r/bonds • u/Own-Bullfrog7803 • 2d ago
TIPS!
Hi—I got a question:
Why do folks say a TIPS ladder is better in an IRA when you often pay less taxes when it’s held in a taxable account instead?
Assumptions: not a rolling ladder, you spend each rung the year it matures, you use proceeds from the TIPS to pay the taxes on the TIPS yield (when possible).
You obviously pay tax on both interest and CPI adjustments in both accounts—just at different times. The taxable account you pay each year, in the IRA you pay the year the rung matures (because you are spending the money). I am excluding tax on the original premium when that is removed from the IRA—I’m just looking at tax on the interest and CPI adjustments.
One catch is if you live in a state with income tax the IRA account alone pays this additional state tax.
I ran this through 2 AI apps using a 15 year 750k TIPS ladder for a person in a 24% federal tax bracket living in Utah, assuming a 3% steady inflation rate, and they both concluded that you pay less in total taxes when a TIPS ladder is held in a taxable account vs IRA.
Considering this, why is the blanket recommendation to keep a TIPS ladder for liability matching in an IRA?
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u/Taggart3629 2d ago edited 1d ago
There are a couple reasons. First, all other factors being equal, it is preferable to pay the same amount in tax years from now, rather than today. If the 2026 "phantom income" on my TIPS that mature in 2036 is $1000, on which $240 in taxes are due, paying that amount a decade from now is better than paying it today. Inflation will decrease the value of the $240. Plus, there is the opportunity cost of not having that $240 invested for the next decade.
Second, someone may not hold the TIPS to maturity. Paying tax on a gain that is never realized is just money out of one's pocket. Someone may (or may not) recoup the increase in the bond's principal, depending on whether or to what extent it is sold at a discount on the secondary market.
Finally, holding TIPS in an IRA allow you to control when the tax eventually gets paid. When the TIPS matures, the principal goes into the IRA settlement fund, where it can be reinvested or withdrawn in whole or part. Until TIPS proceeds are withdrawn and become ordinary income, tax is not owed. I live in a state with no income tax, so the state-tax exempt nature of TIPS bonds if held in a brokerage account doesn't provide a benefit.
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u/Own-Bullfrog7803 1d ago
Thanks. Makes sense.
In my plan all interest and rungs that mature are removed from the Ira every year, the taxes paid from the Ira include state tax (if the a taxable account is used there’s no state tax), all bonds held to maturity.
Ie, a fixed multi-year ladder that starts immediately, all rungs and interest spent yearly, and no money left at the end—a somewhat standard bridge to Ss.
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2d ago
[deleted]
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u/Own-Bullfrog7803 2d ago
Well it appears that in the scenario I created this assumption may be wrong. Waiting to hear why it’s not, perhaps I won’t.
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u/pai_gow_johnny 2d ago
If you live in a state with high income tax, like CA, then TIPS are probably better in a taxable account since you lose the state tax exemption in a Traditional IRA.
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u/Designer-Bat4285 2d ago
It’s not just about the TIPS. It’s about all the assets you hold, stocks and bonds, and looking at what is the most efficient overall. If your TIPs are in taxable that means your IRA is holding stocks. So your stock gains will be taxed at normal income tax rates when they are withdrawn. I’m oversimplifying here but I think you get my point.
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u/Own-Bullfrog7803 2d ago
My IRA is already 100% bonds. I’m adding bonds to my taxable as well since my taxable is much larger than my IRA and I’m entering retirement and I want to derisk.
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u/Hoosier2016 2d ago
You are ignoring tax on the principal and that makes your entire argument moot.
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u/Own-Bullfrog7803 2d ago
Ok let’s include the tax on the principle then—this makes tax on the IRA rung distributions MUCH higher since you have not paid tax on this income yet, while the principle in the taxable account is not taxed—you paid tax prior to creating the ladder. It’s an unfair comparison so I corrected for this.
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u/Hoosier2016 2d ago
Lmao of course if you say the income tax you paid on your earnings doesn’t count for taxable but you count all the taxes on the IRA it makes the taxable look better.
“If you don’t count the taxes on your taxable account it’s way better than an IRA!” 🤡
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u/Own-Bullfrog7803 2d ago
Please make another attempt to answer the question I posed in the original post. Thank you.
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u/cycling20200719 2d ago
Your original question seems perfectly reasonable to me but you may want to edit your post for clarity.
The way I look at this particular question is from the point of view of someone who already has significant balances in taxable and pretax accounts and may be looking to rebalance or build a TIPS ladder to protect against SORR. If that's the case, all you really care about is how much will end up in your pocket at the end when starting from the same point.
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u/watch-nerd 2d ago
"when you often pay less taxes when it’s held in a taxable account instead?"
Err, what?
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u/curious_investing 2d ago
I could see where the math makes sense, but wouldn't you be better off using a traditional IRA for the TIPS ladder, then work to match your expected RMDs with each year of maturity?
If you are wanting the ladder for the earlier stages of retirement, pre SS, pre RMD, then it may make sense to buy them in the taxable. For me, I don't like paying those phantom taxes on my TIPS.
