Join Early Retirement Today
Reply
 
Thread Tools Search this Thread Display Modes
When to use tax exempt funds
Old 07-27-2016, 01:54 PM   #1
Recycles dryer sheets
 
Join Date: Aug 2013
Posts: 115
When to use tax exempt funds

We are in the cash accumulation stage prior to our retirement in 20 months or so. I am trying to find the best place to park this cash. Currently:
CU $64k : 0-25k 3.5%, >25k .50%
CD $25k (3 yr) 1.74%
Ally $57k @ 1%

Thinking of moving $50k to Vanguard High-Yield Tax Exempt fund (VWALX).Yield is approx 3.69%.

We had $300k gross income in 2015, maxed out our 401k's 24k each (project same for 2016 & 2017). DH contributes max to HSA. No deductions so we are in high tax bracket. Also, current 401k is slightly over 2.mil. Have done back door Roth IRA for DH last 2 years as well.

So basically trying to get the most return for the cash with relatively small risk. Does this sound like a reasonable plan? Thoughts, critique welcome.
Thanks in advance.
__________________

__________________
whatnot is offline   Reply With Quote
Join the #1 Early Retirement and Financial Independence Forum Today - It's Totally Free!

Are you planning to be financially independent as early as possible so you can live life on your own terms? Discuss successful investing strategies, asset allocation models, tax strategies and other related topics in our online forum community. Our members range from young folks just starting their journey to financial independence, military retirees and even multimillionaires. No matter where you fit in you'll find that Early-Retirement.org is a great community to join. Best of all it's totally FREE!

You are currently viewing our boards as a guest so you have limited access to our community. Please take the time to register and you will gain a lot of great new features including; the ability to participate in discussions, network with our members, see fewer ads, upload photographs, create a retirement blog, send private messages and so much, much more!

Old 07-27-2016, 03:13 PM   #2
Give me a museum and I'll fill it. (Picasso)
Give me a forum ...
 
Join Date: Jun 2005
Posts: 8,248
I don't have any cash nor fixed income in any taxable account. That is, no savings account, no CDs, no bonds, no bond funds, etc. The reason is taxes. I don't want to earn any interest or dividends that increase my income and cause me to pay more taxes.

Instead, I use my tax-deferred accounts to hold all bond funds that I need for my asset allocation. In my taxable account, I just use a tax-efficient stock index fund.

The reason to use a tax-efficient stock index fund is three-fold:
1. If it goes up in value and I need some money, then I just sell it. I would not pay any taxes on the gains because of previous tax-loss harvesting. It usually would not even increase my AGI because I have sufficient carryover losses from years and years of TLHing.

2. If it goes down in value, so what? I just tax-loss harvest and I save on taxes. If I need to raise money, I am happy to sell at a loss because I save on taxes AND I can restore my asset allocation by exchanging from a bond fund to an equity fund in one or more of my tax-advantaged accounts. Note that if I had the stock fund in a tax-advantaged account, that would not have prevented it from losing money anyways.

3. If it stays about the same, then no-harm and minimal taxes.

I've got to put stock funds somewhere, so I think it is best to hold them in a taxable account and fixed income in a 401(k) or other tax-deferred account if there is room for all my fixed income in tax-deferred accounts (and there is, plus more room for equities, too).

At your income level, you probably have about 20 years of expenses in your taxable account anyways, so having a tax-exempt bond fund there is not going to do you any good anyways nor change your risk level at all.

I think the only time to use tax-exempt bond funds in a taxable account is when one's tax-deferred accounts are already 100% fixed income, so no more room there AND one needs even more fixed income funds to meet one's asset allocation goals.
__________________

__________________
LOL! is offline   Reply With Quote
Old 07-27-2016, 03:20 PM   #3
Full time employment: Posting here.
 
Join Date: Jun 2016
Posts: 931
High yield is not without credit and quality risk. Less return, but less risk would be something like MUB. It is also AMT tax free which you might be running into at your income level.
I am more or less in the same boat.
__________________
COcheesehead is offline   Reply With Quote
Old 07-27-2016, 03:35 PM   #4
Recycles dryer sheets
 
Join Date: Aug 2013
Posts: 115
LOL - Thank you for your response.
1st, our 401k's are 70% stock, 30% bond. The cash is what we are saving outside of our 401k. Basically, my 2-3 year buffer if the stock market crashes and I do not want to liquidate stocks from our 401k in retirement.
2nd, regarding the tax issue. From what I understand any distribution from the fund ((VWALX) is tax exempt by definition. So basically, earning 2.5% more than what I am earining at Ally + no tax owed on earnings so an additional benefit.
These were the assumptions I was using when contemplating the use of the Vanguard High-Yield tax exempt fund. I just thought it might be a better place to park the money until it is needed in the future.
__________________
whatnot is offline   Reply With Quote
Old 07-27-2016, 04:02 PM   #5
Give me a museum and I'll fill it. (Picasso)
Give me a forum ...
 
