Bridging to SS with a TIPS ladder

[finvest2]

Hi all, first post here but have been working on early retirement for a number of years now.

I'm looking to retire at age 40 in 2026. This gives me 22 years until I can collect my estimated social security check of $1,500/month at age 62. I've been thinking: wouldn't it be nice if I could start collecting at age 40 to reduce sequence of returns risk?

I've been working on building out a treasury/CD ladder for the first 3 years of retirement, but this post https://tipswatch.com/2023/06/26/can-we-build-a-better-tips-etf/ got me thinking: why not build a 22 year TIPS ladder and have a "guaranteed" $1,500/month for life so that my SS kicks in just as my TIPS ladder expires?

Using tipsladder.com I created a 2026-2047 ladder that pays out $18k/year, total cost is $321,853. Supposing this purchase come from a portfolio of $1m, this leaves $678,147 for a 70/30 mix.

My expenses run about $35k/year, so after the $18k reduction from TIPS/SS this is reduced to $17k/year which is covered at a very conservative 2.5% withdrawal rate. Targeting 4% withdrawal rate would mean I could technically pull the plug at $746,853 (25x17,000+321,853)

I'm thinking this is a better option than buying a traditional annuity for 2 reasons:
1. I get inflation adjusted payments
2. I don't rely on a single company not going bankrupt

I'm wondering does anyone have thoughts on this strategy or is anyone doing it? The taxation of a TIPS ladder like this is a little fuzzy to me, but presumably it would be best in a tax advantaged account (in my case, it would be in a Roth IRA)

Thanks in advance!

 

[njhowie]

So you're single and intend to remain single?

Based on what little information you've provided, I think it's very risky what you're considering doing at the income/portfolio level you're looking at.

 

[COcheesehead]

There’s a whole lotta life unaccounted for in your plan.

 

[gauss]

If it were me, I wouldn't plan to start collecting SS at 62, but rather wait until age 70. The payout would be nearly twice as much, by adding a few more years to your ladder.

FWIW our pensions will decrease at age 62 until age 72. As such I need to bridge the years from 63 until age 70 with ~ $2,500 /month and have been setting up a ladder of target-date maturity corporate bond ETF funds (ie Invesco bulletshare BSC(x) series) to accomplish this.

I do appreciate your thinking but will caution that your $35,000 / year living expenses may be a bit optimistic/limiting as suggested by other posters.

-gauss

 

[SecondCor521]

Welcome to the board! Questions for you about your plan:

1. Have you evaluated how much more SS you could get if you waited until FRA or age 70?

2. How do you plan to get that much $$$ into your Roth IRA?

3. Do you think 4% at age 40 is safe?

4. How does collecting at age 40 reduce SORR?

5. How sure are you of your $35K expenses number?

6. Do you think your personal inflation rate will match the TIPS rate (CPI I guess) for the next 22 years?

7. Have you considered something simple like a 60/40 portfolio? A $1M 60/40 portfolio spending $35K historically would have allowed 22 years of inflation adjusted spending...and you'd be left with anywhere between ~$306K and ~$4M in current dollars left at the end, plus your $1500 SS check.

I think your plan is better than an annuity, but I think there are other options out there that work a lot better if you're willing to accept the investment risk (and maybe you aren't, which is OK too).

 

[finvest2]

So you're single and intend to remain single?

Based on what little information you've provided, I think it's very risky what you're considering doing at the income/portfolio level you're looking at.

I'm not single, but my partner of 8 years manages her finances and retirement separately. We aren't married, but obviously our plans are somewhat intertwined since we live together and have common expenses. There will never be kids, however.

If it were me, I wouldn't plan to start collecting SS at 62, but rather wait until age 70. The payout would be nearly twice as much, by adding a few more years to your ladder.

FWIW our pensions will decrease at age 62 until age 72. As such I need to bridge the years from 63 until age 70 with ~ $2,500 /month and have been setting up a ladder of target-date maturity corporate bond ETF funds (ie Invesco bulletshare BSC(x) series) to accomplish this.

I do appreciate your thinking but will caution that your $35,000 / year living expenses may be a bit optimistic/limiting as suggested by other posters.

