Trying to understand TEY on a Municipal Bond Fund (Taxable)?
Trying to understand TEY on a Municipal Bond Fund (Taxable)?
I am in the 35% Federal tax bracket and 6.37% State tax bracket and my income is above the MAPI threshold so on a Treasury Bond Fund I would owe a 3.8% Medicare Tax. I am trying to understand the tax benefit for me of an intermediate term tax exempt bond fund (VWIUX) vs. a intermediate term treasury bond fund (VSIGX).
The municipal bond fund income would be Federally tax exempt, exempt to Medicare but taxed by my state at 6.37%
1 - 0.0637 = 0.9363 for VWIUX
VNJUX SEC 30 day Yield = 0.89%
TEY = 0.95%
The treasury bond fund would be exempt to State taxes, but taxed as 15% in my income tax bracket and subject to a 3.8% medicare tax.
1 - 0.188 = 0.812 for VSIGX
VSIGX SEC 30 day Yield = 1.29%
TEY = 1.05%
I am at a fairly high tax bracket so I thought the risk premium for municipal bonds over treasury bonds would be worth while. Am I missing something or is there just not a lot of benefit (Caveat, I suppose the SEC 30 day yield can and will change)?
The municipal bond fund income would be Federally tax exempt, exempt to Medicare but taxed by my state at 6.37%
1 - 0.0637 = 0.9363 for VWIUX
VNJUX SEC 30 day Yield = 0.89%
TEY = 0.95%
The treasury bond fund would be exempt to State taxes, but taxed as 15% in my income tax bracket and subject to a 3.8% medicare tax.
1 - 0.188 = 0.812 for VSIGX
VSIGX SEC 30 day Yield = 1.29%
TEY = 1.05%
I am at a fairly high tax bracket so I thought the risk premium for municipal bonds over treasury bonds would be worth while. Am I missing something or is there just not a lot of benefit (Caveat, I suppose the SEC 30 day yield can and will change)?
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Re: Trying to understand TEY on a Municipal Bond Fund (Taxable)?
Several comments/questions.
Why are you using a 15% income tax rate on your Treasury bond? Shouldn't it be 25%+3.8%=38.8%?
I am not following your math or logic, but I will share my process doing the analysis I believe you are trying to accomplish.
1.) identify the current SEC 30 yields for the funds in question.
as of 1/13 or 1/14 as per vanguard.com
Fund = Y
VWIUX = 0.89%
VNJUX = 1.35%
VSIGX = 1.29%
VBTLX = 1.66%
2.) identify the tax treatment for each fund, based up on how much of each fund is invested in as a percentage of the fund assets. You can look this up using last year's tax reporting information from Vanguard. This is what I have recorded for 2020, as 2021 is not yet published.
- In-state Munis (Ps)
- Out-of-state Munis (Pm)
- Treasuries (Pg)
- Fully Taxable (Pt)
- Technically, AMT may be an issue if you have other large tax deductions, but we'll leave this out of the discussion
Fund = Ps, Pm, Pg, Pt
VWUIX = 0%, 100%, 0%, 0%
VNJUX = 100%, 0%, 0%, 0%
VSIGX = 0%, 0%, 100%, 0%
VBTLX = 0%, 0%, 35%, 65%
3.) Specify your marginal state (s) and federal (f) tax rates
f = 38.8%
s = 6.37%
3.) Use the following formulas to calculate the TEY so we can compare against something like VBTLX
TEY = Y * Ps / (1-f-s) + Y * Pm * (1-s) / (1-f-s) + Y * Pg * (1-f) / ( 1-f-s) + Y * Pt
Note, I will leave out the addend components that have Px = 0 since they will be zero in all cases.
So for VWUIX TEY = 0 + 0.89% * 1 * (1-.0637) / (1-.388-.0637) + 0 + 0 = 1.52%
VNJUX = 1.35% * 1 / (1-.388-.0637) + 0 + 0 + 0 = 2.46%
VSIGX = 0 + 0 + 1.29% * 1 * (1-.388) / (1-.388-.0637) + 0 = 1.44%
VBTLX = 0 + 0 + 1.66% * .35 * (1-.388) / (1-.388-.0637) + 1.66% * .65 = 1.73%
As you can see, Total Bond is actually giving a pretty decent yield against both VWUIX and VSIGX. This is not surprising as corporate bond rates are rising faster than Treasuries. BTW, NJ even with its concentration risk looks like a potentially valuable option at your rates.
Also, the duration of VBTLX is longer than VWIUX and VSIGX so they are not as risky though...
Why are you using a 15% income tax rate on your Treasury bond? Shouldn't it be 25%+3.8%=38.8%?
I am not following your math or logic, but I will share my process doing the analysis I believe you are trying to accomplish.
