A TIPS Ladder Can Boost The 4% Retirement Withdrawal Rule To 4.7%. Here’s How

Not long ago, investors had to pay the U.S. government for the privilege of owning Treasury Inflation-Protected Securities. The real yields, that is the yields after factoring in inflation, were negative. Last year, like a phoenix rising, real yields broke above 0%. Today, the real yield on 10-year TIPS is about 2.50%. This offers some intriguing options for those in or near retirement.

TIPS, for short, are U.S. government bonds whose principal amount adjusts for inflation. They are as close to a sure thing as an investor can get. Of course, there is no free lunch. What an investor gives up with TIPS is the possibility of better returns with nominal bonds (should inflation end up lower than expected) or with more risky assets such as stocks. For many retirees, however, risk is a four-letter word.

So let’s explore two TIPS ladder strategies that retirees might want to consider.

A 30-Year TIPS Ladder

People planning on a traditional 30-year retirement, once could build out a 30-year TIPS ladder that outperforms the 4% rule. As real yields rise, TIPS enable retirees to increase their safe withdrawal rate. The higher the real yield goes, the higher the SWR. So, just how high can current yields push a SWR?

A great tool to answer this question and build a TIPS ladder is tipsladder.com. You enter the length of the ladder you want, up to 30 years, and your desired after-inflation annual income. I assumed a $1 million portfolio and entered $47,000 as the desired income (which would give us a 4.7% SWR).

The tool generates a list of the TIPS bonds you should buy, including the CUSIP number of each bond. The total cost comes out to $989,234. You get a 30-year retirement income starting with a 4.7% withdrawal and adjusted for inflation with about $11,000 left over for walking around money.

Recall that I said there is no free lunch. Retirees need to keep in mind that after 30 years, they will have spent down their portfolio. There’s nothing left unless they invested that $11,000 left over after buying the TIPS. That means nothing to sustain them should they live longer than 30 years. It also means nothing to give their children, grandchildren or charities.

A Partial 30-Year TIPS Ladder

One alternative is to build a TIPS ladder using a portion of your retirement savings. John Rekenthaler suggested this option in an excellent Morningstar article this past week.

For example, with a $1 million portfolio, one might build a 30-year TIPS ladder to generate $30,000 of annual real income. Consulting the tipsladder.com tool, the cost of this ladder comes in at $631,220. A retiree could then invest their remaining assets in a combination of stocks and perhaps more bonds to cover longevity risk and giving.

A 5-Year TIPS Ladder

There’s also a strong case to be made for a shorter TIPS ladder. Let’s imagine you retire five years before you claim Social Security. To bridge that gap, one could build a five-year TIPS ladder. It would take the risk of a severe market crash off the table during this time. The remaining assets could be invested in a mix of stocks and bonds to be used to supplement income once Social Security kicked in.

For TIPS ladders of 10 years or fewer, one could of course buy individual TIPS as described above. Another option is a new ETF series launched by BlackRock
BLK
. The new ETS are part of BlackRock’s iBonds series (not to be confused with U.S. government Series I bonds).

BlackRock offers fixed maturity TIPS ETFs from one to 10 years. These ETFs function similarly to individual bonds in that they mature at a given time and return the assets to the investor. Think of it as an easy way to buy TIPS. There is of course a cost (remember, no free lunch), but it’s a low fee of 10 basis points.

Note that BlackRock offers a nifty bond ladder tool. Unfortunately, it doesn’t yet incorporate its new TIPS funds.

Final Thoughts

Today’s real yields make a compelling case for building a TIPS ladder in retirement. Just keep in mind that every strategy has pros and cons, and a TIPS ladder is no different. You are getting a high degree of certainty in exchanging for giving away any potential upside. For many in retirement, this may be a good bargain.