Bonds with limited tax advantaged space

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mchriton
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Bonds with limited tax advantaged space

Post by mchriton » Sun Sep 10, 2017 11:39 pm

Hi all,

This community has been an invaluable help to get my portfolio in order -- I've migrated mostly to a boring 3 fund portfolio :) Over the past few years, income has continued to increase and I'm making most of my contributions to taxable accounts (after maxing tax advantaged), which has led me to municipal bonds. I live in California and selected VCADX Vanguard California Intermediate-Term Tax-Exempt Fund Admiral Shares -- my portfolio is on track for 12-15% in VCADX. Which doesn't feel balanced to have that much of the portfolio in muni bonds for one state (albeit a large economy).

Thoughts on VCADX at 12-15% of a portfolio? Are there any better alternatives? Should I mix in fed-exempt and pay california tax with VWITX Vanguard Intermediate-Term Tax-Exempt Fund Investor Shares?

I'm expecting to put bonds in taxable because I have limited space in 401k/roth ira, if I put all my bonds in tax advantaged I'd have nothing else in the 401k which doesn't seem like a great situation - I've read through https://www.whitecoatinvestor.com/asset ... n-taxable/ which has some supporting data points.

Overview of relevant financial situation:
  • Tax rate: high [top marginal rates; 50% combined?]
  • Target AA: 50% US, 30% international, 20% bonds
  • Tax advantaged space: trending to 20% of portfolio
  • Taxable space: trending to 80% of portfolio
  • Current bond funds: 12-15% in VCADX, rest is in bond funds in 401k
  • Age: 32

venkman
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Re: Bonds with limited tax advantaged space

Post by venkman » Mon Sep 11, 2017 12:23 am

mchriton wrote:
Sun Sep 10, 2017 11:39 pm
This community has been an invaluable help to get my portfolio in order -- I've migrated mostly to a boring 3 fund portfolio :) Over the past few years, income has continued to increase and I'm making most of my contributions to taxable accounts (after maxing tax advantaged), which has led me to municipal bonds. I live in California and selected VCADX Vanguard California Intermediate-Term Tax-Exempt Fund Admiral Shares -- my portfolio is on track for 12-15% in VCADX. Which doesn't feel balanced to have that much of the portfolio in muni bonds for one state (albeit a large economy).

Thoughts on VCADX at 12-15% of a portfolio? Are there any better alternatives? Should I mix in fed-exempt and pay california tax with VWITX Vanguard Intermediate-Term Tax-Exempt Fund Investor Shares?
I'll repeat some advice I've seen previously offered on this topic (sorry I don't remember whom to give credit to):

Rather than putting everything into the CA Intermediate Muni fund, put half into the CA Long-term Muni fund (VCITX), and the other half into a national short-term muni fund (VWSTX or VMLTX). You end up with an overall maturity/duration profile that's similar to the intermediate fund, while diversifying away from a single state. The majority of the income is generated from the CA fund, and thus not subject to state taxes.

mchriton
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Re: Bonds with limited tax advantaged space

Post by mchriton » Mon Sep 11, 2017 10:07 pm

Can you explain how the tax reporting works for VWSTX ? Would the $s in those funds be taxed in CA?

venkman
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Re: Bonds with limited tax advantaged space

Post by venkman » Tue Sep 12, 2017 12:36 am

mchriton wrote:
Mon Sep 11, 2017 10:07 pm
Can you explain how the tax reporting works for VWSTX ? Would the $s in those funds be taxed in CA?
I'm not a tax expert, but I'm pretty sure all the interest paid by a nationally diversified muni fund is subject to state taxes. Even the percentage of the fund's interest earned from CA bonds would be subject to CA tax.

bandoba
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Re: Bonds with limited tax advantaged space

Post by bandoba » Tue Sep 12, 2017 1:02 am

Repeating advice seen earlier on this forum. Other options are:
- I-bonds
- bonds funds in IRA or HSA accounts. You get more bond space if you have option of after tax Roth.

mega317
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Re: Bonds with limited tax advantaged space

Post by mega317 » Tue Sep 12, 2017 1:55 am

Google "asking portfolio questions". A more complete picture might give you better responses.

