Municipal bonds placed in tax deferred accounts instead of taxable accounts?

CFA Level III Portfolio Management
#1

The textbook cites yield concession as a reason saying that “yield concession more than offsets the value of tax sheltering equity returns from taxes”. What is yield concession? Thanks.

#2

you get a lower yield on the municipal bonds

#3

Thanks,but why does yield matter? I thought since it’s tax exempt we should be indifferent between tax deferred or taxable account…

#4

Wait… what? Is the title wrong? You put muni bonds in a taxable account, since it’s already tax exempt you would rather put non tax-advantaged higher coupon securities in the TDA.

#5

Its simple :

Muni bond total return = Actual Return( lower ) + virtual return due to tax exemptions ( non trivial )

Corp bond total return = Actual Return ( higher ) + no tax exemptions ( i.e. taxed on cash flows and taxed on gains)

Now give these choices to the tax exempt investor ( i.e. 401 K investor ) , who does n’t care for the tax exemption bit and they will want the risky corp bond.

Give the same choice to a ordinary taxable investor and they will want the muni ( all other things equal i.e. the same total return on both bonds)

#6

The use of Muni’s is also a good way to keep track of taxability. ie non-life insurance co’s use them frequently therefore they must be taxable because they use tax advantaged products (life ins. co’s are also taxable even though many of the products they offer are not).

Pop quiz: what percentage of a pensions portfolio should consist of municipal bonds?

#7

0 % ?

#8

That is exactly what I just said? The thread title says this

“Municipal bonds placed in tax deferred accounts instead of taxable accounts?”

Muni bonds should not be in a TDA.

#9

Chen36051,

Where did you get the question / title from? Can you give the text page number etc.?

#10

Pg 261, Book 2

Some jurisdictions exempt municipal bond interest or other types of interest from taxes. In this case, it could conceivably make sense to place tax-free munic- ipal bonds in a taxable account and more heavily taxed stock in the TDA. The yield on tax-free bonds, however, is generally much lower than those on taxable bonds so that in a well functioning market their after-tax returns are approxi- mately equal. This yield concession is a significant disadvantage to placing low yielding tax-free bonds in a taxable account and equity in a TDA. In most instances the yield concession more than offsets the value of sheltering equity returns from taxes. As a result, it is generally better to follow the general strategy of locating bonds in TDAs and equity in taxable accounts.

#11

Thanks

#12

Pop quiz: what percentage of a pensions portfolio should consist of municipal bonds?

janakisri's picturejanakisri Feb 24th, 2012 1:51pm

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0 % ?

-Yup.