US Treasuries vs Munis in taxable

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Jefferson
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US Treasuries vs Munis in taxable

Post by Jefferson » Tue Jul 10, 2018 10:04 pm

I'm asking solely about US bond funds in a taxable account. I am in the highest federal tax bracket, with a 6% state tax rate.

Short version - Why not VGIT over VTEB in taxable? (Intermediate US Treasuries vs Intermediate Tax Exempt)

Long version - I've seen many threads that suggest an Intermediate Term Tax-Exempt bond fund in taxable accounts. For a Vanguard ETF, I believe this would be VTEB (please correct me if I am wrong). As I understand it, the goal there is to reduce taxes, which is surely a good thing. But should taxes be the only consideration here? What about the added risk (however slight) of municipal bonds vs US Treasuries? I would think that, between the two, munis carry a higher risk of default than US Treasuries. My question is whether that difference in risk is enough to outweigh the tax advantage.

Bonus question - Why not BND in taxable? How does the return of Total Bond Market weigh against the lower taxes of VTEB or VGIT?

radiowave
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Re: US Treasuries vs Munis in taxable

Post by radiowave » Tue Jul 10, 2018 10:18 pm

Jefferson, welcome to the forum. Here's a link to the Bogleheads Wiki that discusses tax efficient placement: https://www.bogleheads.org/wiki/Tax-ef ... placement . This would be the best place to start and if you have additional questions, please feel free to ask.
Bogleheads Wiki: https://www.bogleheads.org/wiki/Main_Page

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Re: US Treasuries vs Munis in taxable

Post by mcraepat9 » Tue Jul 10, 2018 10:27 pm

Jefferson wrote:
Tue Jul 10, 2018 10:04 pm
I'm asking solely about US bond funds in a taxable account. I am in the highest federal tax bracket, with a 6% state tax rate.

Short version - Why not VGIT over VTEB in taxable? (Intermediate US Treasuries vs Intermediate Tax Exempt)

Long version - I've seen many threads that suggest an Intermediate Term Tax-Exempt bond fund in taxable accounts. For a Vanguard ETF, I believe this would be VTEB (please correct me if I am wrong) If you are only using Vanguard ETFs, then yes. There are other muni options at Vanguard (VWIUX) and outside (MUB, BMBIX). As I understand it, the goal there is to reduce taxes, which is surely a good thing. But should taxes be the only consideration here? What about the added risk (however slight) of municipal bonds vs US Treasuries? I would think that, between the two, munis carry a higher risk of default than US Treasuries. My question is whether that difference in risk is enough to outweigh the tax advantage. I agree with you 100% - Treasuries are riskless, munis are not. That's why I use the Baird muni fund (BMBIX) as opposed to the other muni options at Vanguard - I found it to be the muni fund that has the safest, highest rated muni bonds - safer than Vanguard and MUB. I do think, however, that saving 30% taxes on bond interest is worthwhile. I think that if you stick with the safest munis you can find, and not try to reach for yield (i.e. introduce risk into your "safe" assets), i think munis can be make sense. I would note that, for the most part, people are not comparing munis vs. Treasuries in taxable. They are comparing munis in taxable accounts vs. Treasuries in tax-advantaged accounts due to the tax treatment of Treasuries. Avoiding state income tax alone usually isn't enough of a sweetener.

Bonus question - Why not BND in taxable? I would not hold BND anywhere - I hold only Treasuries/savings bonds and muni bonds. But assuming you determined that you wanted to hold BND, it of course should not be held in taxable - you are paying full freight on taxes on BND's interest payments (your highest marginal state and local tax rate). Hard to imagine that making sense.How does the return of Total Bond Market weigh against the lower taxes of VTEB or VGIT? Have not compared (and won't compare). Corporate bonds do not make any sense to me (see http://www.etf.com/sections/index-inves ... nopaging=1). I think if you are holding fixed income in taxable accounts, it is likely that munis make the most sense if you're in the top tax bracket. Like you, I agree there is added risk in munis vs. Treasuries. Thus, I am laser focused on making sure I have the safest munis I can find - hence my use of BMBIX.
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patrick013
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Re: US Treasuries vs Munis in taxable

