Delay bridge for Social Security, retirement income plan

[Airco_DH2_pilot]

Gotcha. Since I can’t buy TIPS in my 401k I think I have to wait until right when I retire (using the rule of 55) and then roll it over to an IRA where I could then build the TIPS ladder.

Can you buy TIPS funds in your 401k?

If yes, there are strategies to simulate a ladder using short and long TIPS funds.

Unfortunately, no I can't. It doesn't offer TIPS funds. It has 3 fixed income options: Stable Value, a Bond market index fund, and a "Fixed Income" fund that is tilted toward corporate bonds.

[Airco_DH2_pilot]

Now that you've all educated me on the TIPS ladder strategy, I've played with modeling two different strategies for this bridge: one based on the TIPS ladder and one based on using MYGA's (conservatively assuming 4% fixed rate and a ladder approach that would cover 15 years from a MYGA that allows up to 10% withdrawals each year, effectively drawing down the account balance over time).

Assumptions: Basic essential expenses are 70k, 30k comes from pension annuity, 18k comes from 1% withdrawal from stock index fund, remaining 22k comes from other fixed income either: TIPS ladder or MYGA modeled here. 3M 60/40 portfolio, 1.2M fixed income portion deployed to one of two strategies: Tips Ladder + fixed income reserve vs MYGA + fixed income reserve.

TIPS ladder strategy

Total Fixed Income available based on Asset allocation $1,200,000
Subtract pension lump sum for annuity $550,000
Left over after annuity starts $650,000
Fund TIPS ladder $300,000 This provides inflation protected 15 year bridge for remaining essential expenses to SS
Remaining Fixed Income Reserve Fund $350,000
This provides 350k spending cash when stocks are down and/or some bond funds to support rebalancing with stocks. I would probably divide this up into 1 years' worth of spending cash & the remaining in a short-term Treasury bond fund. This feels pretty good.

MYGA strategy
Total Fixed Income based on Asset allocation $1,200,000
Subtract pension lump sum for annuity $550,000
Left over after annuity starts $650,000
Invest in MYGA $375,000 This provides some fixed income for essential expenses until SS, non-inflation adjusted 22k / year
Remaining Fixed Income Reserve Fund $275,000 This provides spending cash when stocks are down and/or some bond funds to support rebalancing with stocks.

The issue I can see with the MYGA approach is that it already takes more up front funding to provide non-inflation adjusted 22k per year and so its not constant purchasing power. To allow the MGYA withdrawal to increase as inflation significantly erodes the purchasing power of those fixed withdrawals, I'd have to put up even more up front into the MYGA. The 375k would probably need to be as high as 500k to enable MYGA withdrawals to increase enough to compensate for inflation (gut feel estimate, haven't done that math yet). Bumping that MYGA premium up to 500k would leave me with only 150k left for a bond / cash reserve fund at the start of retirement. That is too low to support cash flow needs and any rebalancing I'd need to do.

Conclusion at this point: TIPS ladder is looking like a better approach now than it did before.

[RyeBourbon]

Gotcha. Since I can’t buy TIPS in my 401k I think I have to wait until right when I retire (using the rule of 55) and then roll it over to an IRA where I could then build the TIPS ladder.

Can you buy TIPS funds in your 401k?

If yes, there are strategies to simulate a ladder using short and long TIPS funds.

This is what I did. I bought a TIPS fund (FIPDX) in my 401k about a year before I was able to roll it into an IRA and buy the ladder. I monitored the cost of the ladder over the year and it tracked the value of my TIPS fund pretty well. So I feel that I was able to "lock in" the yield that was prevalent when I bought the fund.

If you buy a fund now at around 2% real yield, and 3 years from now when you are ready to buy your ladder, if real yields have gone negative, the ladder will be more expensive, but the value of your TIPS fund should have appreciated by a similar amount. It's not going to be precise but should be close enough.

[Airco_DH2_pilot]

Thanks RyeBourbon, our 401k options are pretty good but we don't have access to TIPS or TIP funds unfortunately.

[Airco_DH2_pilot]

Okay so I'm on board & studying further the scenario where I use a TIPS ladder for this bridge. Per my earlier scenario analysis, I'd have about $350k left over in my fixed income allocation. Since this is for rebalancing the stock/bond portfolio and short term cash savings; the Vanguard Money Market Fund (VMRXX) looks like a very safe place to keep the 350k cash.

