when to sell equities when using taxable and no EF

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tomsense76
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Re: when to sell equities when using taxable and no EF

Post by tomsense76 »

Marseille07 wrote: Sat Oct 16, 2021 5:23 pm
MrJedi wrote: Sat Oct 16, 2021 2:26 pm I guess I don't understand the aversion to selling out of taxable if you need the money. If you are investing in taxable consistently, you probably have high cost basis shares that would result in very low gains or even losses. You also have the option for preferential tax treatment for LTCG for long term shares. This is the whole point to be more tax efficient.

If you instead try to shift your taxable to cash, bonds or tax exempt bonds, you are guaranteeing yourself to either get subject to ordinary income tax or choosing lower yielding tax exempt bonds vs keeping "normal" bonds in a 401k or similar.
When they have 150K of bonds in 401K, they want to spend that down before equities. It doesn't make any sense to sell stocks and keep 150K of bonds in 401K.

The solution is simple, they need to slash some of the 150K fixed income in 401K and hold bonds in taxable so they can slash if they run into a cashflow issue.
Yeah OP could rebalance. Though given their higher tax rate and the frequency of the liquidity issues, selling equity in taxable will result in more substantial tax drag.

Simply holding fixed income in taxable (as you suggested) should simplify this process and cutdown on tax drag significantly. If OP uses munis, they will actually earn more after tax vs. taxable bonds that are held in their 401k currently.
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Re: when to sell equities when using taxable and no EF

Post by MrJedi »

Marseille07 wrote: Sat Oct 16, 2021 5:23 pm
MrJedi wrote: Sat Oct 16, 2021 2:26 pm I guess I don't understand the aversion to selling out of taxable if you need the money. If you are investing in taxable consistently, you probably have high cost basis shares that would result in very low gains or even losses. You also have the option for preferential tax treatment for LTCG for long term shares. This is the whole point to be more tax efficient.

If you instead try to shift your taxable to cash, bonds or tax exempt bonds, you are guaranteeing yourself to either get subject to ordinary income tax or choosing lower yielding tax exempt bonds vs keeping "normal" bonds in a 401k or similar.
When they have 150K of bonds in 401K, they want to spend that down before equities. It doesn't make any sense to sell stocks and keep 150K of bonds in 401K.

The solution is simple, they need to slash some of the 150K fixed income in 401K and hold bonds in taxable so they can slash if they run into a cashflow issue.
Why does it not make sense to sell the equities? The equities have favorable tax treatment compared to bonds. You sell the equities and the rebalance your 401k bonds into 401k equities if you want to preserve your equity exposure. This can even turn into a tax deduction if you have losses on the taxable side to sell.

If you hold the bonds in taxable, you are guaranteeing to hit yourself with ordinary income tax or otherwise compromising with lower yielding tax exempt bonds.
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Re: when to sell equities when using taxable and no EF

Post by MrJedi »

tomsense76 wrote: Sat Oct 16, 2021 5:33 pm
Marseille07 wrote: Sat Oct 16, 2021 5:23 pm
MrJedi wrote: Sat Oct 16, 2021 2:26 pm I guess I don't understand the aversion to selling out of taxable if you need the money. If you are investing in taxable consistently, you probably have high cost basis shares that would result in very low gains or even losses. You also have the option for preferential tax treatment for LTCG for long term shares. This is the whole point to be more tax efficient.

If you instead try to shift your taxable to cash, bonds or tax exempt bonds, you are guaranteeing yourself to either get subject to ordinary income tax or choosing lower yielding tax exempt bonds vs keeping "normal" bonds in a 401k or similar.
When they have 150K of bonds in 401K, they want to spend that down before equities. It doesn't make any sense to sell stocks and keep 150K of bonds in 401K.

The solution is simple, they need to slash some of the 150K fixed income in 401K and hold bonds in taxable so they can slash if they run into a cashflow issue.
Yeah OP could rebalance. Though given their higher tax rate and the frequency of the liquidity issues, selling equity in taxable will result in more substantial tax drag.