Post by patrick013 » Tue Jul 10, 2018 10:36 pm

Jefferson wrote:
Tue Jul 10, 2018 10:04 pm
My question is whether that difference in risk is enough to outweigh the tax advantage.
If there is a return advantage after tax the added risk is mitigated
by broad diversification. Most of those muni funds own thousands
and thousands of bonds. So being investment grade the risk of
default there is smallish also but not nonexistent. Some AA for
muni's would lessen taxes I think. The VG muni money market fund
is very safe. All mig-1 investments. That would diversify into muni's
at the highest short term rating.
age in bonds, buy-and-hold, 10 year business cycle

printer
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Re: US Treasuries vs Munis in taxable

Post by printer » Wed Jul 11, 2018 12:36 pm

You could ask a different question: why not both in taxable?

Jefferson
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Re: US Treasuries vs Munis in taxable

Post by Jefferson » Wed Jul 11, 2018 10:25 pm

printer wrote:
Wed Jul 11, 2018 12:36 pm
You could ask a different question: why not both in taxable?
That's actually what I was thinking. How would this look for my bond allocation in taxable?

50% - VGIT
50% - VTEB

afan
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Re: US Treasuries vs Munis in taxable

Post by afan » Thu Jul 12, 2018 7:14 am

According to Portfolio Visualizer
April 2001-present
VWIUX had higher return and higher Sharpe ratio than BMBIX.
VWIUX had a very slightly higher standard deviation, by 0.07%. Negligible.

BMBIX had a worst year drawdown of -1.19%, slightly better than VWIUX worst year of -1.48%.

This period included the great recession.
To whatever extent the difference in average credit rating between the two funds reflects an actual difference in credit quality, it does not seem to have mattered. There has long been a practice of using stricter criteria for rating Muni than corporate debt. For bonds with the same rating corporates have higher default rates than munis. In other words, many munis that have less than AAA ratigns would be AAA based on default risk if they were corporate. So the difference between a Muni fund with an average rating of AA and one that is AAA may not reveal any difference in risk.

Over these turbulent times the Baird fund has not shown itself to be safer than VWIUX, so I don't consider it worth paying any extra for it.

The credit risk of a high quality Muni fund is way too small to worry about. Before I get down to caring about this level of difference, if any differential risk exists, then I should be zero percent in stocks, which dwarf munis in risk.
We don't know how to beat the market on a risk-adjusted basis, and we don't know anyone that does know either | --Swedroe | We assume that markets are efficient, that prices are right | --Fama

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watchnerd
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Re: US Treasuries vs Munis in taxable

Post by watchnerd » Sat Sep 01, 2018 12:52 pm

Jefferson wrote:
Wed Jul 11, 2018 10:25 pm
printer wrote:
Wed Jul 11, 2018 12:36 pm
You could ask a different question: why not both in taxable?
That's actually what I was thinking. How would this look for my bond allocation in taxable?

50% - VGIT
50% - VTEB
I hold both of these (well, I just switched from VTEB to VWIUX) in taxable for the reasons stated in this thread -- Treasuries are risk-free, munis aren't.

I view it as an insurance policy to offset my equities. I don't hold treasuries/munis in a 50/50 ratio, as you stated, instead holding enough treasuries to equal my taxable equities holdings, with the rest in munis.
Tax Sheltered: 35% US Stock | 35% ex-US Stock | 30% TTM || Taxable: 35% US Stock | 35% ex-US Stock | 15% TTM | 15% Munis

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grabiner
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Re: US Treasuries vs Munis in taxable

Post by grabiner » Sat Sep 01, 2018 2:55 pm

Jefferson wrote:
Tue Jul 10, 2018 10:04 pm
I'm asking solely about US bond funds in a taxable account. I am in the highest federal tax bracket, with a 6% state tax rate.

Short version - Why not VGIT over VTEB in taxable? (Intermediate US Treasuries vs Intermediate Tax Exempt)

Long version - I've seen many threads that suggest an Intermediate Term Tax-Exempt bond fund in taxable accounts. For a Vanguard ETF, I believe this would be VTEB (please correct me if I am wrong). As I understand it, the goal there is to reduce taxes, which is surely a good thing. But should taxes be the only consideration here? What about the added risk (however slight) of municipal bonds vs US Treasuries? I would think that, between the two, munis carry a higher risk of default than US Treasuries. My question is whether that difference in risk is enough to outweigh the tax advantage.

