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Tax free Municipal Bonds

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  • Tax free Municipal Bonds

    I am planning on shifting my new contributions for bonds to post-tax side of my portfolio in order to maximize equities in my pre-tax account. I am in the highest tax bracket. Which of the four would be recommended?

    1) Vanguard total bond market index or something similar with corporate bond exposure

    2) US treasuries (Regular or TIPS)

    3) Tax free Municipal bond fund (Vanguard)

    4) Individual tax free municipal bonds

  • #2
    Why are you thinking of making this change?


    • #3
      Typically, one would have the bonds portion of your Asset Allocation in the tax sheltered account. The taxable account would have stocks. Advantage being that the taxable account can grow without too much income being generated. The second advantage is the ability to harvest tax losses.

      Having said that, many high income people will have majority of their total Net Worth in the taxable account. And if your asset allocation model then requires you to have bonds in the taxable account,  tax free bonds or tips would be a good option. My taxable account is 4 times the size of my pretax account. I have BND and VWIUX in my taxable account.


      • #4
        I think most detailed analyses have shown the math works slightly better with bonds in taxable, even if one chooses the most tax-efficient funds, and even accounting for TLH. But it is close enough that it really doesn’t matter. Your fine either way.

        I prefer bonds (muni) in taxable for a few reasons:
        1) Taxable account has some potentially intermediate term uses (ie kids college after 529s, cars, weddings). I want the option to draw from muni funds with less capital gains rather than equity indexes if the market is up at that time.
        2) They could eliminate specific ID cost basis (TLH) in the future. Almost happened with this tax bill.
        3) Even Vanguard funds, particularly international indexes, gave more unqualified dividends than you may realize.


        • #5
          I agree with you,  donquixote,  that bonds belong in taxable;;  at least until bonds are generating 4-5% in dividends.  More strongly yet, I believe that the AA of each portfolio should be specific to that portfolio goal, INDEPENDENT  of the other portfolio AAs.

          Given that, 1) The Vanguard BND will protect during a recession or bear market, but with the corporates will generate slightly higher dividends.   2) Treasuries will protect you during a recession or bear market in equities.  3) muni fund will protect you from taxes and bear markets,  4) ditto #3 but more work.

          TIPS will protect you from inflation.   Short term bonds will protect you from rising rates.  What do you fear most?  probably taxes, no?

          I use short muni bond fund #3;  VMLUX in taxable.


          • #6
            One has to ask the why first.

            We live in high tax state.   If say in FL, probably not the best category to invest.

            We use TE Munis in our taxable 'mortgage' fund that we keep to on hand to pay off the 600k balance at any given moment  Since we have 10+ years on income stream planned, about 1/2 of the fund is TE muni mutual funds at the moment.



            • #7
              I have BND in tax protected space.  VWIUX (intermediate muni) in taxable.  Considering starting a position in VMLUX (short term muni)   in taxable.  I have two long state specific munis also (individual bonds). I have never owned any tips.


              • #8
                For me, here is where I like to put bonds, from best to worst

                1. Tax-deferred retirement accts

                2. Taxable accts

                3. Roth IRA



                Right now I only have bonds in #1.  Probably have less of my portfolio in bonds than most here do.


                • #9
                  Thank you very much for the responses. I am now convinced that bonds go into taxable until the interest rates go up significantly. On further review looks like Option 4 is too difficult and time taking. So I am down to the first three options at least till I get a better idea of laddering.

                  Does any one think that there is benefit in terms of cash flow at time of retirement with Municipal Bonds than regular bonds?

                  I am worried about TIPS due to need to pay taxes on earnings that I have not realized. So I am going to stay away from them.

                  Favoring at least some percentage of VWIUX at this time in the post tax space just for the reason that whatever the government does in the future regarding taxation, most likely they will not mess with tax free nature of municipal bonds.

                  Any suggestions on percentage that I should carry of BND and VWIUX?


                  • #10
                    JZ, I agree with you I fear taxation more than anything else. However how much more the government can beat an already dead horse. Most practicing doctors pay close to 50 percent of income in taxes including payroll taxes and state taxes. I am not much worried about raise in income taxes. I am more worried about the capital gains tax rate. Just like they slipped in Obamacare surcharge they may keep adding other surcharges.


                    • #11
                      Does any one think that there is benefit in terms of cash flow at time of retirement with Municipal Bonds than regular bonds?

                      At various intervals during retirement, you can compare muni returns to fully taxed returns in your income bracket.  If this changes form time to time, just switch;  you will have little if any cap gains to pay up.