Simply holding fixed income in taxable (as you suggested) should simplify this process and cutdown on tax drag significantly. If OP uses munis, they will actually earn more after tax vs. taxable bonds that are held in their 401k currently.
Fixed income in taxable is the worst kind of tax drag, ordinary income tax every year. Yes tax exempt bonds will alleviate that but they yield less and you can otherwise just put your bonds in the 401k. Tax exempt bonds make more sense for somebody who already has a 401k completely filled with bonds and has no more space other than taxable.

Equities are taxed much more favorably.
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Re: when to sell equities when using taxable and no EF

Post by Marseille07 »

MrJedi wrote: Sat Oct 16, 2021 5:37 pm Why does it not make sense to sell the equities? The equities have favorable tax treatment compared to bonds. You sell the equities and the rebalance your 401k bonds into 401k equities if you want to preserve your equity exposure. This can even turn into a tax deduction if you have losses on the taxable side to sell.

If you hold the bonds in taxable, you are guaranteeing to hit yourself with ordinary income tax or otherwise compromising with lower yielding tax exempt bonds.
Yes, you can sell taxable, sell the bonds in 401K and buy equities in 401K...that's essentially the same as not selling equities. I'm not a bonds person, my approach would simply be to go 100/0 in 401K and hold cash in HYSA and call it a day. No cashflow issues as I'd hold way more than 25K.
tomsense76
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Re: when to sell equities when using taxable and no EF

Post by tomsense76 »

MrJedi wrote: Sat Oct 16, 2021 5:41 pm Fixed income in taxable is the worst kind of tax drag, ordinary income tax every year. Yes tax exempt bonds will alleviate that but they yield less and you can otherwise just put your bonds in the 401k. Tax exempt bonds make more sense for somebody who already has a 401k completely filled with bonds and has no more space other than taxable.

Equities are taxed much more favorably.
Right that's why we are suggesting munis. I think we are agreeing :sharebeer

Just for context OP is in the 32% bracket (MFJ IIUC), which means they are also subject to NIIT (3.8%). Though should still be in typical LTCG/QD tax bracket (15%). So Federally they are looking at 35.8% on ordinary income and 18.8% on LTCG/QD. We don't know OP's state tax rate atm, but the effect would be the same for everything considered below (we could optimize further for the state though).

So they can either choose Vanguard Total Bond with SEC yield of 0.88% after tax (pre-tax 1.37%) or they can choose Fidelity Municipal Bond Index with SEC yield of 0.91%. IOW they are looking 0.03% more by using munis. Not to mention the munis chosen have a lower duration than taxable bonds. So OP would be taking on less interest rate risk and earning a bit more.

In addition stocks in taxable face tax drag for OP from dividends. Taking VTI (one of OP's holdings) for simplicity, the current dividend yield is 1.25% (this varies of course). With 18.8% LTCG tax, OP is looking at a tax drag of 0.235%. However if they are holding in munis in taxable, the equivalent sized stock holding can be moved to OP's 401k. IOW OP can save 0.235%, which is added to the 0.03% advantage of munis in taxable to net OP 0.265%.

Lastly selling in taxable for any liquidity needs would face an 18.8% LTCG tax. As most of stocks value comes from growth as opposed to dividends this could be significant. Whereas munis mainly generate income with very little capital appreciation. So OP would largely avoid this tax by using munis for liquidity crunches as well.

Please feel free to check my math. Though the main point is OP nets a decent chunk by tax optimizing here and holding munis in taxable. This will help OP with the liquidity crunches and generally provide better return on an after tax basis.
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Re: when to sell equities when using taxable and no EF

Post by grabiner »

tomsense76 wrote: Sat Oct 16, 2021 5:29 pm Ok so knowing that you are at Fidelity, one option might be Fidelity Municipal Bond Index Fund (FMBIX). While the fund is somewhat new, it is a low cost, broadly diversified, high quality, intermediate-term index fund.

