Should You Build a TIPS Ladder in Retirement? (FQF)
For retirees seeking predictable and inflation-protected income, a Treasury Inflation-Protected Securities (TIPS) ladder is often touted as a safe and effective strategy. But is it the right choice for everyone? Let’s delve into the pros and cons to help you decide if building a TIPS ladder in retirement is the right move for you.
What is a TIPS Ladder?
A TIPS ladder involves purchasing a series of TIPS bonds that mature at regular intervals, typically annually. Each maturing bond provides a stream of inflation-adjusted income, creating a ladder of payments over time. This structure aims to protect your purchasing power against the eroding effects of inflation, a crucial concern for retirees with fixed incomes.
The Allure of TIPS for Retirees:
TIPS offer several compelling advantages for retirees:
- inflation protection: This is the primary draw. TIPS adjust their principal value based on changes in the Consumer Price Index (CPI). As inflation rises, the principal increases, and so does the interest payment. This ensures your income keeps pace with rising costs.
- Safety: Backed by the U.S. government, TIPS are considered virtually risk-free from default. This provides peace of mind, especially important during retirement when capital preservation is paramount.
- Predictable Income: The ladder structure provides a predictable stream of income, making it easier to budget and plan your finances. You know when you’ll receive payments and that those payments will maintain their purchasing power.
- Diversification: Including TIPS in a portfolio can help diversify away from stocks and other potentially volatile assets, providing stability during market downturns.
The Downsides to Consider:
While the advantages are significant, a TIPS ladder isn’t without its drawbacks:
- Complexity: Building and managing a TIPS ladder can be complex. Understanding bond yields, maturity dates, and reinvestment strategies requires some financial knowledge or the assistance of a financial advisor.
- Lower Yields: TIPS generally offer lower yields compared to nominal Treasury bonds of similar maturities. This is because you’re paying a premium for the inflation protection. In periods of low inflation, the difference can be noticeable.
- Potential for Tax Implications: While the interest earned on TIPS is exempt from state and local taxes, it’s subject to federal income tax. The annual inflation adjustment to the principal is also considered taxable income, even though you don’t receive the money until the bond matures. This "phantom income" can increase your tax burden.
- Liquidity Concerns: Breaking the ladder before maturity can result in a loss if interest rates rise. While TIPS can be sold on the secondary market, their value can fluctuate, and transaction costs can eat into your returns.
- Alternative Investment Options: There are other investment vehicles that also offer inflation protection, such as I-bonds, which might be more suitable for certain individuals due to their tax advantages or ease of use.
Who is a TIPS Ladder Right For?
A TIPS ladder might be a good fit for retirees who:
- Are highly concerned about inflation: If you fear that rising prices will significantly erode your purchasing power, TIPS can provide valuable peace of mind.
- Value safety and predictability: If you prioritize capital preservation and a stable income stream, TIPS can be a good option.
- Have a long-term investment horizon: TIPS are best suited for those who can hold them until maturity, avoiding the potential for losses when selling prematurely.
- Understand the tax implications: Be sure you’re prepared to pay taxes on the inflation adjustment to the principal each year.
- Have a diversified portfolio: TIPS should be part of a well-diversified portfolio that also includes stocks, bonds, and other assets.
Alternatives to Consider:
If a TIPS ladder doesn’t seem quite right, consider these alternatives:
- I-Bonds: These U.S. government savings bonds also offer inflation protection and are generally simpler to purchase and manage than TIPS. They also have tax advantages if used for qualified education expenses.
- Inflation-Linked Funds (ETFs or Mutual Funds): These funds invest in a portfolio of TIPS and can provide diversification and professional management. However, they also come with management fees and may not provide the same level of predictability as a ladder.
- Social Security COLAs: Social Security benefits are adjusted annually for inflation, providing a guaranteed stream of income that keeps pace with rising prices.
- Annuities with Inflation Riders: Some annuities offer riders that provide inflation protection, but they often come with higher fees.
Conclusion: Weighing the Pros and Cons
Building a TIPS ladder in retirement can be a smart strategy for protecting your income against inflation and ensuring a predictable stream of cash flow. However, it’s crucial to carefully weigh the advantages and disadvantages, consider your individual financial situation, and explore alternative options before making a decision. Consult with a qualified financial advisor to determine if a TIPS ladder is the right choice for you and to develop a comprehensive retirement plan that meets your needs and goals.
FQF: Frequently Questioned Facts:
- Myth: TIPS always outperform nominal bonds.