Can we assume your taxable contributions will continue at a ratio of 8:2 going forward? Otherwise your tax-advantaged space could grow as a percentage of the total portfolio.

I would put Roth in 100% stocks (no RMDs, no taxes, I want this to have the largest expected growth possible)

I would put only bonds in the 401k (will be subject to RMDs, less growth here is good)

The bonds that don't fit in the 401k I would put in munis in taxable. Mixing CA with national is good. At this point it probably doesn't much matter as it's a small piece of your portfolio. It could be more important in future decades.

I bonds is a fine idea, but it sounds like 10k a year is going to be peanuts for the OP.

retiredjg
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Re: Bonds with limited tax advantaged space

Post by retiredjg » Tue Sep 12, 2017 8:30 am

It would not bother me at all to have my 401k completely filled with bonds. I'd like at least some stocks, maybe near all stocks, in Roth IRA though. But having enough bonds in Roth to rebalance would be nice.

I like (grabiner's) idea of long term CA muni combined with short term national tax-exempt. This gives an overall intermediate term duration while getting most of the income from the CA bonds (exempt from CA taxes).

I probably would not hold more than half my fixed income assets in taxable in any one state muni fund. The risk is just too concentrated.

You might investigate I Bonds, but that will only handle a small portion of your portfolio since there is an annual limit on how much you can buy.

Edited to add....if you are using mega back door Roth and therefore have a large Roth account, put a chunk of bonds there too.

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Doc
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Re: Bonds with limited tax advantaged space

Post by Doc » Tue Sep 12, 2017 10:26 am

Another option is to break up the bond part of your 3-fund portfolio into its components and put the most tax efficient parts like short Treasuries into tax advantaged taxable and the least tax-advantaged parts like intermediate corporates into tax advantaged.

Edit: Typo, Thanks retiredjg for the correction.
Last edited by Doc on Wed Sep 13, 2017 11:05 am, edited 1 time in total.
A scientist looks for THE answer to a problem, an engineer looks for AN answer and lawyers ONLY have opinions. Investing is not a science.

retiredjg
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Re: Bonds with limited tax advantaged space

Post by retiredjg » Tue Sep 12, 2017 3:39 pm

Doc, did you mean to put the short term treasuries into taxable, not tax-advantaged?

mchriton
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Re: Bonds with limited tax advantaged space

Post by mchriton » Tue Sep 12, 2017 8:03 pm

mega317 wrote:
Tue Sep 12, 2017 1:55 am
Can we assume your taxable contributions will continue at a ratio of 8:2 going forward? Otherwise your tax-advantaged space could grow as a percentage of the total portfolio.
Yes.
mega317 wrote:
Tue Sep 12, 2017 1:55 am
I would put Roth in 100% stocks (no RMDs, no taxes, I want this to have the largest expected growth possible)

I would put only bonds in the 401k (will be subject to RMDs, less growth here is good)
I hadn't considered roth vs 401k. I had read the WCI article at https://www.whitecoatinvestor.com/asset ... n-taxable/ suggesting bonds go in taxable. Even for 401k he is recommended taxable "It’s the same thing, just more complicated due to the additional arbitrage factor. For these purposes, just consider that a traditional IRA is 2/3 a Roth IRA that belongs to you and 1/3 a Roth IRA that belongs to the government."

Thoughts on his data?
retiredjg wrote:
Tue Sep 12, 2017 8:30 am
I like (grabiner's) idea of long term CA muni combined with short term national tax-exempt. This gives an overall intermediate term duration while getting most of the income from the CA bonds (exempt from CA taxes).
I misunderstood the idea in my first reply. It makes sense now and an improvement over what I'm currently doing IMHO.

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Doc
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Re: Bonds with limited tax advantaged space

Post by Doc » Wed Sep 13, 2017 8:09 am

retiredjg wrote:
Tue Sep 12, 2017 3:39 pm
Doc, did you mean to put the short term treasuries into taxable, not tax-advantaged?
Yes. No, senior moment. I edited the original post.

