VBTLX vs VTEAX for taxable account - low tax bracket

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corner559
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VBTLX vs VTEAX for taxable account - low tax bracket

Post by corner559 »

I've had VBTLX in my taxable account for years and have never thought to change it until I just read through the "Bogleheads' Guide to the 3-Fund Portfolio". After some further research, it seems like VTEAX may be more appropriate for me. However, I came across some other threads that said VTEAX would only be appropriate if my tax bracket were higher. However, I'm still not clear why that is.

Because I an currently overseas and nearly all my income is exempt from US taxation (though I still report it), my tax bracket is 10%. That being the case, would it make sense for me to switch over to VTEAX? And if not, why wouldn't it be?

I do plan on moving back to the US within the next 3-5 years, so I expect my tax bracket to go up to 24% at some point.
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grabiner
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Re: VBTLX vs VTEAX for taxable account - low tax bracket

Post by grabiner »

Taxable bonds yield more than muni bonds of comparable risk. My rule of thumb is that the break-even is a 25% tax rate, so that you should prefer munis in a lower bracket. The current yields on Total Bond Market and Tax-Exempt Bond Index are 2.69% and 3.27%, which suggests that investors believe the muni index is riskier, probably because it has somewhat lower-quality bonds.

Does the foreign income exclusion actually give you a very low marginal tax rate? My understanding is that you exclude the tax on up to $X of foreign income, but your marginal tax rate above $X is based on your total income. Thus you might well be in the 24% tax bracket even now, which is about the break-even point for munis. (Many investors in the 24% bracket actually have a 27.8% marginal tax rate because of the Net Investment Income tax.)
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corner559
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Re: VBTLX vs VTEAX for taxable account - low tax bracket

Post by corner559 »

grabiner wrote: Tue Aug 02, 2022 9:25 pm Taxable bonds yield more than muni bonds of comparable risk. My rule of thumb is that the break-even is a 25% tax rate, so that you should prefer munis in a lower bracket. The current yields on Total Bond Market and Tax-Exempt Bond Index are 2.69% and 3.27%, which suggests that investors believe the muni index is riskier, probably because it has somewhat lower-quality bonds.

Does the foreign income exclusion actually give you a very low marginal tax rate? My understanding is that you exclude the tax on up to $X of foreign income, but your marginal tax rate above $X is based on your total income. Thus you might well be in the 24% tax bracket even now, which is about the break-even point for munis. (Many investors in the 24% bracket actually have a 27.8% marginal tax rate because of the Net Investment Income tax.)
Thanks for pointing that out. I just took another look and you are indeed correct. I'm actually at the 22% tax bracket at the moment.

That said, would it make sense then to switch to VTEAX or just stay put?
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Re: VBTLX vs VTEAX for taxable account - low tax bracket

Post by grabiner »

corner559 wrote: Fri Aug 05, 2022 7:40 am
grabiner wrote: Tue Aug 02, 2022 9:25 pm Taxable bonds yield more than muni bonds of comparable risk. My rule of thumb is that the break-even is a 25% tax rate, so that you should prefer munis in a lower bracket. The current yields on Total Bond Market and Tax-Exempt Bond Index are 2.69% and 3.27%, which suggests that investors believe the muni index is riskier, probably because it has somewhat lower-quality bonds.

Does the foreign income exclusion actually give you a very low marginal tax rate? My understanding is that you exclude the tax on up to $X of foreign income, but your marginal tax rate above $X is based on your total income. Thus you might well be in the 24% tax bracket even now, which is about the break-even point for munis. (Many investors in the 24% bracket actually have a 27.8% marginal tax rate because of the Net Investment Income tax.)
Thanks for pointing that out. I just took another look and you are indeed correct. I'm actually at the 22% tax bracket at the moment.

That said, would it make sense then to switch to VTEAX or just stay put?
At 22%, I would prefer the taxable fund, since you don't pay state tax and thus cannot benefit from a single-state fund. (If you move to CA when you return to the US, you might consider a CA muni fund then.)

Another possible reason to avoid munis when overseas would be if your foreign income is subject to foreign tax; this depends on your country. You can take a credit for foreign tax paid, but only if you pay US tax on the same income.
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