I have immense respect for the variety and depth of experience that regularly post on MFO, and would like some feedback on what I am contemplating. Currently 90% of my bond exposure is three North Carolina municipal bonds (inherited) that all have first call date of June 1 2016. They range from 4.15% to 4.75% coupon. All very highly rated. My total bond exposure is 32% of my portfolio. I am 62.
I retired this year and my plan is to withdraw 4% of the value of my total portfolio each year, one third of which currently comes from dividends, interest in bond funds and the municipal bonds in my taxable portfolio. The rest I was originally planning to withdraw from two iras (one traditional and one roth). This would amount to 5% of the IRAs each year.
The conundrum is this: Would it be better to sell one of the muni bonds which would supply approximately two years of income, and let the IRAs alone or do as originally planned and start taking out of the IRAs now and leave the bond intact. My cash substitute fund is MWLDX in which I would place half the proceeds of the sale of the bond, the rest in cash account at ML. I also may put some in OSTIX which I bought earlier this year. I have not yet discussed this with my advisor at ML, but I think I know what she will say Before I discuss this with her, would love to hear back from some of you regarding this. Thank you in advance for your input and guidance. I find MFO a valuable resource and applaud David , his staff and volunteers for all their hard work.
Comments
Here's an inexpert question: assuming a 22% tax rate, wouldn't you need to expect returns of noticeably more than 5.5% on your IRAs over the next two years in order to justify selling the bonds? That is, the bonds are guaranteed a taxable-equivalent return of 5.5% (4.5% average coupon plus the tax savings) while the remainder offers an imperfect chance of earning the hypothetical return.
Would part of the equation be asking what the prospect is of your fund portfolio exceeding that? In making that equation, you might try guessing (and, in short time horizons, it's going to be a pretty wild guess) at the probability that you'll exceed that target. Perhaps trying something like T Rowe Price's ClearFuture / Retirement Income Calculator where you plug in the shape of your portfolio, set a target date of three years and ask it for the probable range of returns?
David
In addition to David's question I am a little puzzled by your intent to withdraw from a Roth IRA. Not knowing anything about your finances, or your reasons for doing so, it's always been a general assumption (and intent) of mine to leave Roth IRA positions alone as long as possible, or at least until the very last. I'd be interested on your thought process if you'd care to share.
Mark
Not too easy to find a bond exactly fitting your description (to get a sense of the market). But I came up with CUSIP 462670CP3 - Iredell County NC CTFS Partners Cops. It's AA3 (which is about as low as one can go with "high quality" ratings), with a first (par) call 6/1/16, current YTW (yield to worst) of 3.15%. Ask price (per Fidelity) is 103.365.
Commissions on sales can run multiple percent - you can see this by looking at the trade history of a bond (see, e.g. emma.msrb.org). For example, this bond was sold by a customer 10/1 (near end of day, 3:26PM) at 101.862. (That means that the customer received $1,018.62 for each $1,000 par value bond sold.) The next morning (9:54AM), the dealer sold those bonds to another dealer (dealer to dealer prices are generally somewhat midway between what you get for selling and what you need to pay when buying.) That price was 103.25. So the spread between buying and selling this bond is likely around 2.5-3%.
What all this means is that even though your bonds may be trading around 103 (ask), you're likely to get only around 100 (par) to sell them. Let's say you do well and get 101.
So in actuality, you're likely looking at a lower yield to worst, pre-tax equivalent around 3.9%, not quite David's 5.5% - if you hold the bonds and tap the IRA(s). Alternatively, if you sell, you might get a slight premium on the bonds (i.e. you might net, say $1010 on a $1000 bond after commissions/spread). And you'd have the IRAs likely earning more than 4%. As David noted though, that's a gamble.
I don't think anyone expects interest rates to fall. So the bonds' market value will only drop or stay steady (if market rates don't rise). Where your risk with the bonds comes in is on interest rates rising. If they rise significantly by 2016, the bond will likely not get called (i.e. if the market interest rates rise to be higher than the coupon rate, the municipality has no reason to borrow at higher rates to pay off the old bonds). Then you'll be locked into what has become a low rate (relative to the market) for perhaps many more years.
On the other hand, the rate you're getting on the bonds may be adequate for your needs. If so, it's not a bad rate to be locked into. Sorry to sound so wishy washy here. Depends on your needs, your tolerance for risk, etc.
One other point - since these bonds are inherited, you may have ordinary income tax to pay on these bonds when they're called/sold or mature. This is a little complex. Inheriting bonds is just like buying bonds - you acquire them at the current market price. If that price is below par (assuming no Original Issue Discount), then you purchased them at a discount. The "appreciation" back up to par value is treated as ordinary (not tax-free) income by the IRS when you cash in the bonds. (On the other hand, if you acquire bonds at a premium, i.e. price above par, then a portion of the interest payments you receive are considered just a return of principal; you can't take a loss on this.)
Thank you for such a detailed and enlightening answer to my original post. To answer some of your concerns, I inherited them just about a year ago, and as of the transfer date, they were valued above par, and they were originally purchased at a premium. It carries a 4.13% coupon rate. The bond is rated A with S + P and BAA1 with Moody's, so is indeed considered investment grade. Issuer is U of NC at Wilmington, not likely to default in my opinion. If it was sold and I had a taxable event, I have some loss carryforward that could cover it.
Thank you all for your thoughtful responses, I learned quite a bit from them, never having owned individual bonds before. Since I spent a good part of my career as a self employed consultant, most savings went to 401K and IRAs and most of the inherited funds were in IRAS and the bonds. Retirement income will be provided by these assets plus some stocks and low duration bond fund, no pension. Jury still out whether I will take social security at 66 or wait til 70.
Actually got a bid of 106 and change and decided to pass. Both you and David made some very valid points on my expected return on IRAs if funds were left alone to grow vs the yield I am receiving on the bond 4.13% . From now until the call date of June 1 2016, I will be receive $10,325 in federally tax free interest. If I sold the bond now, net of expenses for lets say 105,000, it would be $5000 above the face value, (msf you made a good point that they may not call bond) vs par value of $100,000 plus $10,325 if I hold. As expected, my advisor was dead set against my selling it, but it would not be the first time we disagreed
When I first came up with the idea to sell the bond, it made sense. Now it seems keeping it makes more sense, and I thank you for your research and information you and David provided.
While my advice pales in comparison with the previous responses, I would stress that you want to maintain as much flexibility as possible. Each of our retirement instruments has a different withdrawal profile and while some might not seem to apply to you at this point, retirement is a long time gig and your wants and needs will change and evolve.
I really love my state muni bond fund with the wee exception that with the bankruptcy of datwah the principal has been hammered. feh. I just sold 2/3 for the tax loss and figure that I can wait until after Jan 1 to repurchase because this thing is not going to be settled by then and that gets me beyond the 30 day quiet period. What's not to love with a muni bond paying you tax free 4-5%?
just a thought,
peace,
rono
BTW, retirement is the second most favoritist thing I've ever done. teehehe
The only thing I dislike about them is that they are in larger increments, I would have preferred smaller laddered bonds or at least ones with diffrent call dates, so as they were called or matured, I could use the cash instead of going to the iras.. They were originally purchased by my father in law for his retirement, and they were passed to hubby, then me.
When they are called in June 2016 assuming they are, will redesign this bucket
Thanks for your comments.