Join Date: Jun 2005
Posts: 8,248
Only tax-exempt dividends from VWALX are tax-exempt. Any capital gains distributions would not be tax-exempt. It has not paid any cap gains distros in the past few years. Any cap gains from selling at a gain (higher NAV than purchase) would not be tax-exempt. Losses might be deductible, but there are some rules for losses in tax-exempt funds.

I have my buffer if the stock market crashes in my 401(k) where I think it belongs in a bond fund with decent credit rating. What happened to VWALX in 2008-2009? Not too bad, it dropped about 14%. Contrast that with VBTLX over the same time period which dropped less and recovered by the time VWALX was still down 14%.
__________________
LOL! is offline   Reply With Quote
Old 07-27-2016, 04:06 PM   #6
Full time employment: Posting here.
 
Join Date: Jun 2016
Posts: 931
If you still want to go down the tax free high yield road, HYD is another ETF to look at. It will yield about 4.43% right now.
__________________
COcheesehead is offline   Reply With Quote
Old 07-27-2016, 04:21 PM   #7
Thinks s/he gets paid by the post
 
Join Date: Nov 2009
Posts: 3,602
I use an intermediate-term muni bond fund as my second-tier emergency fund. It has checkwriting privileges so it is a little more easily accessible than most other mutual funds. I have about $40k in this fund, earning mostly tax-free interest at about 2.6% annually with little risk to the principal. I rarely have to tap into it, on average about once a year in the 22 years I have been in this fund. I hate having large blobs of money sitting around doing nothing so at least I earn something decent in this fund.
__________________
Retired in late 2008 at age 45. Cashed in company stock, bought a lot of shares in a big bond fund and am living nicely off its dividends. IRA, SS, and a pension await me at age 60 and later. No kids, no debts.

"I want my money working for me instead of me working for my money!"
scrabbler1 is offline   Reply With Quote
Old 07-27-2016, 04:52 PM   #8
Give me a museum and I'll fill it. (Picasso)
Give me a forum ...
pb4uski's Avatar
 
Join Date: Nov 2010
Location: Vermont & Sarasota, FL
Posts: 14,953
As you know, VWLAX has credit risk and interest rate risk that your CDs and online saving account do not.

That 3.5% rate on the first $25k at your CU is a sweet deal. Can you double dip by having one for you, one for your spouse and another joint account?
__________________
If something cannot endure laughter.... it cannot endure.
Patience is the art of concealing your impatience.
pb4uski is online now   Reply With Quote
Old 07-28-2016, 08:38 AM   #9
Recycles dryer sheets
 
Join Date: Aug 2013
Posts: 115
Thanks for all your replies. By credit risk do you mean loss of principal? If so, then yes I am aware of that, but when I looked at the historical performance - the fund has done well. (i know that history is not a guarantee of future performance)

COcheesehead - I looked up VanEck Vectors High-Yield Municipal Index ETF(NYSE Arca : HYD but the Vanguard website shows "information is currently unavailable for this fund".

I was just trying to find a better yield for the cash buffer we are builing. I know there is additional risk, but was just looking and do appreciate the comments. I will look for muni bonds as suggested above as well. Thanks again.
__________________
whatnot is offline   Reply With Quote
Old 07-28-2016, 09:04 AM   #10
Recycles dryer sheets
 
Join Date: Feb 2015
Posts: 107
Quote:
Originally Posted by LOL! View Post
I don't have any cash nor fixed income in any taxable account. That is, no savings account, no CDs, no bonds, no bond funds, etc. The reason is taxes. I don't want to earn any interest or dividends that increase my income and cause me to pay more taxes.

Instead, I use my tax-deferred accounts to hold all bond funds that I need for my asset allocation. In my taxable account, I just use a tax-efficient stock index fund.

The reason to use a tax-efficient stock index fund is three-fold:
1. If it goes up in value and I need some money, then I just sell it. I would not pay any taxes on the gains because of previous tax-loss harvesting. It usually would not even increase my AGI because I have sufficient carryover losses from years and years of TLHing.

