Tax benefit of putting cash/expenses needs in tax advantaged account

[M]

Hello! I’m working through a tax comparison of having a Treasury bond ladder in spouse and my joint taxable account vs in our IRAs and swapping with VTSAX liquidated funds from our taxable account annually. Unfortunately I found this wiki after I bought a 6yr Treasury ladder in our taxable account a couple months ago to cover our annual expenses in our early retirement years with no pre-59.5 penalties: https://www.bogleheads.org/wiki/Placing_cash_needs_in_a_tax-advantaged_account. So now I’m wondering if there would be value in moving our bond ladder (since yields are getting close to when I bought in) into our IRAs by selling VTSAX by selling the bonds and buying an equal amount of VTSAX in our taxable account.

Here’s my comparison so far: Bond ladder in taxable, we’d have roughly $7k in interest and gains a year. Our taxable income is projected to be $22k (with the bond ladder, other dividends and interest, and reductions from HSA and prior year carryover capital losses), so 10% bracket. Therefore, we’d owe $700 each year in taxes just from the bond ladder and this would take the space of being able to do $7k more in Roth conversions each year a rung of the ladder matures. So over the 6 year ladder, we’d be paying $4200 in income taxes on the ladder instead of paying that amount in taxes on being able to do $42k in Roth conversions. However, the benefit is each year, we know what will be maturing and won’t come up short if VTSAX values drop in the taxable account and we won’t have to be bothered to do the annual buying and selling in our taxable and IRA accounts.

If the bond ladder were in the IRAs instead, I’m having trouble figuring the taxes we’d owe on the long-term capital gains of selling the roughly $70k annually of VTSAX in the taxable account, which would cover our projected annual expenses. I’m thinking if I assume I buy the same amount of VTSAX as I bought for the whole 6 year ladder at roughly $360k (about $60k per year) that would mean I’d have about $10k in capital gains if I cashed out $70k per year. But I’m not sure how I’d show the IRS that $10k should be taxed at the 0% bracket and how that links to the taxable income number on line 15 of my 1040 so that our ordinary income isn’t driven up higher than the 10% bracket. And I’m wanting to see if I actually would gain more space for a larger Roth conversion annually.

Any insights you could share on how I would complete the comparison and any problems you see so far would be greatly appreciated!

[gocurrycracker]

Your income is ~50k and with standard deduction your taxable income is ~$22k?

Does ordinary income exceed $27.7k/year? (2023 MFJ standard deduction)
If no, then that bond interest would be taxed at zero. The standard deduction applies to ordinary income first.

Taxes on long-term gains from the sale of VTSAX would be at 0% as long as total income is less than ~$117k (2023.)
Since a portion of each sale is a non-taxable return of capital, and you get to pick which shares are sold (and can choose the shares with the smallest gain (or loss)) this seems unlikely.
https://www.gocurrycracker.com/long-term-long-term-capital-gains/

Taxes are calculated on the Schedule D Qualified Dividend and Capital Gains Tax Worksheet
I go through this worksheet on our 2016 tax return writeup
https://www.gocurrycracker.com/go-curry-cracker-2016-taxes/


By having $7k of ordinary income in taxable account you do forfeit the tax-free Roth conversion opportunity on that same amount.


This is federal taxes only.
ACA premium tax and State taxes also apply.

[M]

Thanks so much for those links- it worked out as you said! So it seems keeping the Treasury ladder in taxable means we’ll lose out on $42000 total in additional Roth conversions (roughly equivalent to a year’s worth of Roth conversions for us) which I’m guessing might equate to about $10k in extra state and federal taxes in the future if tax brackets are shifted for example. (Luckily ACA at the moment is very generous and so that’s not an issue right now.) After all this figuring, we are leaning toward keeping it in the taxable mostly because the whole reason we picked Treasuries (vs corporates or even municipal bonds) and a long-term ladder (vs bond fund, etc) was to allocate our bond portion of our asset allocation to be a sure thing to cover our expenses in many of our pre-59.5 early retirement years. So having it in the taxable account has the function of access and there is a trade off for that (more taxes), although that does sting. Am I off-base in my thinking and what would you do? Thanks again for your insights!

[gocurrycracker]

There is such a thing as diminishing returns, and simple is great.

Still, I would tend to put all of the bonds in the tax-deferred account.

Money is fungible... There is no portfolio difference between A and B, but the taxes on B are lower

A - I have $10k in bonds in my taxable account. I want to spend $10k so I sell them.

B - I have $10k in bonds in my IRA. I want to spend $10k, so I sell the bonds in my IRA and buy $10k worth of VTSAX. In the brokerage account, I sell $10k worth of VTSAX.

[M]

That makes sense. The last hurdle for us is that in option B if VTSAX loses value in any given year(s) but we need the funds for expenses it would mean we’d have to liquidate at a loss in the bucket we have access to (taxable) unless we did some other maneuvers. (Also, unfortunately we have no use for capital loss because we have enough rollover losses to last many years.) We have enough ibonds to cover a year. And we could move some of our Roth IRA money to cash-like positions to get to our contributions, although I’ll have to look at what that does to our asset allocation. Any other ideas? I’d like to put backup plans in place that have similar surety as the ladder maturing in taxable, if possible, but maybe the answer is we can’t. Thank you again!

[gocurrycracker]

You have a loss either way