Key Takeaways
- Treasury Inflation-Protected Securities (TIPS) Are Designed for Inflation-Protected Income: Their principal value adjusts with inflation, ensuring that retirees' purchasing power remains intact.
- A TIPS Bond Ladder Creates a Predictable Cash Flow: By structuring a ladder with staggered maturities, retirees can establish a reliable, inflation-adjusted income stream for decades.
- Purpose Built Follows a Proven, Evidence-Based Investment Approach: Our strategy aligns with David Swensen’s portfolio management philosophy, using only U.S. Treasury bonds and TIPS in the fixed-income portion of portfolios.
- TIPS Ladders Reduce Market and Credit Risk in Retirement: Unlike stocks or corporate bonds, TIPS ladders are backed by the U.S. government, eliminating default risk and reducing volatility.
Why Inflation Protection Is Critical in Retirement
One of the biggest risks retirees face is inflation risk. Inflation risk is the erosion of purchasing power over time. A retiree’s expenses don’t stay constant; over a 30-year retirement, even a modest 3% annual inflation rate can cut purchasing power in half (here is a fun example using everyone’s favorite beverage!). This means that a retirement income stream that seemed sufficient at age 65 could be woefully inadequate by age 85.
Traditional bonds, such as nominal U.S. Treasuries, offer fixed principal and interest payments, meaning their real value declines over time when inflation rises. This is why Treasury Inflation-Protected Securities (TIPS) are an ideal solution for retirees looking to maintain their standard of living.
Unlike traditional bonds, TIPS are specifically designed to protect against inflation:
- Their principal value adjusts with the Consumer Price Index (CPI), ensuring that at maturity, you receive the original face value plus any inflation adjustments.
- Interest payments (paid twice per year) are calculated based on the inflation-adjusted principal. Because the principal grows with inflation, the dollar amount of your interest payments also increases over time, keeping pace with rising prices.
This structure makes TIPS particularly attractive for retirees looking for certainty, predictability, and inflation protection in their income stream.
How a TIPS Bond Ladder Works
A TIPS bond ladder is a structured investment strategy that spreads TIPS bonds across multiple maturity dates, creating a predictable and inflation-protected income stream. Instead of relying on a fluctuating stock portfolio, a TIPS ladder ensures a portion of the portfolio matures each year, providing cash flow that keeps pace with inflation.
Step-by-Step Guide to Constructing a TIPS Ladder
- Determine Annual Income Needs
- If you need $50,000 per year (in today’s dollars), the goal is to secure inflation-adjusted income for each year of retirement.
- This means buying $50,000 (in today’s dollars) worth of TIPS bonds for each year you plan to cover. Most investors look to cover expenses to cover a normal market depression, usually 3-4 years but it could be longer based on risk tolerance.
- Select TIPS Bonds with Staggered Maturity Dates
- The U.S. Treasury issues TIPS bonds in maturities of 5, 10, and 30 years.
- Since U.S. Treasury only issues in the maturities above, to achieve the desired annual maturities you may need to purchase some TIPS at Treasury auctions when they are initially issued. More often, you'll need to buy existing TIPS bonds on the secondary market (the market for bonds that have already been issued). The secondary market offers greater flexibility in finding bonds with the specific maturity dates needed to complete your ladder. Because of this flexibility, Purpose Built primarily constructs TIPS bond ladders using bonds purchased on the secondary market.
- Let Inflation Work for You
- Over time, each bond’s face value will increase with inflation.
- When the bond matures, you receive the inflation-adjusted principal, ensuring that the purchasing power of your retirement income remains stable.
- Reinvest or Spend the Maturing Bonds
- Upon maturity, the proceeds can either be spent as planned income or reinvested if additional income is needed in later years.
By structuring the portfolio in this way, a retiree gains guaranteed inflation-protected cash flow without being subject to market volatility or interest rate risk.
Why Purpose Built Uses TIPS for Fixed Income
At Purpose Built Financial Services, we follow a strict evidence-based investment philosophy that aligns with the principles outlined by David Swensen, the former Yale endowment manager. Swensen’s research emphasized that when investing in bonds, only government-issued securities should be considered as they offer the highest level of security and reliability.
Swensen argued that corporate bonds and high-yield investments introduce unnecessary risks, such as default risk and liquidity concerns, without providing sufficient compensation in return. In contrast, U.S. Treasury bonds and TIPS are backed by the full faith and credit of the U.S. government, making them the safest fixed-income option available. If you are going to chase returns, go with equities, if you are targeting safety use government issues.
Additionally, during periods of market stress or economic downturns, investors historically flee to the safety of government-issued bonds, driving up their prices and providing a stabilizing effect on portfolios. This makes Treasuries and TIPS an essential component of a well-constructed fixed-income strategy.
