Munis in taxable account

[BOBOT]

As a result of recent rebalancing and tax-loss harvesting we have considerable funds in a money mkt fund in our joint taxable account. Our AA across all accounts is where we want it. The money mkt fund at the moment is yielding over 5%, all taxable of course.
Wondering if it would make sense to park at least some of it in a muni fund, probably yielding 3.5% or so. Our regular qualified dividends are taxed at 15%.


Thoughts?

 

[Montecfo]

Well, is your marginal tax rate above 30%? then yes.

Otherwise no.

Don't forget state taxes.

Or is there another goal here other than after tax return?

 

[BOBOT]

Well, is your marginal tax rate above 30%? then yes.

Otherwise no.

Don't forget state taxes.

Or is there another goal here other than after tax return?

Thanks. We're in the 22% bracket. I guess I don't get the math implicit in your reply....?

 

[N02L84ER]

5% * 22% = 1.1% So, taxable is equivalent to 5% - 1.1% = 3.9% which is greater than the 3.5% muni rate.

 

[BOBOT]

5% * 22% = 1.1% So, taxable is equivalent to 5% - 1.1% = 3.9% which is greater than the 3.5% muni rate.

The mm fund (VMFXX) reports as dividends, so are taxed at 15% in our case.


So 5% * 0.85 = 4.25%, an even stronger argument against the munis.


Thanks.

 

[Montecfo]

The mm fund (VMFXX) reports as dividends, so are taxed at 15% in our case.


So 5% * 0.85 = 4.25%, an even stronger argument against the munis.


Thanks.

They are actually nonqualified dividends since their source is interest on debt securities. Taxation would be at ordinary, not capital gain rates.

 

[Montecfo]

Thanks. We're in the 22% bracket. I guess I don't get the math implicit in your reply....?

5% minus 3.5% equals 1.5%, which is the difference in the two rates. What tax rate makes the two investments equivalent on an after tax basis?

Answer:

1.5 divided by 5 equals . 3 or 30%. That is the marginal tax rate (federal and state combined ) needed to make the investments equivalent.

To check this multiply 5% times . 3 and you get 1.5%. 5% minus 1.5% equals 3.5%.

So... If they tax rate is higher than 30% the muni comes out better. If the tax rate is lower than 30% the taxable account is better.

 

[Phroig]

Although tax-exempt interest is added back for things like IRMAA, the difference in amounts might matter if you’re right at the threshold. That is, $3.5K of muni interest might help you come under the cutoff where $5K of taxable interest was putting you just over.

 

[audreyh1]

The mm fund (VMFXX) reports as dividends, so are taxed at 15% in our case.


So 5% * 0.85 = 4.25%, an even stronger argument against the munis.


Thanks.

Not qualified dividends. Taxed as ordinary income just like interest.

 

[njhowie]

A more important question in my mind is what is the muni fund that you are looking at? VMSXX? If not, then which?

 

[BOBOT]

5% minus 3.5% equals 1.5%, which is the difference in the two rates. What tax rate makes the two investments equivalent on an after tax basis?

Answer:

1.5 divided by 5 equals . 3 or 30%. That is the marginal tax rate (federal and state combined ) needed to make the investments equivalent.

To check this multiply 5% times . 3 and you get 1.5%. 5% minus 1.5% equals 3.5%.

So... If they tax rate is higher than 30% the muni comes out better. If the tax rate is lower than 30% the taxable account is better.

Got it, thanks.
Interesting that in this case at least tax avoidance doesn't make sense!

 

[Fotodog]

If you are comfortable buying individual muni bonds, they can make sense if you are in a high tax state. I’m in California with a 9.3% state tax, so I have set up a ladder of California munis exempt from both federal and state taxes. My 5 year ladder has an average yield over 4%, which in the 22% bracket is equivalent to over 6% taxable. This makes sense for me because I will be using my taxable account for living expenses and paying Roth conversion taxes over the next few years until RMD’s start. Just be aware that most offerings at the best rates are callable. Here’s a great calculator to show the tax equivalent yield of municipal bonds:
https://www.bankrate.com/retirement/tax-equivalent-yield-calculator-tool/

 

[Surewhitey]

Any thoughts on FXIEX? Looks like a higher yield than most with a lower quality of municipals. Average is BBB rated.

 

[imbatman]

Yeah I am in Fido which doesn't have a clean TE sweep fund, but they do have auto-liquidation options if use Fidelity funds. I am well above 22% once I factor in state/ local taxes and Additional Medicare 0.9% and NII 3.8%.

So for me, SPAXX (full taxable) is almost always lower return after tax than FDLXX (treasury no state) or FZEXX (muni no fed).....so I pick advantageously when I have spare cash to wait for my next buy.