My preference is to minimize interest rate risk as much as possible, so I'd only entertain short or ultra-short term bond funds, a TIPS fund like VTIP, or money market funds. What would you suggest? How big a deal is not having FDIC insurance on the money market fund?

[watchnerd]

Okay so I'm on board & studying further the scenario where I use a TIPS ladder for this bridge. Per my earlier scenario analysis, I'd have about $350k left over in my fixed income allocation. Since this is for rebalancing the stock/bond portfolio and short term cash savings; the Vanguard Money Market Fund (VMRXX) looks like a very safe place to keep the 350k cash.

My preference is to minimize interest rate risk as much as possible, so I'd only entertain short or ultra-short term bond funds, a TIPS fund like VTIP, or money market funds. What would you suggest? How big a deal is not having FDIC insurance on the money market fund?

For short term liquidity, I use Vanguard Treasury MMF (VUSXX) and laddered individual T-bills

https://investor.vanguard.com/investmen ... x#overview

[sycamore]

... My preference is to minimize interest rate risk as much as possible, so I'd only entertain short or ultra-short term bond funds, a TIPS fund like VTIP, or money market funds. What would you suggest?

You mentioned minimizing interest rate risk but it's not clear how you feel about reinvestment risk. I could assume something but better to have you confirm it.

I'm guessing your time horizon for the $350k fixed income is actually much longer than 90 days (of a typical money market fund). I'll suggest it's probably better performance-wise to balance the interest rate risk and reinvestment risk and go for a short-term bond fund with an average duration around 2-3 years:
- VTIP or STIP if you want even more of your fixed income to be inflation-indexed
- VGSH if you want nominal Treasuries
- BSV for a mix of Treasuries and investment grade

In between MMF (or an ETF like SGOV) and short-term is ultra-short like VUSB, but I wouldn't bother trying to split the difference. If you really, really, really can't stomach the price fluctuations of a short-term bond fund, go for money market or something with 90 day maturity of less.

... How big a deal is not having FDIC insurance on the money market fund?

Not a big deal at all.
The underlying assets are very short-term and there's very low probability of "breaking the buck".
I think MMFs themselves have a good amount of regulation on them to ensure they're properly run.
Other scenarios with brokerage-related problems (bankruptcy, fraudulent account) are applicable to any assets you hold in a brokerage, so not applicable to deciding whether to use a MMF or not.

[Airco_DH2_pilot]

Okay so I'm on board & studying further the scenario where I use a TIPS ladder for this bridge. Per my earlier scenario analysis, I'd have about $350k left over in my fixed income allocation. Since this is for rebalancing the stock/bond portfolio and short term cash savings; the Vanguard Money Market Fund (VMRXX) looks like a very safe place to keep the 350k cash.

My preference is to minimize interest rate risk as much as possible, so I'd only entertain short or ultra-short term bond funds, a TIPS fund like VTIP, or money market funds. What would you suggest? How big a deal is not having FDIC insurance on the money market fund?

For short term liquidity, I use Vanguard Treasury MMF (VUSXX) and laddered individual T-bills

https://investor.vanguard.com/investmen ... x#overview

Thanks watchnerd!

[Airco_DH2_pilot]

Thanks for the info sycamore, good question on reinvestment risk. I am okay with the yield coming down as rates go down. I’ll explain my logic…

For this 350k portion of the portfolio I do not need to maximize yield to cover the base expenses (that job is being done by the pension, TIPS ladder, and dividends from the stock index funds). The idea is to use this 350k bond fund (or MMF) as funds for rebalancing with the stocks to maintain target asset allocation. It also serves as a liquidity source of needed when stocks are down. I was looking at VTIP and it did look like a solid option. I will look at the other bond funds you suggest.

Thanks

[watchnerd]

Thanks for the info sycamore, good question on reinvestment risk. I am okay with the yield coming down as rates go down. I’ll explain my logic…

For this 350k portion of the portfolio I do not need to maximize yield to cover the base expenses (that job is being done by the pension, TIPS ladder, and dividends from the stock index funds). The idea is to use this 350k bond fund (or MMF) as funds for rebalancing with the stocks to maintain target asset allocation. It also serves as a liquidity source of needed when stocks are down. I was looking at VTIP and it did look like a solid option. I will look at the other bond funds you suggest.

