Bonds in taxable account

[Travelwanted]

I have high-yield, int-term and limited-term tax-exempt bonds in taxable account now because of current tax bracket. No brainer better after tax return now.

However, once retired, my income will drop significantly...just interest, dividends, distributions. It will stay below 250k, but be above 74k, putting us in the 25% income/15%ltcg/qual dividend brackets.

At that point it seems the tax-exempt funds are no longer the better after tax return assuming apples-apples bond funds.

Am I seeing this correctly? And if so, at that point does one bail on those and convert to taxable bonds?

Thanks.

 

[LOL!]

It is hard to give good advice without knowing the rest of your portfolio and its location.

In the past year, there have been a few bloggers who say that bonds in taxable are good. This is because
(1) bond yields are very low so income is lower and taxes may be lower
(2) bond funds are expected to lose money, so there is the opportunity for tax loss harvesting and getting out of bond funds if yields go up
(3) they like equities in Roth IRAs and don't want lower performing assets there.

For myself, I don't want any bonds in taxable and have no bonds in taxable. All my fixed income is in tax-advantaged accounts. I don't want my 401(k) and IRAs to grow fast because I don't want my RMDs to get large. Instead I want my taxable account to grow fast and my Roth IRAs to grow fast, so I have equities in both of them. Equities in taxable will be taxed much less than equities in my 401(k) and traditional IRAs.

So this doesn't answer your question.

 

[scrabbler1]

If you can, might you be able to create hypothetical (federal and state, you did not mention which state you live in or if the bond funds are national or home-state) income tax returns, one with projected dividends from each type of bond funds (munis versus corporate) and see which one gives you a better after-tax income. You should be able to find recent monthly dividends per share so you can estimate your annual dividends for each type of bonds.

FWIW, I faced this same question when I ERed in 2008. I had a lot in munis and was in the 25% marginal (federal) tax bracket, going down to the 15% bracket after I ERed. I did not liquidate my muni bond fund holdings (for other reasons) but have greatly reduced my holdings in favor of corporate bonds.

 

[Travelwanted]

It is hard to give good advice without knowing the rest of your portfolio and its location.

In the past year, there have been a few bloggers who say that bonds in taxable are good. This is because
(1) bond yields are very low so income is lower and taxes may be lower
(2) bond funds are expected to lose money, so there is the opportunity for tax loss harvesting and getting out of bond funds if yields go up
(3) they like equities in Roth IRAs and don't want lower performing assets there.

For myself, I don't want any bonds in taxable and have no bonds in taxable. All my fixed income is in tax-advantaged accounts. I don't want my 401(k) and IRAs to grow fast because I don't want my RMDs to get large. Instead I want my taxable account to grow fast and my Roth IRAs to grow fast, so I have equities in both of them. Equities in taxable will be taxed much less than equities in my 401(k) and traditional IRAs.

So this doesn't answer your question.

I'm not exactly looking for AA or asset location advice specifically. More, best after-tax return. Due to high income, most of my investments are post-tax non-sheltered. If I only kept bonds in tax-deferred, my AA would be 90% equities.

I also believe in the total return approach for retirement. I want to live off mutual fund dividends/distributions and bonds income as much as I can and allow to principle to grow. But the best-after tax scenario is what I am trying to achieve. Thanks!

 

[Travelwanted]

If you can, might you be able to create hypothetical (federal and state, you did not mention which state you live in or if the bond funds are national or home-state) income tax returns, one with projected dividends from each type of bond funds (munis versus corporate) and see which one gives you a better after-tax income. You should be able to find recent monthly dividends per share so you can estimate your annual dividends for each type of bonds.

FWIW, I faced this same question when I ERed in 2008. I had a lot in munis and was in the 25% marginal (federal) tax bracket, going down to the 15% bracket after I ERed. I did not liquidate my muni bond fund holdings (for other reasons) but have greatly reduced my holdings in favor of corporate bonds.

So you have somewhat answered my question. The fact that in ER you moved to corporates while reducing munis sounds like the answer. I assume you did this because of the higher yield and better after-tax return once in the lower tax bracket?

May I ask what "big bond fund" you bought? How is your bond allocation now?
Thanks!

 

[LOL!]

Why not actually do as scrabbler1 suggests and run some "What if?" tax returns?

I will guess you will find that a mix of taxable and tax-exempt bond funds may be the answer. Where the cut-off will be …?

 

[Travelwanted]

Why not actually do as scrabbler1 suggests and run some "What if?" tax returns?

Yep, I sort of did. But I always feel I am missing something or forgetting to account for something. I guess I am just so new to this I am not always confident in the results I get. Thanks for your suggestion.

 

[scrabbler1]

So you have somewhat answered my question. The fact that in ER you moved to corporates while reducing munis sounds like the answer. I assume you did this because of the higher yield and better after-tax return once in the lower tax bracket?

May I ask what "big bond fund" you bought? How is your bond allocation now?
Thanks!

I moved from munis to corporates indirectly but for the reason you stated - I netted more money after taxes by earning the higher return on corporates and paying the taxes on it than paying little or no taxes on munis with their lower return. I used my munis to pay the income taxes when I cashed out the company stock upon leaving the company. I also moved some more money from the munis to the corporates in 2009. And any other time I needed some large blob of money in the last 5 years I tapped into the munis, my general plan being to drain them slowly.

As for the "big bond fund" I bought to begin my ER, it is the Fidelity Focused High Income Fund (FHIFX). It might technically be a "junk bond" fund but unlike the typical junk bond funds this fund attempts to find a certain layer funds barely at (BBB) or slightly below investment grade (BB, B rated) to boost returns without adding a lot of risk.

As for my bond allocation, most of it in the taxable account is in FHIFX. In my IRA, however, I have Fidelity's Intermediate-term corporate bond fund (investment grade). That's nearly half of my IRA.