account for what is best for you.
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retired@50
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Re: WSJ Article/what to do with inherited bonds in taxable

Post by retired@50 »

I wouldn't allow a $100k inheritance to force me into a "gamble" or alter my asset allocation, or asset location.

Do what you know is right and hold your desired bond allocation in a tax-deferred account and hold a tax-efficient total stock market fund in taxable.

Regards,
If liberty means anything at all it means the right to tell people what they do not want to hear. -George Orwell
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Re: WSJ Article/what to do with inherited bonds in taxable

Post by jebmke »

Depending on the values by duration I'd at least sell the long ones. You'll take a haircut selling bonds unless they are US Treasuries or the like so if there were some that will roll off relatively soon you might consider letting them just mature. That's what I did with some munis that were held by my mother. Sold some, kept some to roll off. In a couple of years they were all gone.
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Re: WSJ Article/what to do with inherited bonds in taxable

Post by Meg77 »

Without knowing about your age and goals and current financial situation it's impossible to make a recommendation.

I would use the windfall to accomplish the following basics if you haven't already:

1. Pay off any non-mortgage debt and ensure you have sufficient insurance coverage across health, home, auto, disability and life, if applicable.
2. Have 6 - 12 months expenses in a cash reserve (the vanguard Federal money market/settlement account is paying 5.28% currently which is a higher yield than you can get on safe bonds currently and with principal protection as well).
3. Max a Roth IRA for 2023 and also for 2024 (I'd put that in the total stock market index at almost any age as Roth funds should be spent last and often aren't spent at all and instead pass to the next generation). This assumes you have earned income.
4. Max your 401k/403b if you have a job that provides one.
5. Consider paying off or paying down mortgage debt if the rate is over 5%.

It rarely makes sense to keep a mortgage and also invest in bonds. The exception is times like now where bonds may yield 4%+ whereas older mortgages may be fixed at 2-3%. But generally bonds will always return less than mortgages cost - by definition, as many bonds are literally mortgage backed securities or US treasuries which are what mortgage rates are generally established by.

If you've accomplished all the above goals however and are simply at the stage where you are investing in taxable to boost your net worth, then I recommend investing according to your asset allocation target. You clearly state that for you that means buying bonds right now, not stocks. So, bonds it is. Either keep what you've got or sell them to reallocate them to better/more diversified bonds, depending on your portfolio and the profile of the individual bonds you inherited.
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hcs77135
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Re: WSJ Article/what to do with inherited bonds in taxable

Post by hcs77135 »

Meg77 wrote: Sun Feb 11, 2024 1:56 pm I would use the windfall to accomplish the following basics if you haven't already:

1. Pay off any non-mortgage debt and ensure you have sufficient insurance coverage across health, home, auto, disability and life, if applicable.
2. Have 6 - 12 months expenses in a cash reserve (the vanguard Federal money market/settlement account is paying 5.28% currently which is a higher yield than you can get on safe bonds currently and with principal protection as well).
3. Max a Roth IRA for 2023 and also for 2024 (I'd put that in the total stock market index at almost any age as Roth funds should be spent last and often aren't spent at all and instead pass to the next generation). This assumes you have earned income.
4. Max your 401k/403b if you have a job that provides one.
5. Consider paying off or paying down mortgage debt if the rate is over 5%.

It rarely makes sense to keep a mortgage and also invest in bonds. The exception is times like now where bonds may yield 4%+ whereas older mortgages may be fixed at 2-3%. But generally bonds will always return less than mortgages cost - by definition, as many bonds are literally mortgage backed securities or US treasuries which are what mortgage rates are generally established by.