Bonus question - Why not BND in taxable? How does the return of Total Bond Market weigh against the lower taxes of VTEB or VGIT?
You have to look at the trade-off between risk and return. For different types of bonds, return depends on your own tax situation.

I don't know the actual break-even between risk and return for munis versus taxable bonds, but I usually use 25% as an estimate. That is, a muni with a 3% yield has the same risk as a taxable bond with a 4% yield. (They may have different types of risk; a long-term Treasury bond has more inflation risk, a long-term municipal bond has more call risk, and a BBB-rated corporate bond has more default risk.)

Given that estimate, if you hold bonds in taxable, you should hold munis if the tax rate you would pay on taxable bonds is over 25%. In the highest tax rate with a 6% state tax, you pay 40.8% tax on Treasuries (37% plus 3.8% ACA surtax), 46.8% on corporate bonds, 6% on out-of-state munis, and 0% on in-state munis. Therefore, if you hold bonds in your taxable accounts, they should be munis; consider in-state munis if there is a low-cost fund for your state. If you want to hold Treasuries, hold them in an IRA.

For an investor in the 22% or 24% brackets, it is much closer. Most investors in those brackets would be better off holding all their bonds in tax-deferred accounts, but if that is not possible (limited room, or a 401(k) with a low-cost stock fund and high-cost bond funds), holding Total Bond Market in taxable is reasonable. I would only recommend a muni fund in those brackets if there is a low-cost in-state fund.
Wiki David Grabiner

JimmyJammy
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Re: US Treasuries vs Munis in taxable

Post by JimmyJammy » Sun Sep 02, 2018 11:19 pm

For an investor in the 22% or 24% brackets, it is much closer. Most investors in those brackets would be better off holding all their bonds in tax-deferred accounts, but if that is not possible (limited room, or a 401(k) with a low-cost stock fund and high-cost bond funds), holding Total Bond Market in taxable is reasonable. I would only recommend a muni fund in those brackets if there is a low-cost in-state fund.
For 2018, I'll be in the 24% tax bracket filing married jointly. Most of my bonds are in taxable - in VWIUX (National Intermediate Munis) and VNYTX (Long Term New York).

I've had these for about 7 years now and VWIUX is about 2.5% in the red (though it's performed better than BND at least) and VNYTX is 1% up.

I do have room to change asset allocations in my tax-deferred accounts. Do you think I should dump VWIUX and maybe buy some Treasuries in my tax-deferred? (side note: I'm not sure how I buy Treasuries in Tax Deferred - aren't they through TreasuryDirect.gov?)

Theoretical
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Re: US Treasuries vs Munis in taxable

Post by Theoretical » Mon Sep 03, 2018 9:46 am

Buy the treasuries at Fidelity, Schwab or Vanguard at auction. There’s no fee period and it’s very convenient.

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Re: US Treasuries vs Munis in taxable

Post by Call_Me_Op » Mon Sep 03, 2018 9:59 am

printer wrote:
Wed Jul 11, 2018 12:36 pm
You could ask a different question: why not both in taxable?
+1
Best regards, -Op | | "In the middle of difficulty lies opportunity." Einstein

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grabiner
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Re: US Treasuries vs Munis in taxable

Post by grabiner » Mon Sep 03, 2018 10:34 am

JimmyJammy wrote:
Sun Sep 02, 2018 11:19 pm
For an investor in the 22% or 24% brackets, it is much closer. Most investors in those brackets would be better off holding all their bonds in tax-deferred accounts, but if that is not possible (limited room, or a 401(k) with a low-cost stock fund and high-cost bond funds), holding Total Bond Market in taxable is reasonable. I would only recommend a muni fund in those brackets if there is a low-cost in-state fund.
For 2018, I'll be in the 24% tax bracket filing married jointly. Most of my bonds are in taxable - in VWIUX (National Intermediate Munis) and VNYTX (Long Term New York).

I've had these for about 7 years now and VWIUX is about 2.5% in the red (though it's performed better than BND at least) and VNYTX is 1% up.