-gauss

I think waiting until 70 is probably optimal. I played around with building a ladder to 70, but it ends up being a higher percentage of the overall portfolio than I think makes sense. My hope would be to get to 62 and find that I don't really need to collect social security yet, because my equities have grown so much over 20+ years and I can defer SS to 70. But worst case, collect at 62.

I agree that $35k isn't a lot, but it's certainly not poverty levels. It's probably worth mentioning that my partner is also aiming to have a similar portfolio with $35k of spend or so, so considered as a couple it's more like $70k. That does include housing (we rent) but plan to buy a place in a LCOL area before retirement.

Welcome to the board! Questions for you about your plan:

1. Have you evaluated how much more SS you could get if you waited until FRA or age 70?

2. How do you plan to get that much $$$ into your Roth IRA?

3. Do you think 4% at age 40 is safe?

4. How does collecting at age 40 reduce SORR?

5. How sure are you of your $35K expenses number?

6. Do you think your personal inflation rate will match the TIPS rate (CPI I guess) for the next 22 years?

7. Have you considered something simple like a 60/40 portfolio? A $1M 60/40 portfolio spending $35K historically would have allowed 22 years of inflation adjusted spending...and you'd be left with anywhere between ~$306K and ~$4M in current dollars left at the end, plus your $1500 SS check.

I think your plan is better than an annuity, but I think there are other options out there that work a lot better if you're willing to accept the investment risk (and maybe you aren't, which is OK too).

1. Mentioned above, I think 70 would be the better choice if I can do it at that point. It's hard to predict my situation 20-30 years in advance, so I was defaulting to collecting at 62 as a worst-case scenario. I am also a little worried about SS benefits not being paid out 100% 20-30 years from now.
2. I was lucky enough to buy AAPL in my Roth, I nearly have enough room now. I probably would have to supplement a bit of it in a taxable account, likely the earliest maturing TIPS to minimize the 'phantom' taxes. My 401k will eventually be converted to a trad IRA as well, but I likely won't be able to do that for another 3 years.
3. No I don't, which is partly why I'm thinking about trying to reduce risk with TIPS. 3-3.5% at 40 seems reasonable to me. I've been thinking of doing a variable withdrawal strategy (the bogleheads VPW spreadsheet) with the TIPS/SS acting as the floor on my income.
4. If the market drops 50% and I have a large portion of my income from TIPS, I can limit how much I need to sell from equities while they're down. Any discretionary expenses can be pushed off to future years, while the TIPS pays the bills.
5. I've been below 35k for the last 8 years since I started budgeting, so I'm pretty certain in terms of lifestyle inflation, but not so confident in terms of #6.
6. This one is hard, since 2020 I've seen my personal expenses increase by more than CPI due to regional issues. So I have no guarantee that this won't happen again sometime in the future. I'm not really sure how to avoid this risk however. The biggest thing I can think of to eliminate this risk is having a mortgage or paid off home, rather than renting.
7. Yes I have been thinking of a 60/40 portfolio, with the first 3-5 years of expenses in CDs/treasuries to help with SORR. I'm fairly risk tolerant, but given my relatively lean income in RE I probably won't have the flexibility of just "cutting back" if the market goes south for a decade. Given the performance of both bonds and equities over the last few years, I've been pondering ways to make sure I'm not taking on too much risk... but I might just be adding extra complexity without much extra value.

Thanks for the replies!

 

[gauss]

Having a partner with income/assets to bring into the relationship could improve things significantly.

-gauss

 

[Out-to-Lunch]

I set up a TIPS ladder as a bridge to SS at 70. So conceptually, I am in agreement with the idea. The devil may be in the details, though.

My bridge is much shorter, as I did this when I was 57. Thus, the uncertainties were much smaller. I hold mine in a tIRA (because money is fungible). Are you eligible to withdraw enough from your Roth when you will need it? (I.e., is your account 5 years old, have you contributed and/or converted enough to cover your needs, etc.?)

 

[finvest2]

I set up a TIPS ladder as a bridge to SS at 70. So conceptually, I am in agreement with the idea. The devil may be in the details, though.

My bridge is much shorter, as I did this when I was 57. Thus, the uncertainties were much smaller. I hold mine in a tIRA (because money is fungible). Are you eligible to withdraw enough from your Roth when you will need it? (I.e., is your account 5 years old, have you contributed and/or converted enough to cover your needs, etc.?)