One can improve on this by following grabiner's suggestion above ( viewtopic.php?p=6273674#p6273674 ) and finding a long-term tax-exempt bond fund that is state specific and using a nationally diversified short-term tax-exempt bond fund. One then barbells these 50/50 for intermediate term. The main challenge is at Fidelity these may be higher expense funds.
I wouldn't recommend doing this with Fidelity funds. The single-state funds at Fidelity all have at least 0.45% expenses, while the index has 0.07% expenses. The tax savings from using a single-state fund is less than the amount you lose to higher expenses.

I recommend this strategy at Vanguard, where the national and single-state funds have similar expenses. But if you have a Fidelity account, you will pay a transaction fee to hold Vanguard mutual funds there, and Vanguard doesn't have an ETF version of its single-state funds.
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Re: when to sell equities when using taxable and no EF

Post by tomsense76 »

grabiner wrote: Sat Oct 16, 2021 6:14 pm
tomsense76 wrote: Sat Oct 16, 2021 5:29 pm Ok so knowing that you are at Fidelity, one option might be Fidelity Municipal Bond Index Fund (FMBIX). While the fund is somewhat new, it is a low cost, broadly diversified, high quality, intermediate-term index fund.

One can improve on this by following grabiner's suggestion above ( viewtopic.php?p=6273674#p6273674 ) and finding a long-term tax-exempt bond fund that is state specific and using a nationally diversified short-term tax-exempt bond fund. One then barbells these 50/50 for intermediate term. The main challenge is at Fidelity these may be higher expense funds.
I wouldn't recommend doing this with Fidelity funds. The single-state funds at Fidelity all have at least 0.45% expenses, while the index has 0.07% expenses. The tax savings from using a single-state fund is less than the amount you lose to higher expenses.

I recommend this strategy at Vanguard, where the national and single-state funds have similar expenses. But if you have a Fidelity account, you will pay a transaction fee to hold Vanguard mutual funds there, and Vanguard doesn't have an ETF version of its single-state funds.
Thanks for the counterpoint. Yeah was wondering about that. Would it make sense for a high tax state (like CA or NY)? Or is the high expense ratio still too much of a hurdle?
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Re: when to sell equities when using taxable and no EF

Post by grabiner »

tomsense76 wrote: Sat Oct 16, 2021 6:23 pm
grabiner wrote: Sat Oct 16, 2021 6:14 pm
tomsense76 wrote: Sat Oct 16, 2021 5:29 pm Ok so knowing that you are at Fidelity, one option might be Fidelity Municipal Bond Index Fund (FMBIX). While the fund is somewhat new, it is a low cost, broadly diversified, high quality, intermediate-term index fund.

One can improve on this by following grabiner's suggestion above ( viewtopic.php?p=6273674#p6273674 ) and finding a long-term tax-exempt bond fund that is state specific and using a nationally diversified short-term tax-exempt bond fund. One then barbells these 50/50 for intermediate term. The main challenge is at Fidelity these may be higher expense funds.
I wouldn't recommend doing this with Fidelity funds. The single-state funds at Fidelity all have at least 0.45% expenses, while the index has 0.07% expenses. The tax savings from using a single-state fund is less than the amount you lose to higher expenses.