- Fact: TIPS outperform nominal bonds when inflation is higher than expected. If inflation is lower than expected, nominal bonds may offer higher returns.
- Myth: Building a TIPS ladder is a set-it-and-forget-it strategy.
- Fact: While the ladder provides a predictable income stream, it requires ongoing management, including reinvesting proceeds from maturing bonds and monitoring interest rates and inflation.
- Myth: TIPS are completely risk-free.
- Fact: While TIPS are virtually risk-free from default, they are subject to interest rate risk. If interest rates rise, the value of your TIPS can decline if you need to sell them before maturity.
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When comparing a TIPS ladder to an annuity, in addition to the lack of inflation protection from annuities, also keep in mind that when you pass away, the money invested in the annuity is gone. That's another reason annuity payments look better than the payouts of a similarly priced TIPS Ladder.
Investing in TIPS under the current US regime seems like a bad idea. The federal government can no longer be trusted to accurately report CPI. If Trump's policies (e.g., tariffs) lead to runaway inflation, he will almost certainly understate it.
I guess I dont see how inflation can remain low when we have $36 trillion in debt.
In a previous live Q&A titled “Should I buy individual TIPS instead of TIPS Funds” you said you find owning individual TIPS a hassle and don’t think it solve the problem that people think they have. In this video, you said you would probably create a TIPS ladder in retirement that covers 50% of your fixed income. Why the change?
Regarding the first part of your video (and by the way, I'm a big fan and watch all your content), you discuss TIPS vs Annuity…and of course TIPS provides the inflation protection that an annuity does not. But here's an interesting point I haven't seen brought up by anyone when they are talking about TIPS and that's the subject of the expenses against which you're wanting inflation protection…they don't all go up with inflation. I'm speaking specifically of a mortgage. Yes, homeowner's insurance and property tax go up each year, but the mortgage itself (P&I) don't. And if when you look at your total expenses, a mortgage is likely a big percentage of that, hence you only need to protect/consider the NON-mortgage expenses for inflation protection. I'm not necessarily advocating for an annuity (no a fan of those), but am pointing out that some expense are less sensitive to inflation than others.
We use a 10 year rolling TIPs ladder. Also have QLACs.
Hi Rob! What do you think about planning for a 40 year retirement with a normal 30 year tips ladder augmented with a 10 year ladder with the intention to roll over each of the 10 years to new 30 year issues. A little tricky perhaps to calculate it correctly, but it seems like the basic concept is sound. Each year a rung matures out of the 10 year ladder in then current inflation adjusted amounts. As long as those are fully rolled over, I should expect the inflation adjusted principal upon maturity. Obviously, there is no guarantee what rates I will get and I suppose yields could go negative again, but it seems like it should be a decent approximation of a longer ladder. For me a tips ladder is an alternative to an annuity, and it is intended to supplement my social security and hopefully provide a better guaranteed floor to my income. I'd appreciate any thoughts you have on this. Thanks. I appreciate your channel. It is a great reference.
You're no more likely to run out of money before you die, with an all T.I.P.S. ladder, than with any other portfolio. It all depends on the ratio of burn-rate, to portfolio balances.
Enjoyed your answer for the TIPS question and looking forward to your show with Bill Bernstein. Many shows ago you said “friends don’t let friends buy TIPS in a taxable account. As you will be covering the TIPS topic more, please could you dig deeper into this issue as I would love to hear your take on the research that compares buying TIPs in taxable vs Tax deferred accounts. Appreciate your videos, thanks.
So helpful on the TIPS ladder education- thank you!!
I don't know why you would pull out any sizable amount from your ROTH when it's mostly stocks that have just dropped 30%! I would think it's the best time to pull from an IRA or SEP as to limit the overall taxes on those funds which ultimately will be withdrawn. To me I would pull from the ROTH if it made my overall tax rate for a given year less (by a different bracket). Maybe a small amount, but ROTH's are like the goose that lays golden eggs.
Mr. Berger, how do you handle the RMD with a 30 year TIPS ladder with qualified money? Love these videos. Thank you.
The tips ladder looks like a lot of work for the average investor.
I partnered with Moonacy Protocol, and in 2 months, I’ve made over 60% profit. It’s changed how my year started
Well…TIPS WERE secure prior to 11/05/24….
Rob, thanks for all your content. I do have a question about third party investment portfolio tools that you promote. I recently learned that linking these to your brokerage account such as Schwab will void your fraud protection with them according to their terms of service. What are your thoughts on this issue? Thanks!