Thanks

VTIP is a solid choice, but even with a duration of 2.4, got a bit whacked recently (temporarily) during rising rates.

Using the rule of thumb of 2*duration - 1, I'd use it for costs you see as 3.8 years into the future.

[Airco_DH2_pilot]

Appreciate the comment watchnerd. It will probably come down to a “sleep better at night” factor. The money market fund approach you used was rock solid during the 2022 mess. That’s appealing.

[Airco_DH2_pilot]

Hello,
A follow up question. If I go with a TIPS ladder as a bridge to SS, should it be purchased inside of a traditional IRA, or a taxable brokerage account?

Does it have to be purchased some years before retirement, or can I wait until retirement starts?

Thanks

[dogagility]

A follow up question. If I go with a TIPS ladder as a bridge to SS, should it be purchased inside of a traditional IRA, or a taxable brokerage account?

TIPS spin off taxable interest each year, so it's preferred (but not required) to purchase TIPS in a tIRA.

Does it have to be purchased some years before retirement, or can I wait until retirement starts?

It can be purchased at any point. The current yield on TIPS is fairly high relative to many other times in the past.
https://fred.stlouisfed.org/series/DFII10
https://www.wsj.com/market-data/bonds/tips

[Airco_DH2_pilot]

Thanks dogagility,
Since I can’t buy tips in my 401k, I suppose I’d have to wait until it is rolled over to an IRA and then buy the tips.

That raises another question: If I was relying on the rule of 55 to access those 401k funds, do I have to leave the funds in the 401k at age 55 (until 59.5), or can I still roll it over to a traditional IRA at age 55 so as to buy the TIPS ladder then and there?

[dogagility]

That raises another question: If I was relying on the rule of 55 to access those 401k funds, do I have to leave the funds in the 401k at age 55 (until 59.5), or can I still roll it over to a traditional IRA at age 55 so as to buy the TIPS ladder then and there?

Pretty sure the funds need to remain in the 401k to take advantage of the rule of 55.

[sycamore]

That raises another question: If I was relying on the rule of 55 to access those 401k funds, do I have to leave the funds in the 401k at age 55 (until 59.5), or can I still roll it over to a traditional IRA at age 55 so as to buy the TIPS ladder then and there?

Pretty sure the funds need to remain in the 401k to take advantage of the rule of 55.

I agree.

Now if someone really wants to build a TIPS ladder (or some other set of assets not available in the 401k) he or she could
(1) rollover the 401k to an IRA prior to age 59.5 and then
(2) buy the desired collection of assets/funds/TIPS
(3) follow a Substantially equal periodic payments plan to make withdrawals prior to age 59.5 and avoid the 10% early withdrawal penalty

There are pros and cons to using SEPP for sure.

[steadyosmosis]

I bought my 30-yr TIPS ladder in my tIRA, but nothing says I must spend from that account.
In fact, I cannot spend from there (yet) without penalty because I am younger than age 59.5.
So, when the 2024 TIPS rung matured last February, I simply bought another rung for 2054 in the tIRA.
And I continued funding my current living expenses from my 100% VTI taxable account.
If using this method skews my AA too much, I can 'skip-a-TIPS' re-investment, and buy stocks instead in my Roth IRA (and/or my tIRA).
(For the years prior to starting SS, my TIPS ladder 'pays' $2x per year. For the years after SS starts, it 'pays' $x per year.)

[Airco_DH2_pilot]

steadyosmosis,

It's interesting that you say that. It has also occurred to me that building a TIPS ladder provides not only a secure bridge for that time period until SS starts, but I can also have the option to spend only a portion of or none of a maturing rung on the ladder. If stocks were doing really well in the year that a run matures, I could reinvest that maturing TIPS rung on the ladder. Or I could choose to only spend a portion of it and reinvest the rest into other fixed income (depending on what was needed to maintain target asset allocation).

Extending that idea further... here is a question. Let's say I built a TIPS ladder for 15 years using $850k. Let's also assume that the real yield is 2% and inflation is running 3% for a total nominal yield of 5%. Would this $850k TIPS ladder, collectively, be throwing out interest payments each year in the amount of $42.5k? (850k x .05 nominal yield). That's large enough that I could choose to just spend the interest payments from the TIPS ladder to cover a significant portion of our essential expenses (with the rest of the essential expenses covered by a very small / very low risk 2% withdrawal rate from the stock portfolio).