I recommend this strategy at Vanguard, where the national and single-state funds have similar expenses. But if you have a Fidelity account, you will pay a transaction fee to hold Vanguard mutual funds there, and Vanguard doesn't have an ETF version of its single-state funds.
Thanks for the counterpoint. Yeah was wondering about that. Would it make sense for a high tax state (like CA or NY)? Or is the high expense ratio still too much of a hurdle?
At current rates, it doesn't make sense in any state. If you are in the top CA 12.3% tax bracket, then a national muni fund with a 3% yield would cost you 0.37% in taxes. Fidelity's CA muni fund costs 0.38% more in expenses than the national index. Therefore, it would only be potentially worthwhile if the national index yielded over 3%. (The actual yields of the funds may differ for reasons other than expenses, but those reasons, such as different duration and credit, are based on fair compensation for risk.)
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Re: when to sell equities when using taxable and no EF

Post by MrJedi »

tomsense76 wrote: Sat Oct 16, 2021 6:12 pm
MrJedi wrote: Sat Oct 16, 2021 5:41 pm Fixed income in taxable is the worst kind of tax drag, ordinary income tax every year. Yes tax exempt bonds will alleviate that but they yield less and you can otherwise just put your bonds in the 401k. Tax exempt bonds make more sense for somebody who already has a 401k completely filled with bonds and has no more space other than taxable.

Equities are taxed much more favorably.
Right that's why we are suggesting munis. I think we are agreeing :sharebeer

Just for context OP is in the 32% bracket (MFJ IIUC), which means they are also subject to NIIT (3.8%). Though should still be in typical LTCG/QD tax bracket (15%). So Federally they are looking at 35.8% on ordinary income and 18.8% on LTCG/QD. We don't know OP's state tax rate atm, but the effect would be the same for everything considered below (we could optimize further for the state though).

So they can either choose Vanguard Total Bond with SEC yield of 0.88% after tax (pre-tax 1.37%) or they can choose Fidelity Municipal Bond Index with SEC yield of 0.91%. IOW they are looking 0.03% more by using munis. Not to mention the munis chosen have a lower duration than taxable bonds. So OP would be taking on less interest rate risk and earning a bit more.

In addition stocks in taxable face tax drag for OP from dividends. Taking VTI (one of OP's holdings) for simplicity, the current dividend yield is 1.25% (this varies of course). With 18.8% LTCG tax, OP is looking at a tax drag of 0.235%. However if they are holding in munis in taxable, the equivalent sized stock holding can be moved to OP's 401k. IOW OP can save 0.235%, which is added to the 0.03% advantage of munis in taxable to net OP 0.265%.

Lastly selling in taxable for any liquidity needs would face an 18.8% LTCG tax. As most of stocks value comes from growth as opposed to dividends this could be significant. Whereas munis mainly generate income with very little capital appreciation. So OP would largely avoid this tax by using munis for liquidity crunches as well.

Please feel free to check my math. Though the main point is OP nets a decent chunk by tax optimizing here and holding munis in taxable. This will help OP with the liquidity crunches and generally provide better return on an after tax basis.
I don't quite fully agree, but I will admit that the tax efficiency benefit of stocks in taxable is not as significant right now because bonds right now are fairly tax efficient due to the current low interest rate environment (low yield = low tax, so not necessarily a good thing). I think the numbers work fairly close right now, but if/when interest rates go up, the tax efficiency of stocks will be more significant.

You cite shielding stock dividends in the 401k by using lower yield muni bonds in taxable. However you will have to eventually pay ordinary tax on those dividends and stock growth in a tax deferred account. In the same vain you can shield a taxable bond in the 401k while taking the stock dividends in taxable which are more tax efficient instead of relying on a lower yield tax exempt bond in taxable.

As mentioned I do not think it makes a big difference right now with bonds yielding so little.
tomsense76
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Re: when to sell equities when using taxable and no EF

Post by tomsense76 »