2. If it goes down in value, so what? I just tax-loss harvest and I save on taxes. If I need to raise money, I am happy to sell at a loss because I save on taxes AND I can restore my asset allocation by exchanging from a bond fund to an equity fund in one or more of my tax-advantaged accounts. Note that if I had the stock fund in a tax-advantaged account, that would not have prevented it from losing money anyways.

3. If it stays about the same, then no-harm and minimal taxes.

I've got to put stock funds somewhere, so I think it is best to hold them in a taxable account and fixed income in a 401(k) or other tax-deferred account if there is room for all my fixed income in tax-deferred accounts (and there is, plus more room for equities, too).

At your income level, you probably have about 20 years of expenses in your taxable account anyways, so having a tax-exempt bond fund there is not going to do you any good anyways nor change your risk level at all.

I think the only time to use tax-exempt bond funds in a taxable account is when one's tax-deferred accounts are already 100% fixed income, so no more room there AND one needs even more fixed income funds to meet one's asset allocation goals.

This scenario does not work for many retirees. If one has SS or pension income or rental income sure. But for retirees relying on their portfolio for the majority of their income....not so much.

You are limited a $3,000 capital loss in any year. By carrying over loss amounts beyond $3,000, you are in effect giving the govt. an interest free loan until the next year.

So in 2008-2009, if you had a huge unexpected expense of say $50,000....then selling at a huge loss may result in many future years of TLH. Not something I would want to do.
__________________
MrLoco is offline   Reply With Quote
Old 07-28-2016, 09:32 AM   #11
Thinks s/he gets paid by the post
DrRoy's Avatar
 
Join Date: Dec 2015
Location: Michigan
Posts: 1,453
The dividends will be federal income tax free, but not state income tax free.
__________________
"The mountains are calling, and I must go." John Muir
DrRoy is offline   Reply With Quote
Old 07-28-2016, 09:41 AM   #12
Full time employment: Posting here.
 
Join Date: Jun 2016
Posts: 931
Quote:
Originally Posted by whatnot View Post
Thanks for all your replies. By credit risk do you mean loss of principal? If so, then yes I am aware of that, but when I looked at the historical performance - the fund has done well. (i know that history is not a guarantee of future performance)

COcheesehead - I looked up VanEck Vectors High-Yield Municipal Index ETF(NYSE Arca : HYD but the Vanguard website shows "information is currently unavailable for this fund".

I was just trying to find a better yield for the cash buffer we are builing. I know there is additional risk, but was just looking and do appreciate the comments. I will look for muni bonds as suggested above as well. Thanks again.
Credit risk meaning unrated bonds are in the portfolio, true junk, so the risk of default is higher and could hurt the performance of the ETF.
Not sure why Vanguard wouldn't show HYD, it is a prominent ETF in the high yield space. Here is the Yahoo link to it. HYD : Summary for VanEck Vectors High Yield Munic - Yahoo Finance
__________________
COcheesehead is offline   Reply With Quote
Old 07-28-2016, 10:31 AM   #13
Give me a museum and I'll fill it. (Picasso)
Give me a forum ...
 
Join Date: Jun 2005
Posts: 8,248
Quote:
Originally Posted by whatnot View Post
Thanks for all your replies. By credit risk do you mean loss of principal? If so, then yes I am aware of that, but when I looked at the historical performance - the fund has done well. (i know that history is not a guarantee of future performance).
A 14% loss in a few months for a bond fund is not what I would consider "has done well." It is pretty atrocious.
__________________
LOL! is offline   Reply With Quote
Old 07-28-2016, 10:34 AM   #14
Recycles dryer sheets
 
Join Date: Aug 2013
Posts: 115
LOL! Yikes I will go back and give it another look. But I think I am keeping my cash where it is for now. I need to really get up to speed on the tax efficiency issues.
__________________
whatnot is offline   Reply With Quote
Old 07-28-2016, 10:36 AM   #15
Give me a museum and I'll fill it. (Picasso)
Give me a forum ...
 
Join Date: Jun 2005
Posts: 8,248
Quote:
Originally Posted by MrLoco View Post
So in 2008-2009, if you had a huge unexpected expense of say $50,000....then selling at a huge loss may result in many future years of TLH. Not something I would want to do.
I'm don't understand. One would tax-loss harvest the huge loss in the year it happened. There would not be future years of TLH unless losses occurred in those years.

We tax-loss harvested losses in 2008-2009 in the mid-6-figure range. Those carryover losses are the reason we do not have to pay much in the way of taxes as retirees today. For instance, if I sell $100,000 of stocks with $50,000 of capital gains, then I offset that $50,000 of capital gains with losses harvesting in 2008 and my taxable income is zero. Actually, it is better than that because I do Roth conversion because my taxable income is so low even though I have plenty of money to spend on expenses.