For these reasons, our fixed-income portfolios exclusively use:
- U.S. Treasury Bonds: Providing nominal income stability and acting as a counterbalance during stock market declines.
- TIPS (Treasury Inflation-Protected Securities): Ensuring that retirees’ purchasing power remains intact by adjusting for inflation.
We agree with Swensen's assessment that these government-issued fixed-income instruments offer the optimal combination of safety and stability. This foundational stability allows the remaining portfolio—focused on growth—to pursue higher returns for Purpose Built’s clients, confident in the security provided by these core holdings.
Tabled: A TIPS Ladder Compared To Other Retirement Income Strategies
Why Not Just Use Dividend Stocks?
Many retirees mistakenly believe that dividend-paying stocks are a substitute for fixed-income investments like TIPS. However, unlike TIPS:
- Dividend payments are not guaranteed and can be cut during economic downturns.The most drastic example of this was in 2008 during the Great Recession when the S&P 500 companies experienced a significant reduction in dividend payouts. In 2009, dividends per share dropped by approximately 23%, marking the most substantial decline since 1948. This sharp decrease followed a smaller decline of about 4% in 2008.
- Stocks are highly volatile, meaning you may need to sell shares at a loss to generate cash flow.
- Dividend yields rarely keep pace with inflation over long periods.
A TIPS ladder, in contrast, ensures guaranteed, stable income that adjusts automatically to inflation. Market risk, dividend risk, and other surprises are eliminated.
Securing Your Future with a TIPS Bond Ladder
A TIPS bond ladder offers a compelling solution for retirees seeking a secure and predictable income stream, especially in what seems to be an increasing inflationary environment. It provides a unique combination of inflation protection, stability, and customization that other retirement income strategies often lack. By carefully structuring a portfolio of TIPS bonds with staggered maturities, retirees can effectively insulate their purchasing power from the eroding effects of inflation, ensuring a comfortable and financially secure retirement. While other investment options like traditional bonds, dividend stocks, and annuities have their place, they often fall short in providing the guaranteed inflation-adjusted income that a TIPS ladder delivers.
For those prioritizing long-term financial security and peace of mind in retirement, a TIPS bond ladder deserves serious consideration. It's a strategy that allows you to focus on enjoying your retirement years, knowing your income will keep pace with the rising cost of living.
At Purpose Built Financial Services, we specialize in crafting customized TIPS bond ladders tailored to individual retirement needs and goals. We believe that a well-structured TIPS ladder is a cornerstone of a secure and inflation-protected retirement.
If you're ready to explore how a TIPS bond ladder can help you achieve your retirement vision, contact us today to see if we would be a good fit. Let us help you build a retirement income plan that provides both peace of mind and lasting financial security.
Frequently Asked Questions (FAQs)
Q: Are TIPS taxable?
A: Yes. TIPS investors must pay taxes on inflation adjustments to the bond’s principal each year, even though the full amount isn’t received until maturity. This is known as phantom income. Tax-efficient strategies, such as holding TIPS in an IRA, can help mitigate this issue.
Q: What happens if inflation is low or negative?
A: If inflation is low, TIPS adjustments will be smaller, but they will never decrease in value. In deflationary periods, you still receive at least the original principal amount at maturity.
Q: What are the risks of a TIPS ladder?
A: The main risks include:
- Reinvestment risk – If additional TIPS bonds need to be purchased later, prevailing interest rates may be lower. However, if each rung of the ladder is matched to expenses and planned to be spent, this reinvestment risk is eliminated.
- Tax inefficiency – If held in a taxable account, phantom income taxation can be a drag on returns.
Q: How do I buy TIPS bonds?
A: TIPS can be purchased:
- Directly from the U.S. Treasury at auction via TreasuryDirect.
- Through brokerage accounts in the secondary market (Purpose Built’s preferred method due to flexibility).
- Using TIPS-focused ETFs and mutual funds (although this removes some of the precision of laddering).
Final Thoughts
For retirees looking for predictable, inflation-protected income, a TIPS bond ladder is one of the safest and most effective strategies available. At Purpose Built Financial Services, we believe in eliminating unnecessary risk, keeping costs low, and ensuring that our clients have financial peace of mind in retirement.
If you’d like to learn how a TIPS bond ladder could fit into your retirement plan, we’re here to help.
About the Author
Sean Lovison, CPA, CFP®, is a flat fee-only financial planner based in Moorestown, New Jersey, serving clients virtually nationwide. After spending 14 years as a corporate chief financial officer (CFO), receiving and designing compensation plans, he decided to help others navigate their plans.
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