MrJedi wrote: Sat Oct 16, 2021 6:57 pm You cite shielding stock dividends in the 401k by using lower yield muni bonds in taxable. However you will have to eventually pay ordinary tax on those dividends and stock growth in a tax deferred account. In the same vain you can shield a taxable bond in the 401k while taking the stock dividends in taxable which are more tax efficient instead of relying on a lower yield tax exempt bond in taxable.
Going to focus on this point, since this seems to be where we differ most. The main thing for a higher income individual with a high savings rate is they are socking away significantly more in taxable than they are in any retirement account. As we know a high contribution rate will be the biggest factor in account growth. So the issue they are going to run into is actually having comparatively less in retirement accounts, which gives them less tax diversification when reaching retirement. One way they can fix this is holding stocks in those accounts to help them grow a bit faster. Upon reaching retirement, its pretty simple to sell muni in taxable (for minimal tax cost) and buy stocks moving an equal amount in tax-deferred to bonds. If the tax cost is more significant, they can fund living cost with munis rebalancing in tax-deferred to preserve their asset allocation thus moving the fixed income incrementally each year.

While it is true that tax-deferred accounts result in ordinary income tax in retirement, IMHO tax-deferred unfairly gets a bad rap. In retirement one likely has higher medical expenses, which are tax deductible. If one opts to get LTC insurance, this can also be paid for with tax-deferred and receive a tax deduction. If OP is concerned about longevity risk, they can buy an annuity with tax-deferred. Yes that will be taxed as ordinary income, but that would have happened even if OP withdrew from the account. Plus this would be beneficial from a tax planning perspective for OP's heirs, who would receive taxable with a step-up in basis and Roth. They can also opt to Roth convert some of the balance in low income years using munis to fund the conversion in a fairly tax efficient fashion providing more tax-free money later. Finally if OP has more than they need and is charitably inclined, tax-deferred can be used to make QCD to charities of OPs choosing. While OP could fund charities out of other accounts, tax-deferred will be best from a tax perspective.
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Re: when to sell equities when using taxable and no EF

Post by masrepus »

grabiner wrote: Sat Oct 16, 2021 6:14 pm
tomsense76 wrote: Sat Oct 16, 2021 5:29 pm Ok so knowing that you are at Fidelity, one option might be Fidelity Municipal Bond Index Fund (FMBIX). While the fund is somewhat new, it is a low cost, broadly diversified, high quality, intermediate-term index fund.

One can improve on this by following grabiner's suggestion above ( viewtopic.php?p=6273674#p6273674 ) and finding a long-term tax-exempt bond fund that is state specific and using a nationally diversified short-term tax-exempt bond fund. One then barbells these 50/50 for intermediate term. The main challenge is at Fidelity these may be higher expense funds.
I wouldn't recommend doing this with Fidelity funds. The single-state funds at Fidelity all have at least 0.45% expenses, while the index has 0.07% expenses. The tax savings from using a single-state fund is less than the amount you lose to higher expenses.

I recommend this strategy at Vanguard, where the national and single-state funds have similar expenses. But if you have a Fidelity account, you will pay a transaction fee to hold Vanguard mutual funds there, and Vanguard doesn't have an ETF version of its single-state funds.
To answer the question about the state, it is NC. I haven't found any good bonds here, so I agree that wouldn't work well.
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masrepus
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Re: when to sell equities when using taxable and no EF

Post by masrepus »

tomsense76 wrote: Sat Oct 16, 2021 6:12 pm
MrJedi wrote: Sat Oct 16, 2021 5:41 pm Fixed income in taxable is the worst kind of tax drag, ordinary income tax every year. Yes tax exempt bonds will alleviate that but they yield less and you can otherwise just put your bonds in the 401k. Tax exempt bonds make more sense for somebody who already has a 401k completely filled with bonds and has no more space other than taxable.

Equities are taxed much more favorably.
Right that's why we are suggesting munis. I think we are agreeing :sharebeer

Just for context OP is in the 32% bracket (MFJ IIUC), which means they are also subject to NIIT (3.8%). Though should still be in typical LTCG/QD tax bracket (15%). So Federally they are looking at 35.8% on ordinary income and 18.8% on LTCG/QD. We don't know OP's state tax rate atm, but the effect would be the same for everything considered below (we could optimize further for the state though).
NC is the state, so 5.25% income tax rate. And yes to getting hit with the NIIT also.
tomsense76 wrote: Sat Oct 16, 2021 6:12 pm So they can either choose Vanguard Total Bond with SEC yield of 0.88% after tax (pre-tax 1.37%) or they can choose Fidelity Municipal Bond Index with SEC yield of 0.91%. IOW they are looking 0.03% more by using munis. Not to mention the munis chosen have a lower duration than taxable bonds. So OP would be taking on less interest rate risk and earning a bit more.