If you've accomplished all the above goals however and are simply at the stage where you are investing in taxable to boost your net worth, then I recommend investing according to your asset allocation target. You clearly state that for you that means buying bonds right now, not stocks. So, bonds it is. Either keep what you've got or sell them to reallocate them to better/more diversified bonds, depending on your portfolio and the profile of the individual bonds you inherited.
Meg77, thank you for your thoughtful response. Sorry for the lack of context. I am 60, retiring in 2-3 years and have been fortunate and met all my financial goals. Have no debt other than a 2.75% 30 year mortgage that is fully tax-deductible. The question I have really is whether, if I sell these bonds (except for 2 that pay over 7%), the WSJ article about buying long bond ETFs in taxable accounts makes sense, or whether I should buy stock etfs in taxable (while selling stock etfs to buy bond etfs in tax-deferred to meet my AA.). Thanks.
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Re: WSJ Article/what to do with inherited bonds in taxable

Post by lakpr »

hcs77135 wrote: Sun Feb 11, 2024 3:36 pm Have no debt other than a 2.75% 30 year mortgage that is fully tax-deductible.
Are you single? The only way this statement makes sense is if you are single, and even then the mortgage interest is NOT, *FULLY* deductible.

Assuming the maximum of $10k in SALT, and standard deduction of $14.6k for a single, the first $4,600 of mortgage interest is NOT deductible. Which means, only if your mortgage is more than $4,600 / 2.75% = $168k, is the interest deductible as itemized expenses.

If you are married, then the standard deduction is $29,200; and therefore only if your mortgage is more than $19,200 / 2.75% = $700k is the mortgage interest deductible. Keep also in mind that the mortgage interest is NOT deductible if the principal amount is more than $750k, so for married folks there is very tiny window of $50k where the interest is actually deductible.

Edit: this past post of your indicates that you are married, not single. Hence, see above ...
viewtopic.php?p=7649477#p7649477

Edit a second time: I can understand the reason why you would NOT want to paydown or pay off a super-low 2.75% mortgage, tax deductible or not. With $100k, have you given a thought about buying I-bonds via the gift-box technique? Between the two of you, you can buy 5-years worth of I-bonds at the same time, and they will NEVER lose value.

With the VBTLX (Total Bond fund), the average duration is 6 to 7 years, and you are also taking the risk that if there is a rate hike in the future or inflation in the future, the value of your bond holding will go down. With I-bonds, you are guaranteed, by the faith of the US government, that the value will never go down ...
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Re: WSJ Article/what to do with inherited bonds in taxable

Post by Artsdoctor »

First step: take a look at what you have. You mentioned that there were losses on the bonds but you didn't mention if they're now discount bonds (versus premium bonds but at a lower price). Forget about the coupon for now, you need to figure out the Yield to Maturity (or Yield to Call) in order to make decent decisions.

You'll need to figure out the tax ramifications of what you have. For example, if your NY muni bonds are now discount bonds, you'll pay income tax on that discount when they mature (that discount is fully taxable--it's not tax-exempt).

You'll also need to know that selling corporates and munis on the secondary market may be expensive (meaning, the bid-ask spread might be large--you may pay dearly for the "privilege" of selling your bonds).

Second step: you'll need to come up with an alternative to buy into that fits your needs. Jason Zweig brought up some good points, as usual. But I wouldn't buy a bunch of long-term bond funds or ETFs especially if you're in your 60s. If you'd like to buy a diversified bond fund (or ETF), I'd recommend that you consider intermediate-term (or shorter) instruments.
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Re: WSJ Article/what to do with inherited bonds in taxable

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hcs77135 wrote: Sun Feb 11, 2024 3:36 pm
Meg77, thank you for your thoughtful response. Sorry for the lack of context. I am 60, retiring in 2-3 years and have been fortunate and met all my financial goals. Have no debt other than a 2.75% 30 year mortgage that is fully tax-deductible. The question I have really is whether, if I sell these bonds (except for 2 that pay over 7%), the WSJ article about buying long bond ETFs in taxable accounts makes sense, or whether I should buy stock etfs in taxable (while selling stock etfs to buy bond etfs in tax-deferred to meet my AA.). Thanks.
Ah, I see what you mean. I just read the article, and in your case the advice doesn't seem to apply. For one thing, your inherited bonds unfortunately lost their unrealized losses when they passed to you. Bummer! Investors holding onto bonds that were bought 1+ years ago can and should take advantage of tax loss harvesting opportunities.