I should be able to access my ~15 years of contributions, but I think I'd probably have to play some accounting tricks to access at least some of the money. Eg if $10k of TIPS matures inside the Roth, I'd buy $10k of VTSAX (or whatever) in the Roth and sell $10k of VTSAX in my taxable brokerage account and pay capital gains tax on it (where I expect to be in the 0% bracket).

It would be much nicer for withdrawing if the ladder could be purchased inside a tIRA, but unfortunately I don't currently have any space in a tIRA.

What was your reasoning for a TIPS ladder, similar to mine?

 

[mrfeh]

+1 to previous posts warning about planning for expenses for 22 years.

Life happens. The chances of your expenses being as consistent as you hope are very small.

Work longer. Save more.

 

[Alex The Great]

To be honest, I wouldn't plan a fixed income for so long time. As others pointed out, everything can happen.
I'm 56 and still working. My plan is to retire this year. I'm in process of building CD ladder for next 7-8 years with a target ~$50K per year, using taxable savings. The plan is to start aggressive withdrawals from tIRA at 65 to 70 as hopefully I'll be on Medicare and don't need to keep income low for ACA. Unfortunately rates are falling for longer term CDs and I may look at something else beyond 5 years. Though not sure about TIPs at this time.

 

[RetiredHappy]

I haven't studied ACA in detail as I am on unsubsidized off market private individual insurance which costs me an arm and a leg. But you probably have to look at where your income falls under ACA and what deductible and max out of pocket you will be responsible for in a major medical event. I know that if your income is barely above Medicaid amount, then you have very low deductible and out of pocket costs. For me, my max out of pocket is $9.1K, and that is in addition to $14.5K in premiums at age 60.

If I were you, I will plan for $50K a year instead of $35K a year and see if you can indeed retire at 40. I would rather pad my number than to see a shortfall. For instance, what if your partner and you are no longer together, you will still need to pay for the fixed expenses alone, that are currently covered by 2 people.

 

[Out-to-Lunch]

I should be able to access my ~15 years of contributions, but I think I'd probably have to play some accounting tricks to access at least some of the money. Eg if $10k of TIPS matures inside the Roth, I'd buy $10k of VTSAX (or whatever) in the Roth and sell $10k of VTSAX in my taxable brokerage account and pay capital gains tax on it (where I expect to be in the 0% bracket).

Yeah, all of that is what I meant by my glib "money i fungible" comment.

What was your reasoning for a TIPS ladder, similar to mine?

Yes, pretty much. There was a nice explanation from some folks (I think) at the Stanford Center for Longevity and the Society of Actuaries that helped to explain this. I cannot find it at the moment, but the gist was that TIPS and SS have similar risk profiles (i.e., nearly riskless). Therefore, as you spend down the TIPS as you approach SS, your risk profile does not change. You are trading like for like.

 

[finvest2]

I haven't studied ACA in detail as I am on unsubsidized off market private individual insurance which costs me an arm and a leg. But you probably have to look at where your income falls under ACA and what deductible and max out of pocket you will be responsible for in a major medical event. I know that if your income is barely above Medicaid amount, then you have very low deductible and out of pocket costs. For me, my max out of pocket is $9.1K, and that is in addition to $14.5K in premiums at age 60.

If I were you, I will plan for $50K a year instead of $35K a year and see if you can indeed retire at 40. I would rather pad my number than to see a shortfall. For instance, what if your partner and you are no longer together, you will still need to pay for the fixed expenses alone, that are currently covered by 2 people.

I'll have to look into this in more detail. If I realize $35k of gains the ACA silver plan is $125/month (same premium at age 40 vs 60). The maximum out of pocket for a silver plan is $9,100, but I haven't actually shopped around individual plans to see if any of them have a lower max out of pocket.

In the past I've often run calculations without accounting for SS, under the premise that SS will pay for whatever increased medical costs I have as I age. The idea in this post relies on SS and is probably not properly accounting for increased healthcare costs as I age, but as many have noted, the chance of accurately forecasting anything 20+ years in advance kind of slim.

Most likely if I hit 40 and still don't think I have enough, I'd switch to a lower paid (maybe seasonal) job just to cover expenses until the numbers look better. My current portfolio still has a large percentage of equities, so it's hard to know where it will be even 3 years from now.