In addition stocks in taxable face tax drag for OP from dividends. Taking VTI (one of OP's holdings) for simplicity, the current dividend yield is 1.25% (this varies of course). With 18.8% LTCG tax, OP is looking at a tax drag of 0.235%. However if they are holding in munis in taxable, the equivalent sized stock holding can be moved to OP's 401k. IOW OP can save 0.235%, which is added to the 0.03% advantage of munis in taxable to net OP 0.265%.

Lastly selling in taxable for any liquidity needs would face an 18.8% LTCG tax. As most of stocks value comes from growth as opposed to dividends this could be significant. Whereas munis mainly generate income with very little capital appreciation. So OP would largely avoid this tax by using munis for liquidity crunches as well.

Please feel free to check my math. Though the main point is OP nets a decent chunk by tax optimizing here and holding munis in taxable. This will help OP with the liquidity crunches and generally provide better return on an after tax basis.
It is going to take me a little to digest this info, but I have to say THANKS! My napkin math was nowhere near as detailed as this, so your comments are very helpful. These are the kinds of details that bring clarity to the decisions. I still admit, I need to understand the whole use taxable, exchange bonds for equities in 401k idea to make sure it isn't better. The mechanics of the idea are understandable, but I have never done it so just not comfortable with it. It seems like about a wash compared to keeping more fixed income in taxable. But keeping only 50k to 100k in taxable it isn't a huge number either way.

Also earlier you mentioned the taxable will overtake the 401k. I do Megabackdoor Roth, so that side still grows, but the taxable does get the bulk of the savings currently since the RSUs come in quarterly and are multiples of what I can contribute to the 401k. The taxable is not larger yet, but it will be in a couple years if the market holds. Either way, I full fund pre-tax, then post-tax (to Roth), backdoor Roth and HSA, and then the rest to taxable.

I will also add I have my first child entering college in a couple years, so I am sure the cash flow issue will again rear it's head. Having a greater fixed income position in the taxable will help. I have 529's for all the kids, but I started those late and the state does not have a a deduction. I have invested fairly aggressively, with the plan if things are not looking so good in years 2-6 then I will just roll those dollars to the next kid's 529. I only have about 125k total across four 529's, so I have a way to go to fully fund four, 4-year educations at 100k each. If the money is there great, if not take out some loans unless I can cash flow it.

Next point, my current plan is 10-15 years continuing work. If things are looking good the next 6 years, I could see early retirement at 55. At that point I can use the 401k, though I do have a good chunk in Roth so I can get by for a while. Having more fixed income in taxable will also help in this plan to avoid needing the 401k money. With the kids school, though, I might have to keep working. Unless the drop in income helps with need-based aid, though I think we would still be too high.
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Re: when to sell equities when using taxable and no EF

Post by Marseille07 »

Tbh you should hold 5% of AA in cash. Based on my understanding, your AA is 1.5M and 150K is in bonds; I'd split that into 75K cash 75K bonds and call it a day.
tomsense76
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Re: when to sell equities when using taxable and no EF

Post by tomsense76 »

masrepus wrote: Sun Oct 17, 2021 10:07 am It is going to take me a little to digest this info, but I have to say THANKS! My napkin math was nowhere near as detailed as this, so your comments are very helpful. These are the kinds of details that bring clarity to the decisions. I still admit, I need to understand the whole use taxable, exchange bonds for equities in 401k idea to make sure it isn't better. The mechanics of the idea are understandable, but I have never done it so just not comfortable with it. It seems like about a wash compared to keeping more fixed income in taxable. But keeping only 50k to 100k in taxable it isn't a huge number either way.