But quite a few people misunderstand how tax-loss harvesting works. I am happy to go into detail on how it works for anybody that wants to know.
__________________
LOL! is offline   Reply With Quote
Old 07-28-2016, 10:50 AM   #16
Full time employment: Posting here.
 
Join Date: Jun 2016
Posts: 931
Quote:
Originally Posted by LOL! View Post
A 14% loss in a few months for a bond fund is not what I would consider "has done well." It is pretty atrocious.
Which one are you referring to? There are several referenced in this thread.
__________________
COcheesehead is offline   Reply With Quote
Old 07-28-2016, 11:02 AM   #17
Give me a museum and I'll fill it. (Picasso)
Give me a forum ...
 
Join Date: Jun 2005
Posts: 8,248
Quote:
Originally Posted by COcheesehead View Post
Which one are you referring to? There are several referenced in this thread.
VWALX. Anybody can go to morningstar.com and chart the history of funds. Here are a couple of charts. The first shows a 14% drop in total return of VWALX in just a couple of months back in 2008. The second shows the past 10 years. The other fund in the charts for comparison is just the total US bond index fund.



__________________
LOL! is offline   Reply With Quote
Old 07-28-2016, 11:06 AM   #18
Full time employment: Posting here.
 
Join Date: Jun 2016
Posts: 931
In comparison to other asset classes at that time in the market, I would have loved only a 14% drop. LOL. I wonder what the yield was at that point. Had to be to the moon.
__________________
COcheesehead is offline   Reply With Quote
Old 07-28-2016, 11:15 AM   #19
Give me a museum and I'll fill it. (Picasso)
Give me a forum ...
 
Join Date: Jun 2005
Posts: 8,248
Quote:
Originally Posted by COcheesehead View Post
In comparison to other asset classes at that time in the market, I would have loved only a 14% drop. LOL. I wonder what the yield was at that point. Had to be to the moon.
Treasuries and even total US bond market index funds were clearly much better than a junk bond fund.

If one is going to buy a bond fund in case the market crashes, it would seem to me they would want to buy a bond fund that doesn't crash when the market crashes.

Added: The charts include re-invested dividends, so yield is implicitly included.
__________________
LOL! is offline   Reply With Quote
Old 07-28-2016, 11:16 AM   #20
Give me a museum and I'll fill it. (Picasso)
Give me a forum ...
audreyh1's Avatar
 
Join Date: Jan 2006
Location: Rio Grande Valley
Posts: 15,116
I wouldn't consider any high yield fund for cash. They are too volatile.

I do use short term muni bond funds as part of my cash position. These only yield slightly more that high yield savings accounts, but it's tax-free.

I also use muni funds as part of my bond allocation. They are govt backed, and while not quite as safe as treasuries, they often behave well during market turmoil - better than corporate bond funds which are more credit sensitive. They work well as an asset class for diversification against other types of bond funds. There are occasional "muni scares". These have been good rebalancing opportunities.
__________________

__________________
Well, I thought I was retired. But it seems that now I'm working as a travel agent instead!
audreyh1 is offline   Reply With Quote
Reply


Currently Active Users Viewing This Thread: 1 (0 members and 1 guests)
 
Thread Tools Search this Thread
Search this Thread:

Advanced Search
Display Modes

Posting Rules
You may not post new threads
You may not post replies
You may not post attachments
You may not edit your posts

BB code is On
Smilies are On
[IMG] code is On
HTML code is Off
Trackbacks are Off
Pingbacks are Off
Refbacks are Off


Similar Threads
Thread Thread Starter Forum Replies Last Post
Roth IRA conversion (with tax-exempt funds) jimbohoward69 FIRE and Money 1 12-18-2012 12:36 PM
Tax Exempt Funds ? hadavi FIRE and Money 3 09-23-2009 07:45 AM
taxable versus tax-exempt bond funds JohnEyles FIRE and Money 3 10-28-2006 01:32 PM
Tax-exempt state bond funds (risk?) LRAO FIRE and Money 5 10-17-2006 05:40 PM
Vanguard tax-exempt MM at 2.6% pre-tax soupcxan FIRE and Money 17 12-28-2005 09:13 AM

 

 
All times are GMT -6. The time now is 10:56 PM.
 
Powered by vBulletin® Version 3.8.8 Beta 1
Copyright ©2000 - 2017, vBulletin Solutions, Inc.