I do have room to change asset allocations in my tax-deferred accounts. Do you think I should dump VWIUX and maybe buy some Treasuries in my tax-deferred? (side note: I'm not sure how I buy Treasuries in Tax Deferred - aren't they through TreasuryDirect.gov?)
Treasuries in taxable are fine in New York in the 24% bracket, particularly if you live in New York City or Yonkers; you avoid the state and city tax.

If you do want to hold Treasuries in tax-deferred, there are lots of Treasury funds and ETFs available for purchase in IRAs, and most 401(k) plans also have a Treasury option. (Alternatively, you could hold Total Bond Market, which includes both Treasury and corporate bonds.)
Wiki David Grabiner

conundrum
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Re: US Treasuries vs Munis in taxable

Post by conundrum » Mon Sep 03, 2018 11:11 pm

Thanks all for the comments, especially grabiner. We are in a similar situation as others, now in the 24% tax bracket and are currently about 50/50 intermediate treasuries and intermediate munis in the bond portion of our taxable account. Considering moving to less munis and more treasuries as at this point we favor safety over yield.

Thanks again,
Drum

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watchnerd
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Re: US Treasuries vs Munis in taxable

Post by watchnerd » Mon Sep 03, 2018 11:24 pm

conundrum wrote:
Mon Sep 03, 2018 11:11 pm
Thanks all for the comments, especially grabiner. We are in a similar situation as others, now in the 24% tax bracket and are currently about 50/50 intermediate treasuries and intermediate munis in the bond portion of our taxable account. Considering moving to less munis and more treasuries as at this point we favor safety over yield.

Thanks again,
Drum
I hold treasuries : munis in a 2:1 ratio.

My rationale:

1. I don't hold treasuries for the income, really, but to act as the the risk-free asset that offsets equities. As a result, in my taxable account, my treasuries = equities.

2. I'm not in retirement, so don't need to live off my income. Thus, I don't need to load up on the income that munis provide.

3. VWIUX SEC yield = 2.42% = 3.184% tax equivalent yield for me (0% state income tax in WA). Compare that to the taxable risk-free alternatives of 2.73% SEC yield from VSIGX (intermediate treasuries) and 3.00% APR for 5 year CD, the spread isn't big enough for me to feel the need to load up super heavy on the munis given the additional risk.
Tax Sheltered: 35% US Stock | 35% ex-US Stock | 30% TTM || Taxable: 35% US Stock | 35% ex-US Stock | 15% TTM | 15% Munis

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Re: US Treasuries vs Munis in taxable

Post by pascalwager » Mon Sep 03, 2018 11:59 pm

watchnerd wrote:
Mon Sep 03, 2018 11:24 pm
conundrum wrote:
Mon Sep 03, 2018 11:11 pm
Thanks all for the comments, especially grabiner. We are in a similar situation as others, now in the 24% tax bracket and are currently about 50/50 intermediate treasuries and intermediate munis in the bond portion of our taxable account. Considering moving to less munis and more treasuries as at this point we favor safety over yield.

Thanks again,
Drum
I hold treasuries : munis in a 2:1 ratio.

My rationale:

1. I don't hold treasuries for the income, really, but to act as the the risk-free asset that offsets equities. As a result, in my taxable account, my treasuries = equities.

2. I'm not in retirement, so don't need to live off my income. Thus, I don't need to load up on the income that munis provide.

3. VWIUX SEC yield = 2.42% = 3.184% tax equivalent yield for me (0% state income tax in WA). Compare that to the taxable risk-free alternatives of 2.73% SEC yield from VSIGX (intermediate treasuries) and 3.00% APR for 5 year CD, the spread isn't big enough for me to feel the need to load up super heavy on the munis given the additional risk.
W. Bernstein formerly recommended 1/3 each of CDs, Treasuries, and munis if you needed to have a lot of bonds in taxable. Now, CDs aren't as attractive, so he might advise 2/3 Treasuries and 1/3 munis. His main argument for using munis was bonds diversification.

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Re: US Treasuries vs Munis in taxable

Post by not4me » Mon Dec 10, 2018 11:41 am

This may have been covered as I didn't read everything, but I didn't see in my skimming. Considerations may be too small to tilt the scales as well. 1st, & I think this might apply more to ETFs than funds, is to consider liquidity. If you have some degree of flexibility on how quickly you can exit, this may not matter. I've no data to quantify the difference. 2nd, I think the state you are taxed in perhaps should be a stronger consideration. The holdings for the muni fund/etf are not necessarily evenly distributed & thus neither are the impact on state taxes even for same rates. Since that will vary over time, it may not be worth even being a tie breaker.

