Best investments for taxable account in a high tax state

[Fotodog]

Greetings to all, and first a thanks for the knowledge that is shared on this forum.

I live in California, retired last year and sold my work condo. I’m trying to decide the best strategy for my taxable account of about 300k. My tIRA holds the majority of my retirement funds with a 60/40 mix of stock index funds and a ladder of individual bonds. I have 4 years before RMD’s start, and I’m using that time to do some Roth conversions of about 50k/year with taxes paid from the taxable account. I need about 50k/year for living expenses which I’m also drawing from this account.

Traditional thinking states that I should have stocks in my taxable account since long term capital gains are taxed lower than ordinary income. However California taxes LTCG’s as ordinary income at 9.3% in addition to Federal tax at 15%.

I’m beginning to think that a better strategy would be building a ladder of California Municipal bonds in my taxable account. I can currently get about 4% tax free yield. When using tools such as Fidelity’s tax calculator, that is equivalent to over 6% yield on a taxable investment.

What are your thoughts?

 

[jebmke]

I prefer equity index funds in a taxable account since their volatility gives me opportunities to tax loss harvest and defer the income in the form of unrealized capital gains.

Can't avoid the dividends, unfortunately but those are taxed at 15% generally + my state rate.

 

[COcheesehead]

Tax efficient ETFs or muni bonds, just don’t invest in funds. The distributions are out of your control and can be a tax gotcha - paying a tax on something you don’t really benefit from.

 

[SecondCor521]

I tend to look at my overall AA first, then asset placement (where to put the various parts of my AA). If those two steps result in bonds in taxable, then if I'm a "high bracket" taxpayer I would look at state muni bonds (or a state muni bond fund) for taxable. "High bracket" is probably 24% or more.

My Dad's and my AA are sufficiently aggressive and our traditional IRAs are large enough that all of our bonds are in our traditional IRAs. The rest of our traditional IRAs, our Roth IRAs, and our taxable are all in stocks.

There's a good "asset placement" article over on Bogleheads that you might like that talks about this stuff.

One consequence of this approach that I'm not fond of is that the taxable account might be quite variable when drawing on it. For those of us drawing on it before a given age (either retirement age or RMD age), this can raise the concern of running out if that variability runs against us during the draw period. We mitigate this issue by having lower than necessary withdrawal rates; there are other methods.

 

[COcheesehead]

Laddering bonds is a good SORR solution if one intends to live initially off the taxable account. The variability is minimized.

 

[imbatman]

I am also in a high tax state (not CA) so for me in my taxable accounts it is (in order of preference):

1) State Munis (no tax at all)
2) Munis from other States (no fed tax)
3) Agencies (no state / local tax)
4) Treasuries (no state / local tax)
5) Whatever left you want to allocate to stocks/stock funds/etfs /taxable bonds

Just always make sure you aren't too concentrated in any category or too heavily weighted within a category to small number of holdings. Ex. The last year it has been easy to load up on high-yielding HSG Munis such that I will buy lower yielding munis from other areas just to get diversification.

 

[OldShooter]

Don't let the tax tail wag the investment strategy dog. Historically, equities have far outperformed the kind of investments you are talking about here.

The goal of the game is to maximize the amount of money in your pocket over the long term. It is not to minimize taxes.

 

[COcheesehead]

If you are drawing on equities in a taxable account to fund your expenses, make sure you understand sequence of return risk.

 

[imbatman]

Don't let the tax tail wag the investment strategy dog. Historically, equities have far outperformed the kind of investments you are talking about here.

The goal of the game is to maximize the amount of money in your pocket over the long term. It is not to minimize taxes.

...yes your point is well taken and lots of truth there.... but in our super high-tax states (ex. California could find you at a fed/state 35+% pretty easily), one can quickly reach a point where you are taking on a lot more volatility/ risk in equities for an unequitable amount of potential excess return...........and the goal of my game isn't solely to maximize $$ in my pocket but to balance that desire with stability and reliability. Luckily, low tax rate holdings are also more stable and reliable.

 

[OldShooter]

...yes your point is well taken and lots of truth there.... but in our super high-tax states (ex. California could find you at a fed/state 35+% pretty easily), one can quickly reach a point where you are taking on a lot more volatility/ risk in equities for an unequitable amount of potential excess return...........and the goal of my game isn't solely to maximize $$ in my pocket but to balance that desire with stability and reliability. Luckily, low tax rate holdings are also more stable and reliable.

Yes, it depends on our individual attitudes. And yes, know about taxes. We paid for a vacation home with IRA withdrawals this year and can only dream of taxes totaling only 35%.

But I view equities as long term investments and not particularly risky -- just posted this slide in another thread here:

Finally I don't buy the idea that volatility is risk except in SORR situations. Risk is Sears, GE, Enron, Worldcom, etc. I deal with this risk by diversification and I pay no attention to standard deviation. (SD doesn't even mean anything in a statistical context because the distribution of stock prices is not Gaussian.)

 

[Fotodog]

Thanks for all the responses. I understand the potential upside for growth with an index fund versus Munis, and also the benefits of tax loss harvesting. But I agree with COcheesehead that SORR is an important consideration, and in my case might be the overriding factor. Between Roth conversion taxes and withdrawals for living expenses, this account is likely to be depleted within 5 or 6 years, so it’s not long term. I have my index funds in my tIRA to ride out the ups and downs of the market.

 

[RetireRay]

Your Federal taxable gains rate may be zero, if your ordinary income levels are low enough. Good reason to lean towards equities.

 

[jim584672]

US Treasuries have no state taxes.

 

[captain3d]

Ca tax is graduated. So can be lower or higher.

 

[Stormy Kromer]

I am also in a state that taxes LTGC as ordinary income, so I try to minimize them even though the Fed tax code is very favorable. I used to ignore LTGC and dividends but now they are increasing as my portfolio increases and I see the impact they have on ACA and State Income taxes.

I put my new investments in Vanguard Tax Managed Capital Appreciation Fund (VTCLX) Very similar holdings to their Total Stock Market Fund with an eye towards tax efficiency.

I wish I had learned more about ETF's and invested in them instead.

 

[DangerDad]

Taxable account in California:
For stocks consider VTCLX
For bonds consider VCADX

 

[target2019]

Thanks for all the responses. I understand the potential upside for growth with an index fund versus Munis, and also the benefits of tax loss harvesting. But I agree with COcheesehead that SORR is an important consideration, and in my case might be the overriding factor. Between Roth conversion taxes and withdrawals for living expenses, this account is likely to be depleted within 5 or 6 years, so it’s not long term. I have my index funds in my tIRA to ride out the ups and downs of the market.

Vanguard Muni Tax Funds?

VCTXX-Vanguard California Municipal Money Market Fund

VCAIX-Vanguard California Intermediate-Term Tax-Exempt

 

[ducky911]

Vtmfx

 

[OldShooter]

Thanks for all the responses. I understand the potential upside for growth with an index fund versus Munis, and also the benefits of tax loss harvesting. But I agree with COcheesehead that SORR is an important consideration, and in my case might be the overriding factor. Between Roth conversion taxes and withdrawals for living expenses, this account is likely to be depleted within 5 or 6 years, so it’s not long term. I have my index funds in my tIRA to ride out the ups and downs of the market.

For a five or six year horizon I retract my suggestion that equities are a better choice than fixed income. As you say, that is not long term. Probably all fixed income is the sleep well recipe. Some equities with a five or six year plan might be OK depending on your personal sleep factor.