Advisors sometimes envy clients with a US government pension.
They are protected from inflation, which is a major concern. It’s not that anyone can tell what future inflation will be, but high inflation over the next decade (or three) could compound and make any non-inflation-adjusted annuity virtually worthless. But, there are ways to build something similar to a pension. (Full disclosure: I’m doing the first two for my own portfolio, and the third solution is brand new.)
Almost all clients will have Social Security benefits, which hopefully will pay an inflation-adjusted monthly paycheck for life. Clients should think about it this way: Let’s use a 66-year-old client who can take $22,267 in annual Social Security benefits now or may collect 32% more if she waits another four years. She will be giving up $89,068 or, assuming 2% inflation, $92,689, while waiting. In return, however, she will be receiving an extra $7,125 of inflation-protected income every year for life. So delaying Social Security is actually buying a lifetime inflation-adjusted annuity. Go ahead and spend the money that could be collected during this four-year period, as you are really transferring the funds to a better financial vehicle.
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TIPS, Treasury inflation-protected securities, are US government bonds indexed to inflation. By buying as close as possible to bonds maturing each year, advisors can create a 30-year cash flow paying an inflation-adjusted average of $43,800, or 4.38% annually. As of October 9, it can now produce 4.55% annually. (I built and purchased a 30-year TIPS ladder with roughly $1 million of my own money. I wrote about four easy steps to build a TIPS ladder and probably exaggerated a bit how easy it was.)
Knowing that this cash flow is (virtually) guaranteed makes stock market plunges far less daunting. Essentially, this creates a 30-year-period inflation-adjusted annuity. While there is no longevity protection, one could protect for that by buying a low-cost stock index fund and not touching it for 30 years. And, unlike Social Security, TIPS offer a non-spousal survivor benefit for one’s heirs.
While a TIPS ladder is often recommended, it’s not a monthly paycheck. The cash flow comes from a combination of interest being paid out plus bonds maturing with the original principal, plus the accumulated interest from past inflation. There are still four years in which TIPS don’t mature, known as the gap years (2036 – 2039). Thus, one needs to buy additional bonds maturing in 2035 and 2040. This gap will close over the next four years as the Treasury issues new 10-year TIPS. But this would require selling some existing TIPS and buying the newly issued TIPS to fill in the gap.