1.) identify the current SEC 30 yields for the funds in question.
as of 1/13 or 1/14 as per vanguard.com
Fund = Y
VWIUX = 0.89%
VNJUX = 1.35%
VSIGX = 1.29%
VBTLX = 1.66%
2.) identify the tax treatment for each fund, based up on how much of each fund is invested in as a percentage of the fund assets. You can look this up using last year's tax reporting information from Vanguard. This is what I have recorded for 2020, as 2021 is not yet published.
- In-state Munis (Ps)
- Out-of-state Munis (Pm)
- Treasuries (Pg)
- Fully Taxable (Pt)
- Technically, AMT may be an issue if you have other large tax deductions, but we'll leave this out of the discussion
Fund = Ps, Pm, Pg, Pt
VWUIX = 0%, 100%, 0%, 0%
VNJUX = 100%, 0%, 0%, 0%
VSIGX = 0%, 0%, 100%, 0%
VBTLX = 0%, 0%, 35%, 65%
3.) Specify your marginal state (s) and federal (f) tax rates
f = 38.8%
s = 6.37%
3.) Use the following formulas to calculate the TEY so we can compare against something like VBTLX
TEY = Y * Ps / (1-f-s) + Y * Pm * (1-s) / (1-f-s) + Y * Pg * (1-f) / ( 1-f-s) + Y * Pt
Note, I will leave out the addend components that have Px = 0 since they will be zero in all cases.
So for VWUIX TEY = 0 + 0.89% * 1 * (1-.0637) / (1-.388-.0637) + 0 + 0 = 1.52%
VNJUX = 1.35% * 1 / (1-.388-.0637) + 0 + 0 + 0 = 2.46%
VSIGX = 0 + 0 + 1.29% * 1 * (1-.388) / (1-.388-.0637) + 0 = 1.44%
VBTLX = 0 + 0 + 1.66% * .35 * (1-.388) / (1-.388-.0637) + 1.66% * .65 = 1.73%
As you can see, Total Bond is actually giving a pretty decent yield against both VWUIX and VSIGX. This is not surprising as corporate bond rates are rising faster than Treasuries. BTW, NJ even with its concentration risk looks like a potentially valuable option at your rates.
Also, the duration of VBTLX is longer than VWIUX and VSIGX so they are not as risky though...
Last edited by retiringwhen on Sun Jan 16, 2022 2:40 pm, edited 2 times in total.
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Re: Trying to understand TEY on a Municipal Bond Fund (Taxable)?
BTW, I prefer to calculate After Tax Yield (ATY) as the math is much more obvious. Here is that formula applied to the funds and data above:
ATY = Y * Ps + Y * Pm * (1-s) + Y * Pg * (1-f) + Y * Pt * (1-f-s)
VWIUX = 0 + 0.89% * 1 * (1-.0637) + 0 + 0 = 0.83%
VNJUX = 1.35% * 1 + 0 + 0 + 0 = 1.35%
VSIGX = 0 + 0 + 1.29% * 1 * (1-.388) + 0 = 0.79%
VBTLX = 0 + 0 + 1.66% * .35 * (1-.388) + 1.66% * .65 * (1-.388-.0637) = 0.95%
Same relative outcomes, but this shows the cash in your pocket at the end.
ATY = Y * Ps + Y * Pm * (1-s) + Y * Pg * (1-f) + Y * Pt * (1-f-s)
VWIUX = 0 + 0.89% * 1 * (1-.0637) + 0 + 0 = 0.83%
VNJUX = 1.35% * 1 + 0 + 0 + 0 = 1.35%
VSIGX = 0 + 0 + 1.29% * 1 * (1-.388) + 0 = 0.79%
VBTLX = 0 + 0 + 1.66% * .35 * (1-.388) + 1.66% * .65 * (1-.388-.0637) = 0.95%
Same relative outcomes, but this shows the cash in your pocket at the end.
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Re: Trying to understand TEY on a Municipal Bond Fund (Taxable)?
Another comment, these days, Munis rates have been sticky (as in low rates) for reasons that I am not expert to describe, but there has definitely been deterioration in the relative yield of Muni's vs. corporate and Treasuries in the last 60 days. I am in a lower tax rate than you and interim Muni's had made sense in the past 2 years; that changed around Thanksgiving.
Re: Trying to understand TEY on a Municipal Bond Fund (Taxable)?