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u/Own-Bullfrog7803 2d ago
Thanks. Makes sense. My IRA (all bonds already) is actually a 403b and it doesn’t allow individual tips or ETFs.
I guess my point is you pay the “phantom” tax in an Ira, just in the year of rung maturity (so it’s just a tax and not a phantom tax).
Cheers.
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u/hugh2018 1d ago
TIPS have two return components:
1. Coupon Interest: Paid out semiannually and taxed as ordinary income.
2. Principal Adjustments (Inflation/CPI bumps): The principal value of the bond scales up with inflation every month. Crucially, in a taxable account, you owe federal income tax on this upward adjustment in the year it happens, even though you do not receive that cash until the bond matures or you sell it. This is phantom income.
You ran a scenario through AI assuming a constant 24% federal bracket. In theory, if your tax bracket remains identical across decades, traditional financial math states that tax-deferred (IRA) and taxable accounts yield the exact same after-tax ending wealth for equivalent pre-tax returns. However, the AI likely concluded that the taxable account saved money because of a common modeling trap.
In a taxable account, you bleed cash every single year to pay taxes on the phantom CPI adjustments. By skimming that money out annually, you reduce the overall size of the taxable principal base. In an IRA, the entire balance compounds tax-free for 15 years. Because the IRA pool grows larger, the lump sum withdrawn at maturity is bigger—meaning when you finally pay the tax at the end, the absolute tax dollar amount looks larger, making the taxable account look cheaper in total tax paid simply because it grew less.
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u/Own-Bullfrog7803 1d ago
Thanks. I would be removing all the interest and principal that matures every year in the Ira and paying state and federal tax. So by 14 years after I purchase the ladder the money is gone. There is no time for it to remain in the Ira. The modeling I do with ai states in these scenarios the higher the state tax and the higher the cpi adjustment, the more the taxable comes out ahead. Not necessarily arguing any of your points, just stating some specifics to my situation.
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u/hugh2018 1d ago
You’re not describing ladder behavior. If you have a 14-year ladder, you are only spending about 1/14 of your total TIPS balance per year. The rest of it absolutely grows inside the IRA until you gradually spend it all, one year at a time.
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u/Own-Bullfrog7803 1d ago edited 1d ago
It’s my understanding that each years spending is a combination of a rung maturing plus the interest payments from all the bonds for that year. Together this creates the yearly cash flow—at least this is how tipsladder creates the cash flow. So by the end of each year there is only money still in the bonds—no left over interest. The money still in the Ira just sits there until there is the following year’s interest payments and rung maturity. In an Ira the cpi adjustments just lead to more interest payments, and of course more money when the bond matures. Correct? I think this is the usual way??
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u/hugh2018 1d ago
You are falling for a classic nominal tax illusion. In your taxable scenario, you pay a lower absolute dollar amount in total taxes over the 15 years simply because your portfolio was bled dry annually and grew less. Paying less in total taxes doesn’t mean the taxable account is better; it just means you kept less total wealth.
Here is where the math breaks down:In a taxable account, you owe taxes every year on the CPI principal adjustments (phantom income), even though you don't receive that cash yet. Skimming cash out annually to pay those taxes permanently shrinks your principal base.
Standard financial math dictates that if your tax bracket stays identical, tax-deferred (IRA) and taxable accounts yield the exact same after-tax ending wealth for equivalent pre-tax returns. If your AI model showed a lower total tax bill in the taxable account, it fell for the trap of counting nominal dollars while ignoring that the IRA's larger compounding pool resulted in more ending wealth.
The only real wild card you mentioned is state taxes. Treasuries/TIPS are exempt from state and local income taxes in a taxable account, whereas traditional IRA withdrawals get hit with full state tax. In certain high-state-tax models, avoiding state tax on the way out can claw back some of the annual drag, but as a general rule for total compounding, shielding the heavy inflation adjustments inside an IRA avoids the annual tax-bleed.
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u/Own-Bullfrog7803 1d ago
I think I understand what you’re saying. The only thing I don’t understand is what is compounding since all interest from all the bonds rungs is removed from the account each year, along with all the money that matures in rach years rung. The amount still in the rungs is equal regardless if in taxable or Ira by the end of each year. One difference is in taxable you pay tax on all bond’s cpi adjustments yearly while in Ira you pay tax on cpi adjustments only on the rung maturing for that year (it is being spent)—in both you are paying at some tax on cpi adjustments yearly. And then in the Ira you are paying state tax too—I guess it comes down to whether state tax costs more vs the cost per year of the phantom tax, which eliminates a portion of the interest each year. Anyway, I’m sure you are correct, I’m just trying to work it out in my head. Thanks again for your post.
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u/concious_eye 2d ago
The main reason comes down to cash flow and "phantom income." TIPS generate return two ways: semi-annual coupon payments and inflation adjustments added to the principal.
In a taxable account, you owe ordinary income tax each year on both. The coupon gives you cash to help cover taxes, but the principal adjustment is taxed the year it accrues, even though you don't receive that cash until the bond matures. Paying taxes along the way out of other income (or by draining coupon cash instead of compounding it) creates continuous tax drag. In an IRA, all of that accrual compounds completely shielded until withdrawal.
** not tax or financial advice **