 

[Alex The Great]

Today there was an article on Yahoo finance that clearly explain the difference between treasuries, TIPs and annuities:
https://finance.yahoo.com/news/treasury-bonds-vs-tips-ladders-131720815.html
Morningstar's John Rekenthaler found that over a 20-year time horizon, Treasury bonds are best if inflation remains low or moderate. A TIPS ladder generates the highest return if inflation averages 5% per year. An annuity, on the other hand, is best if a retiree ends up living more than 20 years.

 

[finvest2]

Today there was an article on Yahoo finance that clearly explain the difference between treasuries, TIPs and annuities:
https://finance.yahoo.com/news/treasury-bonds-vs-tips-ladders-131720815.html
Morningstar's John Rekenthaler found that over a 20-year time horizon, Treasury bonds are best if inflation remains low or moderate. A TIPS ladder generates the highest return if inflation averages 5% per year. An annuity, on the other hand, is best if a retiree ends up living more than 20 years.

To add a bit more to the mechanics, TIPS are often measured with a breakeven rate which compares them to nominal treasuries. For example I recently bought 5 year TIPS where the breakeven rate was 2.2%.

• The 5 year TIPS auctioned at 1.83% (that is the payout above inflation)
• 5 Year treasury notes were trading at 4.03%

So we can calculate a breakeven rate of 2.2% (4.03-1.83). If inflation averages under 2.2% over the next 5 years, I would have been better off buying the 5 year treasury notes. If it runs higher than 2.2%, I make more with TIPS. The breakeven rate for any given TIPS auction fluctuates based on market conditions since both treasuries and TIPS trade in the open market.

The main advantage (I think) of TIPS is that it guarantees that I will maintain my spending power. With nominal treasuries I could either lose or gain spending power if we have higher inflation, or deflation. I might feel ok taking a guess at inflation rates over the next few years, but I wouldn't hazard to guess what they will be over the next 20.

If I create a 20 year ladder, I expect the funds to be fully depleted after 20 years, where as with an annuity it will generally pay out until end of life (but payments usually aren't inflation adjusted). I tried to do a little research on inflation adjusted annuities to compare them to TIPS but they seem quite hard to find.

Tipswatch also has a good article on some of the nitty gritty of how TIPS work: https://tipswatch.com/tips-in-depth/

 

[RetiredHappy]

I'll have to look into this in more detail. If I realize $35k of gains the ACA silver plan is $125/month (same premium at age 40 vs 60). The maximum out of pocket for a silver plan is $9,100, but I haven't actually shopped around individual plans to see if any of them have a lower max out of pocket.

There are no subsidies when you buy private off exchange insurance and you will pay alot higher premium for the same product.

 

[GravitySucks]

To add a bit more to the mechanics, TIPS are often measured with a breakeven rate which compares them to nominal treasuries. For example I recently bought 5 year TIPS where the breakeven rate was 2.2%.

• The 5 year TIPS auctioned at 1.83% (that is the payout above inflation)
  
• 5 Year treasury notes were trading at 4.03%
  

So we can calculate a breakeven rate of 2.2% (4.03-1.83). If inflation averages under 2.2% over the next 5 years, I would have been better off buying the 5 year treasury notes. If it runs higher than 2.2%, I make more with TIPS. The breakeven rate for any given TIPS auction fluctuates based on market conditions since both treasuries and TIPS trade in the open market.



The main advantage (I think) of TIPS is that it guarantees that I will maintain my spending power. With nominal treasuries I could either lose or gain spending power if we have higher inflation, or deflation. I might feel ok taking a guess at inflation rates over the next few years, but I wouldn't hazard to guess what they will be over the next 20.



If I create a 20 year ladder, I expect the funds to be fully depleted after 20 years, where as with an annuity it will generally pay out until end of life (but payments usually aren't inflation adjusted). I tried to do a little research on inflation adjusted annuities to compare them to TIPS but they seem quite hard to find.



Tipswatch also has a good article on some of the nitty gritty of how TIPS work: https://tipswatch.com/tips-in-depth/

Great article. Thanks.

I like the break even inflation rate concept, kinda like betting on the Over/Under but with an insurance kicker to consider.