The article also discusses holding individual bonds versus bond funds or ETFs in taxable and highlights the fact that currently there is some upside to be had if buying bond funds with embedded losses. But the assumption is that you will be holding bonds in taxable no matter what. Which doesn't sound like it's the case for you since you have the option to own them in tax deferred or taxable accounts.

It seems evident to me that it's much better to hold bonds in tax-deferred/tax-free accounts if possible as opposed to in taxable. Especially newer bonds with yields topping 5%. Stocks are generally much more tax efficient to hold in taxable accounts since they throw off less taxable income than bond funds and their gains are taxed at long term capital gains rates.

Besides, you're likely to have more tax loss harvesting possibilities on new investments in taxable right now which is a separate argument to hold stocks in taxable.

But thanks for bringing my attention to this article! Very interesting.
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hcs77135
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Re: WSJ Article/what to do with inherited bonds in taxable

Post by hcs77135 »

Meg77 wrote: Mon Feb 12, 2024 6:35 pm
hcs77135 wrote: Sun Feb 11, 2024 3:36 pm
Ah, I see what you mean. I just read the article, and in your case the advice doesn't seem to apply. For one thing, your inherited bonds unfortunately lost their unrealized losses when they passed to you. Bummer! Investors holding onto bonds that were bought 1+ years ago can and should take advantage of tax loss harvesting opportunities.

The article also discusses holding individual bonds versus bond funds or ETFs in taxable and highlights the fact that currently there is some upside to be had if buying bond funds with embedded losses. But the assumption is that you will be holding bonds in taxable no matter what. Which doesn't sound like it's the case for you since you have the option to own them in tax deferred or taxable accounts.

It seems evident to me that it's much better to hold bonds in tax-deferred/tax-free accounts if possible as opposed to in taxable. Especially newer bonds with yields topping 5%. Stocks are generally much more tax efficient to hold in taxable accounts since they throw off less taxable income than bond funds and their gains are taxed at long term capital gains rates.

Besides, you're likely to have more tax loss harvesting possibilities on new investments in taxable right now which is a separate argument to hold stocks in taxable.

But thanks for bringing my attention to this article! Very interesting.
Thanks so much for the follow up and good advice. I don't need the income right now from these bonds and I'm paying about 38% on the interest. Two questions: 1. Were you recommending individual bonds for tax-deferred, as opposed to bond ETFs? (2) There are a number of New York munis as well in the account, and a few of them pay as much as 4-5% triple tax free (although if they appreciate the cap gains are taxable), would you keep those? Thanks again.
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Re: WSJ Article/what to do with inherited bonds in taxable

Post by hcs77135 »

Artsdoctor wrote: Sun Feb 11, 2024 5:14 pm First step: take a look at what you have. You mentioned that there were losses on the bonds but you didn't mention if they're now discount bonds (versus premium bonds but at a lower price). Forget about the coupon for now, you need to figure out the Yield to Maturity (or Yield to Call) in order to make decent decisions.

You'll need to figure out the tax ramifications of what you have. For example, if your NY muni bonds are now discount bonds, you'll pay income tax on that discount when they mature (that discount is fully taxable--it's not tax-exempt).

You'll also need to know that selling corporates and munis on the secondary market may be expensive (meaning, the bid-ask spread might be large--you may pay dearly for the "privilege" of selling your bonds).

Second step: you'll need to come up with an alternative to buy into that fits your needs. Jason Zweig brought up some good points, as usual. But I wouldn't buy a bunch of long-term bond funds or ETFs especially if you're in your 60s. If you'd like to buy a diversified bond fund (or ETF), I'd recommend that you consider intermediate-term (or shorter) instruments.
Thank you very much. I'll try to answer your questions -- I really know nothing about individual bonds.