[NatureBoy]

steadyosmosis,

It's interesting that you say that. It has also occurred to me that building a TIPS ladder provides not only a secure bridge for that time period until SS starts, but I can also have the option to spend only a portion of or none of a maturing rung on the ladder. If stocks were doing really well in the year that a run matures, I could reinvest that maturing TIPS rung on the ladder. Or I could choose to only spend a portion of it and reinvest the rest into other fixed income (depending on what was needed to maintain target asset allocation).

Extending that idea further... here is a question. Let's say I built a TIPS ladder for 15 years using $850k. Let's also assume that the real yield is 2% and inflation is running 3% for a total nominal yield of 5%. Would this $850k TIPS ladder, collectively, be throwing out interest payments each year in the amount of $42.5k? (850k x .05 nominal yield). That's large enough that I could choose to just spend the interest payments from the TIPS ladder to cover a significant portion of our essential expenses (with the rest of the essential expenses covered by a very small / very low risk 2% withdrawal rate from the stock portfolio).

The interest payments of TIPS are based on the coupon. The most recent auctions had a 5 year coupon of 1.625% (91282CLV1), 10 year of 1.875% (91282CLE9), and 30 year of 2.125% (912810TY4). The real yield, determined at purchase time, is only realized if kept until maturity.

[Airco_DH2_pilot]

Thanks that helps. So I think you are saying that while I am holding the TIPS bond, the income is just from the coupon rate times the face value. The inflation adjustment or credit comes when I redeem the bond at maturity. I could then choose how much of that to spend vs reinvest. Do I have that right?

[jeffyscott]

The coupon payments (income) will be based on the inflation adjusted value. Your yield is based on that as well as the price at which you buy.

If you buy at the initial auction, the price will be pretty close to 100 and the coupon will be close to the real yield. If you buy at another time the price will change based on current yields.

For example, suppose the auction some time ago set an initial real yield and coupon of 1%, if you are buying that now the price will be under 100 in order to increase the real yield to the current market rate of 2%+.

The 2046 TIPS has a 1% coupon and price is about 74. The combination of that coupon and the price of $74 per $100 face value results in a real yield of about 2.6%. You're getting 1% per year from coupons. The $26 discount is about 35% of what you paid, divide that by 21 years and it's 1.67% per year. Add that to the 1% coupon and it comes pretty close to the actual real yield.

While not a correct or accurate way to determine YTM, I think that way of estimating may, perhaps, help clarify where the yield comes from and when you receive it.

[Airco_DH2_pilot]

The coupon payments (income) will be based on the inflation adjusted value. Your yield is based on that as well as the price at which you buy.

If you buy at the initial auction, the price will be pretty close to 100 and the coupon will be close to the real yield. If you buy at another time the price will change based on current yields.

For example, suppose the auction some time ago set an initial real yield and coupon of 1%, if you are buying that now the price will be under 100 in order to increase the real yield to the current market rate of 2%+.

The 2046 TIPS has a 1% coupon and price is about 74. The combination of that coupon and the price of $74 per $100 face value results in a real yield of about 2.6%. You're getting 1% per year from coupons. The $26 discount is about 35% of what you paid, divide that by 21 years and it's 1.67% per year. Add that to the 1% coupon and it comes pretty close to the actual real yield.

While not a correct or accurate way to determine YTM, I think that way of estimating may, perhaps, help clarify where the yield comes from and when you receive it.

Thanks Jeffyscott, that example is helpful. In your 2046 TIPS example, where that price is $74 and the face value is $100; then is the $26 discount to the face value based on an assumed inflation rate? if so, what if between now & 2046, the inflation rate is higher than it is now for some period of time? Do I get an extra credit when the TIPS matures?

[RyeBourbon]

The coupon payments (income) will be based on the inflation adjusted value. Your yield is based on that as well as the price at which you buy.

If you buy at the initial auction, the price will be pretty close to 100 and the coupon will be close to the real yield. If you buy at another time the price will change based on current yields.

For example, suppose the auction some time ago set an initial real yield and coupon of 1%, if you are buying that now the price will be under 100 in order to increase the real yield to the current market rate of 2%+.

