Most employees today have to save and plan their own retirement. They face major challenges: inflation, low interest rates, a highly volatile and unpredictable stock market, and job insecurity. It’s not always this difficult. A few decades ago, far more employees worked for companies that provided defined benefit pension plans that promised their employees an inflation-adjusted stream of basic retirement income at retirement. Most of these plans have been discontinued and replaced with defined contribution plans, such as 401(k)s. Today, most employees have to save and plan for their own retirement.
So how can today’s employees effectively save and prepare for retirement, if they don’t want to entrust their retirement benefits to stock market changes? Many simply put their money in Certificates of Deposit (CD). But with CD rates generally low, inflation generally high, and all interest taxed annually, this is a very bad choice. Some retirees will choose to purchase an outright income annuity. But annuities are generally expensive. Premiums support not only annuity payments, but also large commissions, generous compensation packages for insurance company executives, and large insurance company overhead, operating and advertising costs.
Fortunately, there is a better option – buying inflation-indexed bonds known as Treasury Inflation-Protected Securities (TIPS). In 1997, the US Treasury began issuing TIPS in 5, 10, and 20 year terms. In contrast to government bonds, TIPS protects the holder from inflation through adjustments, based on the Consumer Price Index (CPI), to the principal. Because they are backed by the full trust and respect of the US government, TIPS are as safe as an FDIC-backed CD and more secure than annuities.
Interest granted by TIPS, however – unlike capital gains – is taxed at the ordinary income tax rate. Therefore, TIPS are best purchased through a tax-advantaged account, such as a standalone IRA. There are several low-cost brokers that allow customers to buy TIPS through a standalone IRA account, so get in touch with some of them and find out.
Rather than building a multilevel CD portfolio, retirees should consider building a multilevel TIPS portfolio of multiple maturities, in a standalone IRA. Retirees should also consider postponing their application for Social Security benefits until they reach age 70 – and taking distributions from IRAs holding TIPS until they reach age 70.
To execute a retirement strategy with TIPS, retirees must calculate the retirement expenditures to be supported by a TIPS-based portfolio. For example, a multi-million dollar TIPS portfolio of IRAs with real yields of 3% would support an inflation-adjusted retirement expenditure of more than $65,000/year for 20 years.