I know some people hold in tax advantaged accounts for reasons beside taxes, but am curious as to extent anyone factors in RMD taxation in that placement.

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brusan
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Re: US Treasuries vs Munis in taxable

Post by brusan » Mon Dec 10, 2018 11:44 am

grabiner wrote:
Mon Sep 03, 2018 10:34 am
JimmyJammy wrote:
Sun Sep 02, 2018 11:19 pm
For an investor in the 22% or 24% brackets, it is much closer. Most investors in those brackets would be better off holding all their bonds in tax-deferred accounts, but if that is not possible (limited room, or a 401(k) with a low-cost stock fund and high-cost bond funds), holding Total Bond Market in taxable is reasonable. I would only recommend a muni fund in those brackets if there is a low-cost in-state fund.
For 2018, I'll be in the 24% tax bracket filing married jointly. Most of my bonds are in taxable - in VWIUX (National Intermediate Munis) and VNYTX (Long Term New York).

I've had these for about 7 years now and VWIUX is about 2.5% in the red (though it's performed better than BND at least) and VNYTX is 1% up.

I do have room to change asset allocations in my tax-deferred accounts. Do you think I should dump VWIUX and maybe buy some Treasuries in my tax-deferred? (side note: I'm not sure how I buy Treasuries in Tax Deferred - aren't they through TreasuryDirect.gov?)
Treasuries in taxable are fine in New York in the 24% bracket, particularly if you live in New York City or Yonkers; you avoid the state and city tax.

If you do want to hold Treasuries in tax-deferred, there are lots of Treasury funds and ETFs available for purchase in IRAs, and most 401(k) plans also have a Treasury option. (Alternatively, you could hold Total Bond Market, which includes both Treasury and corporate bonds.)
Hi grabiner...big fan of all your posts..my wife and I are in a similar situation...we will be in the 24% bracket in 2019 and live in California. Due to a bit of a windfall this year, we will be in the 37% bracket. Due to the extra income this year, to maintain our overall 60-40 AA, we will need to hold some bonds in taxable , due to not having enough room in retirement accounts for more bonds. We are considering an even split in taxable between VWIUX and the California Intermediate-Term Tax-Exempt (VCADX). Given the 24% tax bracket we will normally be in, do you suggest not moving into these 2 funds? Thank you

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grabiner
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Re: US Treasuries vs Munis in taxable

Post by grabiner » Mon Dec 10, 2018 8:34 pm

brusan wrote:
Mon Dec 10, 2018 11:44 am
my wife and I are in a similar situation...we will be in the 24% bracket in 2019 and live in California. Due to a bit of a windfall this year, we will be in the 37% bracket. Due to the extra income this year, to maintain our overall 60-40 AA, we will need to hold some bonds in taxable , due to not having enough room in retirement accounts for more bonds. We are considering an even split in taxable between VWIUX and the California Intermediate-Term Tax-Exempt (VCADX). Given the 24% tax bracket we will normally be in, do you suggest not moving into these 2 funds? Thank you
I would suggest an even split between Limited-Term Tax-Exempt and CA Long-Term Tax-Exempt instead; this has the same duration as the two intermediate-term funds, and half the bonds in CA, but exempts more of your income from CA state tax.

If you buy the funds now, you can always switch to a different set of bond funds when your income decreases in another year; bond funds don't have much in capital gains. Therefore, it is worth buying them now. If you are in the 24% bracket next year, you might keep the CA munis but put the other half of your bonds in a Treasury fund to get the CA tax exemption.