+1 -- this always seemed like the more intuitive way for me to think about itretiringwhen wrote: ↑Sun Jan 16, 2022 2:31 pm BTW, I prefer to calculate After Tax Yield (ATY) as the math is much more obvious. Here is that formula applied to the funds and data above:
ATY = Y * Ps + Y * Pm * (1-s) + Y * Pg * (1-f) + Y * Pt * (1-f-s)
VWIUX = 0 + 0.89% * 1 * (1-.0637) + 0 + 0 = 0.83%
VNJUX = 1.35% * 1 + 0 + 0 + 0 = 1.35%
VSIGX = 0 + 0 + 1.29% * 1 * (1-.388) + 0 = 0.79%
VBTLX = 0 + 0 + 1.66% * .35 * (1-.388) + 1.66% * .65 * (1-.388-.0637) = 0.95%
Same relative outcomes, but this shows the cash in your pocket at the end.
Crom laughs at your Four Winds
Re: Trying to understand TEY on a Municipal Bond Fund (Taxable)?
Another issue is that the Treasury fund has a longer duration (5.5 years versus 4.3), and thus a bit more interest-rate risk.
Re: Trying to understand TEY on a Municipal Bond Fund (Taxable)?
Since rates have fallen recently, long term munis are likely to be called, so they currently report a duration much shorter than their maturity. A 25-year muni callable in 5 years has a duration of 5 years if it is certain to be called, and might have 7 years if it is likely to be called. But it has significantly more interest-rate risk than the duration indicates, because the duration will increase if rates rise significantly.
Re: Trying to understand TEY on a Municipal Bond Fund (Taxable)?
That makes perfect sense to me at explaining that (thanks).
The allure of the enhanced yield on VJNUX and fed + state exempt over VWIUX is attractive to me. Perhaps I need to be cautious about this and consider just a national muni fund?
I imagine even an intermediate term muni fund like VWIUX with an 8.7 year average maturity and > 40% greater than 10 years is subject to a similar callability risk as interest rates are adjusted upward. I suppose the conservative view would be to not invest in a LT state muni fund and to reduce a position in VWIUX and invest in something like VMLUX instead (i.e., 30% VTSAX, 45% VWIUX and 25% VMLUX instead of the riskier VNJUX).
The allure of the enhanced yield on VJNUX and fed + state exempt over VWIUX is attractive to me. Perhaps I need to be cautious about this and consider just a national muni fund?
I imagine even an intermediate term muni fund like VWIUX with an 8.7 year average maturity and > 40% greater than 10 years is subject to a similar callability risk as interest rates are adjusted upward. I suppose the conservative view would be to not invest in a LT state muni fund and to reduce a position in VWIUX and invest in something like VMLUX instead (i.e., 30% VTSAX, 45% VWIUX and 25% VMLUX instead of the riskier VNJUX).
grabiner wrote: ↑Sun Jan 16, 2022 10:05 pmSince rates have fallen recently, long term munis are likely to be called, so they currently report a duration much shorter than their maturity. A 25-year muni callable in 5 years has a duration of 5 years if it is certain to be called, and might have 7 years if it is likely to be called. But it has significantly more interest-rate risk than the duration indicates, because the duration will increase if rates rise significantly.
Re: Trying to understand TEY on a Municipal Bond Fund (Taxable)?
My usual recommendation is a 50/50 split between Vanguard Limited-Term Tax-Exempt and the long-term state fund, so that only half your bonds are in the state but more than half the interest is exempt from state tax. This gives an overall intermediate duration.
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Re: Trying to understand TEY on a Municipal Bond Fund (Taxable)?
All interesting considerations (thank you).
I had not considered the ST national / LT state approach. Perhaps a simple 1/3rd approach of VTSAX / VMLUX / VNJUX might work…
I had not considered the ST national / LT state approach. Perhaps a simple 1/3rd approach of VTSAX / VMLUX / VNJUX might work…
Re: Trying to understand TEY on a Municipal Bond Fund (Taxable)?
Thanks for your input…
I ended up invested in:
33% Vanguard Total Stock Market Index Admiral Shares (VTSAX)
34% Vanguard Limited Term Tax Exempt Admiral Shares (VMLUX)
33% Vanguard New Jersey Long Term Tax Exempt Admiral Shares (VNJUX)
I ended up invested in:
33% Vanguard Total Stock Market Index Admiral Shares (VTSAX)
34% Vanguard Limited Term Tax Exempt Admiral Shares (VMLUX)
33% Vanguard New Jersey Long Term Tax Exempt Admiral Shares (VNJUX)
Re: Trying to understand TEY on a Municipal Bond Fund (Taxable)?
I have started with this 1/3rd allocation approach and plan to taper down over the next 5 years by how I direct my investments. I am only adding contributions to the TSM and Limited Term Muni funds. By 2026 I plan on being 15% VTSAX, 70% VMLUX and 15% VNJUX. I will need this money across the 2027-2031 period to partially fund a retirement house and for bridging income until I collect Social Security at age 70.