Bond ladder in a taxable account: what I didn’t realize until now

Investing Strategies Retirement Investing
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Typical financial guidance says that a bond ladder is a great asset for a traditional IRA. The key reason is because it throws off non-qualified income in the form of bond interest.

My bond ladder sits in an after-tax brokerage account, instead. It’s an artifact of originally starting it to help cover my kids’ college expenses and then having it morph to serve as a bit of a financial shock absorber.

During the accumulation phase, it is more expensive than holding it in a retirement account, but should I have to tap into it, it’s much cheaper. The bond principle payments are more or less tax free, being almost entirely a return of invested capital. The bond interest is taxable, but in a situation where I’d have no other income, the tax would be pretty low.

Say I have a 5-year bond ladder at $3,000 per month. That’s $180,000 in bonds. Even if those bonds pay 5% interest, that works out to at most $9,000 per year of income.

Contrast that with a traditional IRA, where every penny withdrawn would be both taxable and, since I’m under 59 1/2, likely subject to a 10% penalty.

Of course, somewhere between $3,000 and $3,750 per month isn’t exactly living high on the hog. But with the house and cars paid for, the cars running on electric locally, and the solar panels covering a huge chunk of the utility bills, it should be survivable. That’s especially true since an income that low would very likely qualify for some form of health insurance subsidy.

Now, this isn’t a permanent solution, since the bond ladder will run out if not replenished. Still, it’s a decent shock absorber if needed. And if not needed, it becomes a low-cost source of funds for Roth IRA conversions after retirement.

Regards,

-Chuck

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Hi @XMFBigFrog,

I say ‘Ok’, not great.

The best place, by far, is a Roth IRA.

That is why I continued doing Roth conversions after I reached my goal on the size of our trad IRA assets, ultimately eliminating our trad IRA’s. Plus, the tax rates went down.

If I had not done that, I would have needed a rather large mortgage to build this house instead of paying cash for it.

When DW wanted a new car, I pulled the cash and paid for it.

Of course, prior to turning 59.5, we exclusively used our taxable account. I pushed money into it for a lot of years, including enough to build our home in 2005.

I trust that you mean to say “source for taxes to be paid for Roth conversions” since it is not eligible to “convert.”

Gene
All holdings and some statistics on my Fool profile page
Profile - gdett2 - Motley Fool Community (Click Expand)

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In doing so, you have now eliminated the possibility of using Traditional IRA assets to pay for end of life medical care and/or long term care and being able to deduct enough of those distributions so that you will pay no taxes on those distributions.

Pre-paying enough taxes by converting all of your Traditional accounts is often more costly in the long run.

AJ

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Thanks, Gene —

Yes, exactly. “Source of funds to pay the taxes on Roth IRA conversions.” Thanks for the clarification.

I’m glad you were able to get those conversions completed efficiently, my friend. The jury is still out as to whether I will be able to follow in your footsteps.

Long story short, I was slow/late to seeing the benefits of having money in non-qualified (aka standard investing) accounts. As a result, much of the money I can tap “early” would be treated fully as ordinary income. Because of that, Roth conversions could get very expensive once both taxes and health insurance costs are factored in. The longer the “early” window, the tougher Roth conversions would likely be.

Regards,

-Chuck

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Hi @aj485,

Sort of, but I did not pay ‘a lot’ of extra taxes. I brought the tax level up to be level through my first few RMD’s and planned to convert that amount.

To reduce taxes, I transferred appreciated stock to charity, eliminating capital gains on that and gaining the deduction and more importantly, creating a couple needed endowment funds.

I will always give to charity before I send money for taxes that hardly ever pay for the things that are actually needed.

I could have ‘saved’ money on a number of things, but we both sleep better doing t the way we did it. Our tax lady agreed.

If we have any of those expenses, we won’t need any deductions since the withdrawals are Tax Free.

Right now, my widow will have very little tax implications when I die. Her life will be much simpler. That fact by itself made it worthwhile for me!

I will say, if the cost of doing Roth conversions would have depleted our portfolio to a level that in a worst case scenario would have left us ‘pinched’, I would NOT have done it. Always foremost in my planning is safety.

Does that help you?

Gene
All holdings and some statistics on my Fool profile page
Profile - gdett2 - Motley Fool Community (Click Expand)

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Not necessarily true. There are plenty of exemptions mostly involving hardship cases. But there is another way called substantial equal periodic payments that relies on 1 of 3 IRS formulas. I looked into it at 57 but all the formulas forced me to withdraw more than I needed and had to keep withdrawing for 5 years when I really only needed 2.

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It’s good to know SEPPs are there, but the restrictions and limitations on SEPPs make them something I’d rather not use if I don’t need to. In particular, the requirement to keep it going until the longer of 5-years or until age 59 1/2 is something I would like to avoid. I would like to keep working for quite awhile.

With my luck, shortly after I’d set up a SEPP, I’d likely land a great job and then find myself tethered to the “extra” payments for many years.

Regards,

-Chuck

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That still means that you paid taxes at your marginal rate for the years you did conversions, when you could have just lowered the account balance enough so that you all of the distributions would have been taxed in the lower couple of brackets. That’s paying ‘extra’.

You are missing the point. You pre-paid the taxes when you did the conversion, and now you will be missing out on the deduction that could have made distributions tax-free. That’s paying ‘extra’.

As I said, converting all Traditional accounts to Roth is often more costly than leaving some money in Traditional accounts. Your explanation has done nothing to convince me otherwise.

AJ

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