You should also buy I-Bonds, which are state tax-exempt and federal tax-deferred, but given the size of that windfall, I don't think this will do much to your asset allocation.
Wiki David Grabiner

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brusan
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Re: US Treasuries vs Munis in taxable

Post by brusan » Mon Dec 10, 2018 10:22 pm

grabiner wrote:
Mon Dec 10, 2018 8:34 pm
brusan wrote:
Mon Dec 10, 2018 11:44 am
my wife and I are in a similar situation...we will be in the 24% bracket in 2019 and live in California. Due to a bit of a windfall this year, we will be in the 37% bracket. Due to the extra income this year, to maintain our overall 60-40 AA, we will need to hold some bonds in taxable , due to not having enough room in retirement accounts for more bonds. We are considering an even split in taxable between VWIUX and the California Intermediate-Term Tax-Exempt (VCADX). Given the 24% tax bracket we will normally be in, do you suggest not moving into these 2 funds? Thank you
I would suggest an even split between Limited-Term Tax-Exempt and CA Long-Term Tax-Exempt instead; this has the same duration as the two intermediate-term funds, and half the bonds in CA, but exempts more of your income from CA state tax.

If you buy the funds now, you can always switch to a different set of bond funds when your income decreases in another year; bond funds don't have much in capital gains. Therefore, it is worth buying them now. If you are in the 24% bracket next year, you might keep the CA munis but put the other half of your bonds in a Treasury fund to get the CA tax exemption.

You should also buy I-Bonds, which are state tax-exempt and federal tax-deferred, but given the size of that windfall, I don't think this will do much to your asset allocation.
Thank you! Really appreciate the response. We are already buying our 10K each in iBonds annually so we are on the right track. ANy suggestions on Treasury fund?

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Re: US Treasuries vs Munis in taxable

Post by grabiner » Mon Dec 10, 2018 10:30 pm

brusan wrote:
Mon Dec 10, 2018 10:22 pm
grabiner wrote:
Mon Dec 10, 2018 8:34 pm
If you are in the 24% bracket next year, you might keep the CA munis but put the other half of your bonds in a Treasury fund to get the CA tax exemption.

You should also buy I-Bonds, which are state tax-exempt and federal tax-deferred, but given the size of that windfall, I don't think this will do much to your asset allocation.
Thank you! Really appreciate the response. We are already buying our 10K each in iBonds annually so we are on the right track. ANy suggestions on Treasury fund?
How sensitive are you to inflation? Vanguard Inflation-Protected Securities holds TIPS, which are better for protection from inflation risk. If you will have an inflation-adjusted pension, then you may have less need for that risk protection, and might use Intermediate-Term Treasury.
Wiki David Grabiner

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brusan
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Re: US Treasuries vs Munis in taxable

Post by brusan » Mon Dec 10, 2018 10:33 pm

grabiner wrote:
Mon Dec 10, 2018 10:30 pm
brusan wrote:
Mon Dec 10, 2018 10:22 pm
grabiner wrote:
Mon Dec 10, 2018 8:34 pm
If you are in the 24% bracket next year, you might keep the CA munis but put the other half of your bonds in a Treasury fund to get the CA tax exemption.

You should also buy I-Bonds, which are state tax-exempt and federal tax-deferred, but given the size of that windfall, I don't think this will do much to your asset allocation.
Thank you! Really appreciate the response. We are already buying our 10K each in iBonds annually so we are on the right track. ANy suggestions on Treasury fund?
How sensitive are you to inflation? Vanguard Inflation-Protected Securities holds TIPS, which are better for protection from inflation risk. If you will have an inflation-adjusted pension, then you may have less need for that risk protection, and might use Intermediate-Term Treasury.
Thank you. As always , great advice. No pension

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Re: US Treasuries vs Munis in taxable

Post by Dandy » Tue Dec 11, 2018 8:11 am

I am considering having a mix of US Treasuries and muni's rather than all muni's and keeping my muni's mostly in LTD Term Tax exempt. I don't have any special insight on the muni risks but not comfortable with having all my taxable fixed income "eggs" in that basket.

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Re: US Treasuries vs Munis in taxable

Post by UpperNwGuy » Tue Dec 11, 2018 8:32 am

Dandy wrote:
Tue Dec 11, 2018 8:11 am
I am considering having a mix of US Treasuries and muni's rather than all muni's and keeping my muni's mostly in LTD Term Tax exempt. I don't have any special insight on the muni risks but not comfortable with having all my taxable fixed income "eggs" in that basket.
My taxable fixed income holdings are split 50/50 between Total Bond and Intermediate Term Tax Exempt for the same reason (the eggs).

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