Tax efficiency is tax rate times distribution. With low rates on short Treasuries they may be more tax efficient than some equity funds for many. You need to do your own calculation. There may be a link to Grabiner's spreadsheet in the Wiki.
A scientist looks for THE answer to a problem, an engineer looks for AN answer and lawyers ONLY have opinions. Investing is not a science.

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welderwannabe
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Re: Bonds with limited tax advantaged space

Post by welderwannabe » Wed Sep 13, 2017 11:13 am

Doc wrote:
Wed Sep 13, 2017 8:09 am
Tax efficiency is tax rate times distribution. With low rates on short Treasuries they may be more tax efficient than some equity funds for many. You need to do your own calculation. There may be a link to Grabiner's spreadsheet in the Wiki.
Doc's advise is solid. As another poster mentioned as well, don't give up on Savings Bonds. I limit my muni exposure in Taxable to 50% of my bond holdings. The rest of the 50% is currently in Savings Bonds. Once my portfolio gets to the point where Savings Bonds can't take up the slack I may start buying some short term treasury funds like Doc suggests.
I am not an investment professional, but I did stay at a Holiday Inn Express last night.

donaldson
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Re: Bonds with limited tax advantaged space

Post by donaldson » Wed Sep 13, 2017 3:21 pm

venkman wrote:
Tue Sep 12, 2017 12:36 am
mchriton wrote:
Mon Sep 11, 2017 10:07 pm
Can you explain how the tax reporting works for VWSTX ? Would the $s in those funds be taxed in CA?
I'm not a tax expert, but I'm pretty sure all the interest paid by a nationally diversified muni fund is subject to state taxes. Even the percentage of the fund's interest earned from CA bonds would be subject to CA tax.
Can someone confirm if the part in bold above is correct? Thanks.

mega317
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Re: Bonds with limited tax advantaged space

Post by mega317 » Wed Sep 13, 2017 3:49 pm

I can confirm. From instructions to CA schedule 540:
Certain mutual funds pay “exempt-interest dividends.” If the mutual fund
has at least 50% of its assets invested in tax-exempt U.S. obligations and/or
in California or its municipal obligations, that amount of dividend is exempt
from California tax.
VWSTX appears to be 10% California.

retiredjg
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Re: Bonds with limited tax advantaged space

Post by retiredjg » Wed Sep 13, 2017 4:04 pm

It seems to me that does not say that the portion of the dividends derived from CA bonds would be taxable in CA. I think that is what donaldson is asking.

mega317
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Re: Bonds with limited tax advantaged space

Post by mega317 » Wed Sep 13, 2017 4:17 pm

I should clarify. I was agreeing with and confirming what venkman wrote.

In order for mutual fund interest to be exempt from CA state tax, at least 50% of the fund must be in CA and/or US obligations. Since 10% of the bonds in VWSTX are from California, ALL of the interest from that fund is taxable.

If 49% of the fund was in CA, all of the interest would be taxable. If 50% was in CA, then the proportion of interest from CA would not be taxable.

Along the same lines, Vanguard Total Bond index is about 40% treasuries. Since that is less than 50%, ALL of the fund's interest is taxable in California.

retiredjg
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Re: Bonds with limited tax advantaged space

Post by retiredjg » Wed Sep 13, 2017 4:29 pm

I'm reading it differently. It revolves around the "and/or" part of the sentence.

We may be talking about different things or one of us is reading it wrong. Perhaps someone else can comment.

venkman
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Re: Bonds with limited tax advantaged space

Post by venkman » Wed Sep 13, 2017 7:39 pm

retiredjg wrote:
Wed Sep 13, 2017 4:29 pm
I'm reading it differently. It revolves around the "and/or" part of the sentence.

We may be talking about different things or one of us is reading it wrong. Perhaps someone else can comment.
I agree the wording is confusing. I think when it refers to "tax-exempt U.S. obligations," it means STATE tax-exempt, and is talking about federal obligations like Treasuries, which are not subject to state taxes.

So, if there were a bond fund that invested in Treasuries AND munis, and the percentage of CA bonds + treasuries was over 50%, that percentage would be exempt from CA state tax.

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