The 2046 TIPS has a 1% coupon and price is about 74. The combination of that coupon and the price of $74 per $100 face value results in a real yield of about 2.6%. You're getting 1% per year from coupons. The $26 discount is about 35% of what you paid, divide that by 21 years and it's 1.67% per year. Add that to the 1% coupon and it comes pretty close to the actual real yield.

While not a correct or accurate way to determine YTM, I think that way of estimating may, perhaps, help clarify where the yield comes from and when you receive it.

Thanks Jeffyscott, that example is helpful. In your 2046 TIPS example, where that price is $74 and the face value is $100; then is the $26 discount to the face value based on an assumed inflation rate? if so, what if between now & 2046, the inflation rate is higher than it is now for some period of time? Do I get an extra credit when the TIPS matures?

The price is independent of inflation. There is a separate inflation index (or ratio) that each interest payment and bond maturity is multiplied by. See: https://tipswatch.com/tips-in-depth/ and https://www.treasurydirect.gov/instit/a ... 241211.pdf

Today the inflation index for the 2046 TIPS is 1.33204. To buy $1,000 of that TIPS will cost you 74*1.33204*1,000 = $985.71. This year it will pay approximately 1% of $1,332.04 (2 payments of $6.61). If the inflation index is 2.35 at maturity in 2046, you will get $2,350 for your $1,000 TIPS plus an interest payment of $11.75.

[Airco_DH2_pilot]

Thanks Jeffyscott, that example is helpful. In your 2046 TIPS example, where that price is $74 and the face value is $100; then is the $26 discount to the face value based on an assumed inflation rate? if so, what if between now & 2046, the inflation rate is higher than it is now for some period of time? Do I get an extra credit when the TIPS matures?

The price is independent of inflation. There is a separate inflation index (or ratio) that each interest payment and bond maturity is multiplied by. See: https://tipswatch.com/tips-in-depth/ and https://www.treasurydirect.gov/instit/a ... 241211.pdf

Today the inflation index for the 2046 TIPS is 1.33204. To buy $1,000 of that TIPS will cost you 74*1.33204*1,000 = $985.71. This year it will pay approximately 1% of $1,332.04 (2 payments of $6.61). If the inflation index is 2.35 at maturity in 2046, you will get $2,350 for your $1,000 TIPS plus an interest payment of $11.75.

Thanks RyeBourbon, I appreciate the next level of detail. It’s pretty cool that the inflation index enables a discount when you buy and a bump up in value when you sell. A question about the final interest payment in your example. I see that the $11.75 is half of 1% of the $2350. Is that typical that you only get 1 interest payment in the year that the bond matures?

[RyeBourbon]

The price is independent of inflation. There is a separate inflation index (or ratio) that each interest payment and bond maturity is multiplied by. See: https://tipswatch.com/tips-in-depth/ and https://www.treasurydirect.gov/instit/a ... 241211.pdf

Today the inflation index for the 2046 TIPS is 1.33204. To buy $1,000 of that TIPS will cost you 74*1.33204*1,000 = $985.71. This year it will pay approximately 1% of $1,332.04 (2 payments of $6.61). If the inflation index is 2.35 at maturity in 2046, you will get $2,350 for your $1,000 TIPS plus an interest payment of $11.75.

Thanks RyeBourbon, I appreciate the next level of detail. It’s pretty cool that the inflation index enables a discount when you buy and a bump up in value when you sell. A question about the final interest payment in your example. I see that the $11.75 is half of 1% of the $2350. Is that typical that you only get 1 interest payment in the year that the bond matures?

You got the other interest payment for that year six months earlier. They are paid out every six months.

[rob]

No other IRA’s or 401k’s for me or wife

I would invest in a Roth IRA before I would invest in taxable.

Anyone saving 124K a year (90k in taxable) likely cannot contribute directly, so would need to do Trad and then recharacterize assuming there are no rollover IRA's.

[Airco_DH2_pilot]

I would invest in a Roth IRA before I would invest in taxable.

Anyone saving 124K a year (90k in taxable) likely cannot contribute directly, so would need to do Trad and then recharacterize assuming there are no rollover IRA's.

Correct Rob. I should probably be doing some back door Roth IRA contributions, but I can't do Mega Backdoor & with only 5 years left (hopefully), smaller backdoor Roth doesn't seem critical. I do have a Roth conversion strategy modeled in Boldin.