Also earlier you mentioned the taxable will overtake the 401k. I do Megabackdoor Roth, so that side still grows, but the taxable does get the bulk of the savings currently since the RSUs come in quarterly and are multiples of what I can contribute to the 401k. The taxable is not larger yet, but it will be in a couple years if the market holds. Either way, I full fund pre-tax, then post-tax (to Roth), backdoor Roth and HSA, and then the rest to taxable.

I will also add I have my first child entering college in a couple years, so I am sure the cash flow issue will again rear it's head. Having a greater fixed income position in the taxable will help. I have 529's for all the kids, but I started those late and the state does not have a a deduction. I have invested fairly aggressively, with the plan if things are not looking so good in years 2-6 then I will just roll those dollars to the next kid's 529. I only have about 125k total across four 529's, so I have a way to go to fully fund four, 4-year educations at 100k each. If the money is there great, if not take out some loans unless I can cash flow it.

Next point, my current plan is 10-15 years continuing work. If things are looking good the next 6 years, I could see early retirement at 55. At that point I can use the 401k, though I do have a good chunk in Roth so I can get by for a while. Having more fixed income in taxable will also help in this plan to avoid needing the 401k money. With the kids school, though, I might have to keep working. Unless the drop in income helps with need-based aid, though I think we would still be too high.
No worries. Take your time. Glad it was useful :D

Yeah it's trickier to model how selling in taxable will behave as it depends on the sequence of returns. We can estimate using long running averages, but the reality is we don't actually know what those returns look like (particularly in the short-term). Also there can be some optionality as to which tax lots one sells using SpecID.

The average return of the S&P 500 has been 8% since 1957. The portion attributable to capital appreciation over that time frame is ~2/3. IOW on average 5.33% has been due to capital appreciation. If one sells every year and we assume the average return (this latter part is a big if as it could be much higher or lower), then at 18.8% LTCG one is losing ~1%/year to taxes. Now this ~1% is just on the portion sold. So it really depends how much one is needing to sell per year. With munis, they are mostly about dividends and not capital appreciation. Though hopefully this gives you some context to wrap your mind around this use case.

Yep it seems like munis would be applicable to you for a variety of reasons.

Going aggressive in the 529s makes sense, one could approximate a more conservative allocation by holding munis in taxable to create a more balanced allocation. The main advantage of 529s is the tax free growth. So avoid bonds in 529s and holding them elsewhere seems sensible.

While the math above is focused on going all in on munis, the reality is probably more mixed. Munis can be a bumpier ride than treasuries or a total bond heavily weighted in treasuries. There are several people that recommend limiting the amount in munis. No more than 50% in munis is a common rule of thumb. For example, here's a quote from Bill Bernstein on this:
But I think that less than half of your bond portfolio should be in munis, and less than half your munis should be obviously in a single state’s munis, as attractive as that may be if you’re in California or New York. You’re taking too much concentrated risk by, you know, owning all of your munis in, in one state.
So it is possible that some munis in taxable and some Total Bond in 401k will make a good mix. One can sell some munis to cover expenses with minimal tax drag. If the expense is larger, one can start selling stocks in taxable. In other accounts one can rebalance to keep the same asset allocation.

Something else to look into would be savings bonds. In particular would look at I Bonds (maybe EE Bonds as well). These can expand your tax-deferred space while also putting some bonds in taxable where they are easily accessible. Taxes are deferred on them until redeemed or they mature, whichever comes first. There are limits on how much can be purchased per year (for I Bonds $10k/person and $5k/tax return; so $25k/couple). Though these could be a secondary source of liquidity (due to the purchase limits and time to accumulate one wants to avoid tapping into these until necessary).

Anyways hopefully that provides some more food for thought :happy
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