Investors often use tax-exempt municipal bonds for their bond ladders. If so, the bond ladder should be held in a regular taxable account to take advantage of the tax break. Bonds issued within the buyer’s state of residence often avoid state or local income tax as well as federal tax.
For IRAs and other tax-deferred retirement accounts, bond ladders generally should be constructed from corporate bonds or other taxable issues. Yields generally are higher than they are in comparable municipal bonds, and those yields can compound inside the tax-deferred plan.
Either way, if you are building a bond ladder now, buying existing, rather than newly issued, bonds, be aware that older bonds generally trade at a premium because they have higher yields than today’s new issues.
Example 2: When Paula puts together her bond ladder, she pays $27,500 to buy bonds maturing in 2026 with a face value of $25,000. She builds in a $2,500 loss in return for receiving above-market yields for the next eight years, up until maturity.
You shouldn’t expect huge profits from a bond ladder. Instead, you should consider a bond ladder as an arrangement that could possibly improve portfolio income and stability over a long period of time. Every year, you can expect an untaxed bond redemption that you can spend or save as you choose.