1. There were losses on the bonds, but when my mother died last May I received a "step-down" basis and the losses essentially have evaporated. Just about every bond has a very small loss or very small gain.

2. I don't know how to tell whether a bond is a discount bond or a premium bond at a lower price. Most of them are trading close to par now, and have a very small gain or loss because of the adjusted basis. There is one long Goldman bond (matures 2034) that is trading at about $91 and pays 4.25%. It's the only one with more than a nominal loss.

3. All I have in taxable is Vanguard Total Stock Market VTI) and then cash in Treasury MM. I have BIV -- Vanguard Intermediate Bond Fund, in all the tax-deferred. I was thinking my choices would be either to (1) keep these individual bonds until they mature - or at least the ones that mature in the next couple of years, just to avoid the costs of selling, (2) sell them and buy an intermediate tax-exempt bond etf in taxable, or (3) sell them and buy VTI in taxable and then sell an equivalent amount of VTI in tax-deferred and buy BIV, to maintain my AA. It doesn't seem to make sense for me to hold a bond ETF in taxable.
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Re: WSJ Article/what to do with inherited bonds in taxable

Post by Artsdoctor »

^ It's hard to advise you specifically because what one person might find reasonable, another might not. Some thoughts.

Corporates and munis won't be "cheap" to sell because they may not be all that commonly traded and the pricing won't be transparent. So I agree with you that if you only have a couple of years left, I'd be tempted to keep them.

If you have more than a couple of years left on them, I'd probably sell them (for example, your corporate bond maturing in 10 years). Alternatively, if the bonds make up a very small portion of your portfolio, you might choose to be flexible. If you'll be considering keeping them, make sure you check the credit of the issuer (for example, if you have general obligation NY bonds, the likelihood of default would be very small).

A premium bond trades above par so if the price was above 100 on the Date of Death, it's a premium bond. You can google "amortizing a premium bond" to find out how you treat the coupon from a tax point of view.

A discount bond trades below par so the price on the Date of Death may decide how you'll be taxed when the bond matures. For munis, you'll pay regular income tax on the discount, usually when the bond matures (the discount won't be tax-free). There are exceptions for discount bonds when the cost basis is tiny ("de minimis").
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hcs77135
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Re: WSJ Article/what to do with inherited bonds in taxable

Post by hcs77135 »

lakpr wrote: Sun Feb 11, 2024 4:04 pm
hcs77135 wrote: Sun Feb 11, 2024 3:36 pm Have no debt other than a 2.75% 30 year mortgage that is fully tax-deductible.
If you are married, then the standard deduction is $29,200; and therefore only if your mortgage is more than $19,200 / 2.75% = $700k is the mortgage interest deductible. Keep also in mind that the mortgage interest is NOT deductible if the principal amount is more than $750k, so for married folks there is very tiny window of $50k where the interest is actually deductible.

I can understand the reason why you would NOT want to paydown or pay off a super-low 2.75% mortgage, tax deductible or not.
Hi, thank you!, you make a great point. We have SALT of $10,000 (the limit on which could be repealed at end of 2025); charitable contributions of between $5-10,000; and mortgage interest of about $15,000. So you're right, for federal purposes none, or very little of it, has been deductible in the last few years since the SALT cap. For NYS/NYC purposes, I believe it's all deductible, at a little more than 10% tax rate. So I'm guessing that the mortgage really costs around 2.5%. Right now, we're earning a lot more than that on cash (Federal money market 5.3% taxed at 27.8% federal, or about 3.8% post-tax) and total return is much higher on other invested assets that would need to be liquidated to pay it off (mortgage is about $540,000 and the original principal amount was well under $750k). I thought I would wait to see what rates/returns are, and what the status of SALT is, at end of 2025, to see whether it would make sense to pay it off in whole or in part. But I'm not in any rush. I would imagine there is some age at which I would not want a mortgage, but 60 is the new 40 (!) and I'm not feeling that yet.
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