Should I add muni bonds in taxable?

[MtnTravel]

Our asset allocation calls for 10% bonds. Our bonds are currently in Fidelity Total Bond Index in our 401k's. It's time to rebalance to get back to 10%. Instead of adding more total bond in our 401k's, I am curious if it makes sense to add muni bonds to our taxable account?

Basic Data:

State - Colorado
State Income Tax - 5%
Fed Bracket - 35-37%

My thought is that the bonds in our taxable account could provide more diversification and act as a sort of a backup emergency fund. Does it make sense to add any bonds to taxable, or should I continue to rebalance in our 401k's?

If I should add bonds to taxable, what is a good choice? Colorado has a couple seemingly thinly traded muni bond funds, but they have high expense ratios.

[retired@50]

Our asset allocation calls for 10% bonds. Our bonds are currently in Fidelity Total Bond Index in our 401k's. It's time to rebalance to get back to 10%. Instead of adding more total bond in our 401k's, I am curious if it makes sense to add muni bonds to our taxable account?

Basic Data:

State - Colorado
State Income Tax - 5%
Fed Bracket - 35-37%

My thought is that the bonds in our taxable account could provide more diversification and act as a sort of a backup emergency fund. Does it make sense to add any bonds to taxable, or should I continue to rebalance in our 401k's?

If I should add bonds to taxable, what is a good choice? Colorado has a couple seemingly thinly traded muni bond funds, but they have high expense ratios.

If you go down the tax-exempt municipal bond fund path, consider Vanguard funds in this area.
VWIUX and/or VMLUX would be good choices. You can tweak the ratio of these two funds to dial in a duration you're happy with.

Regards,

[JazzTime]

Instead of a bond fund, you can also check to see if your brokerage offers individual Colorado muni bonds. I use Fidelity and have bought a number of MA muni bonds on the secondary market, sometimes underbidding the ask price. I'm mostly an equity guy, but I couldn't pass up adding a few muni's yielding 3.9-4%, double tax free. Of course, my intention is to hold until maturity or death, whichever comes first.

[steadyosmosis]

Sticking with 100% VTI equities in taxable myself, for the tax efficiency.

[colodane]

Given your Federal tax rate, you are a good candidate for using Munis as part of your taxable account.

I'm also in Colorado and have both High Yield Tax Exempt and Intermediate Term Tax Exempt in my Vanguard taxable account. Vanguard has state-specific muni funds for a few states, but not Colorado. Those would be slightly better, as also exempt from state tax. But with the 4.7 % Colorado tax rate, I'm not too concerned.

[Toadinlaw]

I agree that at your tax bracket it makes sense to consider muni. you can use this link to calculate your tax equivalent return. Generally, Muni's have a lower default rate risk so you can afford to go deeper into the risk curve but i would not do individual bonds only funds. IMO.
https://www.raymondjames.com/rj-th3-blu ... quiv-yield

[thenow]

Since you are with Fidelity in a qualified plan, you might also want to think about future investments in a taxable brokerage account. Vanguard tax exempt mutual funds are fine. But, someday you might want to consider only one brokerage and qualified accounts, such as Fidelity or Vanguard. Hence, instead of mutual funds you might go with ETFs. They will give you flexibility if you decide to eventually go with only one firm. Alternatively, even though I’m with Fidelity I have invested in VTES and VTEB in my taxable brokerage account. I’m am embarrassed to say I couldn’t make a decision between short and intermediate tax exempt ETFs. Thus, I put money in both. And, I thought short term VTES gives me some liquidity if needed.

[itnetpro]

Our asset allocation calls for 10% bonds. Our bonds are currently in Fidelity Total Bond Index in our 401k's. It's time to rebalance to get back to 10%. Instead of adding more total bond in our 401k's, I am curious if it makes sense to add muni bonds to our taxable account?

Basic Data:

State - Colorado
State Income Tax - 5%
Fed Bracket - 35-37%

My thought is that the bonds in our taxable account could provide more diversification and act as a sort of a backup emergency fund. Does it make sense to add any bonds to taxable, or should I continue to rebalance in our 401k's?

If I should add bonds to taxable, what is a good choice? Colorado has a couple seemingly thinly traded muni bond funds, but they have high expense ratios.

I'm also considering adding Muni's. I need somewhere to hold cash long term that I pull from my tax deferred investments, that I no longer consider part of my retirement income, or cash reserve.

My understanding is, if I add something like a Vanguard Muni index fund, I won't be taxed federal but will be taxed state and local for slightly over 4% on that income.

It's fine with me, I rather buy a Muni that's Pennsylvania specific anyway and VPALX has a decent performance for my needs.

So check to see if the Muni you want is also exempt from state & local taxes.

John

[MtnTravel]

Thanks for the responses! I think an ETF makes sense for a fund since I don’t want to be wed to a specific brokerage.

I guess the bigger question is when we should consider adding munis to taxable vs just rebalancing in our 401k?

[Ralph Furley]

I have a national Vanguard intermediate muni fund in my taxable account for similar reasons. The amount is equal to about two years of spending.

As I'm adding funds to my taxable account I just look at my overall allocation. If fixed income is below my desired allocation, the money goes into the muni fund.

[breakfastinbed]

Thanks for the responses! I think an ETF makes sense for a fund since I don’t want to be wed to a specific brokerage.

I guess the bigger question is when we should consider adding munis to taxable vs just rebalancing in our 401k?

There are probably two possible approaches:

1) Keep all your bonds in 401k. Only add munis if 401K is already "full" of tax-inefficient assets. This would include international funds, REITs, etc - remember for tax-efficient asset placement municipal bond funds are maximally tax-efficient.

2) Keep a smaller portion of munis in taxable (~20-30%) of total allocation to bonds) to allow for rebalancing with stocks if market drops. Muni bond funds are less correlated with total market than total bond is, so if the market drops 30%, you could sell muni bonds and buy low in taxable - depending on your circumstances this may or may not be better than just rebalancing in 401K. In general this is a more useful strategy for drawdown phase vs accumulation, and is probably not worth doing for 20-30% of 10%.


I'd probably go with option 1 if I were you. When I am approaching retirement I personally plan on putting a few % of my portfolio in intermediate municipal bonds in taxable for the purposes above, but won't do so before.

[Elric]

Instead of a bond fund, you can also check to see if your brokerage offers individual Colorado muni bonds. I use Fidelity and have bought a number of MA muni bonds on the secondary market, sometimes underbidding the ask price. I'm mostly an equity guy, but I couldn't pass up adding a few muni's yielding 3.9-4%, double tax free. Of course, my intention is to hold until maturity or death, whichever comes first.

+1 I don't know Colorado bonds, but I do a similar thing in Virginia. Individual in-state muni bonds, AA or AAA, split up over several issuers, bought on the secondary market and held to maturity. I've also considered bonds from states with no income tax, but so far have stuck with in-state.