Treasury Bonds vs. TIPS Ladders vs. Annuities

Generating enough retirement income to meet your spending needs is important. While Social Security provides inflation-protected retirement income, it is not enough for many retirees.

If you need help planning for retirement, consider working with a financial advisor.

John Rekenthaler, director of research at Morningstar, recently examined three other ways to generate guaranteed income in retirement – Treasury bonds, TIPS ladders and annuities – to see which works best. The answer? It all depends on inflation and life expectancy.

Guaranteed Retirement Income Options

Retirees looking for a guaranteed source of income should look beyond Social Security and pensions.

According to the Social Security Administration, the average monthly benefit check in May 2023 will be approximately $1,700. Pensions, on the other hand, range from the usual to the extraordinary. There were more than 100,000 defined benefit plans in existence in 1975, but that number has dropped to less than 46,000 by 2020, Department of Labor data show.

Three retirement income options recently reviewed by Morningstar include:

Treasury bonds. Debt instruments issued by the US Department of Treasury, these bonds are long-term securities that take 30 years to mature. Until then, Treasury bonds will pay a fixed interest rate twice a year.

TIPS ladder. Treasury Inflation-Protected Securities or TIPS are another type of US government investment. TIPS, however, are designed to protect against rising inflation. While the interest rate is fixed, the principal or face value of a TIPS bond is indexed to inflation. As the principal amount increases with inflation, your interest payments will also increase.

A TIPS ladder is a strategy for building a portfolio of bonds with different maturity dates. The idea is to hold a TIPS bond that matures annually over the course of your time horizon, protecting the purchasing power of your money during that time.

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Single-premium immediate annuities. Also known as SPIA, these insurance contracts turn a lump sum of money into a series of guaranteed periodic payments that usually begin within a year of purchase.

Treasury Bonds vs. TIPS Ladder vs. Annuities

Retirement strategies that rely on Treasury bonds, TIPS ladders or single-premium immediate annuities can be good ways to generate guaranteed income. The best option, however, often depends on inflation and a retiree’s life expectancy, according to Rekenthaler.

Using a hypothetical 20-year retirement — the estimated remaining life expectancy of a 65-year-old woman — Rekenthaler examined how each strategy would perform under different rates of long-term inflation. To do this, he calculated the growth of $100,000 invested equally in each strategy over a 20-year period.

Under average annual inflation (2.4%), he found that Treasury bonds would generate nearly $127,000 after 20 years while the TIPS ladder would generate nearly $118,000. The annuities, however, only generate approximately $113,500.

If inflation averages 5% per year over a 20-year period, the TIPS ladder strategy will outperform Treasury bonds and annuities by 29% and 32%, respectively. Meanwhile, if inflation hovers at just 1% per year during that time, Rekenthaler sees Treasury bonds generating $155,000 — more than an annuity or TIPS ladder strategy.

But what if a retiree lives for more than 20 years? Assuming moderate inflation (2.4%), Rekenthaler found that annuities became the best income option over a 30-year period – delivering $153,000.

“The annuity under that inflation assumption outperformed the TIPS ladder during Year 21, then Treasury bonds in Year 25,” he wrote. “If inflation is very low, annuities will also improve, even if they take a few more years to catch up with Treasury bonds.”

Bottom Line

Retirees looking for guaranteed income beyond Social Security may consider strategies that rely on Treasury bonds, TIPS laddering or annuities. Morningstar’s John Rekenthaler found that over a 20-year horizon, Treasury bonds do best if inflation remains low or moderate. The TIPS ladder generates the highest returns when inflation averages 5% per year. An annuity, on the other hand, is best if a retiree lives more than 20 years.

Retirement Planning Tips

• Retirement planning can be complicated and confusing but a financial advisor can help guide you through the process. Finding a financial advisor doesn’t have to be difficult. SmartAsset’s free tool matches you with up to three vetted financial advisors serving your area, and you can have a free initial call with your advisor matches to decide who you feel is right for you. suits you. If you’re ready to find an advisor who can help you achieve your financial goals, get started today.

• How much money do you expect to have saved by the time you retire? SmartAsset’s retirement calculator can help you estimate how much your savings will be worth when you reach your golden years.

• Social Security remains an important part of many people’s financial plans for retirement. SmartAsset’s Social Security calculator can help you understand how much your benefits are worth.

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