Logistics of puchasing TIPS ladder at auction for a retirement income floor

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gilgamesh
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Logistics of puchasing TIPS ladder at auction for a retirement income floor

Post by gilgamesh »

TIPS are offered at 5,10 & 30 year maturity at auction. I am currently evaluating a possible TIPS ladder as a potential floor for part of my portfolio. If I implement this, I am considering purchasing it directly from the auction. I am wondering whether my purchase sequence makes sense or not.

Say, I need retirement income to start in 2029 and extend to 2049. There after, an SPIA will provide for a floor until death. SPIA to be purchased by a TIPS maturing in 2049.

The following sequence first states the year to buy TIPS. The TIPS in the bracket will be used to buy another TIPS when it matures.

In 2023 - 10 yr for 2033 and ( 10 yr for 2043)
In 2024 - 5 yr for 2029 and 10 yr for 2034 (10 yr for 2044)
In 2025 - 5 yr for 2030 (10 yr for 2040) 10 yr for 2035 (10 yr for 2045)
In 2026 - 5 yr for 2031 (10 yr for 2041) 10 yr for 2036 (10 yr for 2046)
In 2027 - 5 yr for 2032 (10 yr for 2042) 10 yr for 2037 (10 yr for 2047)
In 2028 - 10 yr for 2038 (10 yr for 2048)
In 2029 - 10 yr for 2039 (10 yr for 2049 + money to purchase an SPIA)

So, this is how you read it. In 2025 (4 yrs prior to retirement), I purchase a 5 year TIPS that will mature in 2030 to provide a floor for 2030 and enough to reinvest in a 10 yr TIPS for the 2040 floor. Also, in 2025 I am purchasing a 10 yr TIPS to provide floor for 2035 and enough to reinvest in a 10 yr TIPS for the 2045 floor.

Dollar amount wise. Say the floor needed in 2030 and 2035 is real $80k and floor for 2040 and 2045 is real $30k (assuming a $50k SS). Then in 2025, I will purchase a 5 yr TIPS for $110k. In 2030 when it matures, 80/110% of maturity amount will be used as the floor income for 2030 and 30/110% will be used to purchase another 10 yr TIPS to provide the floor for 2040. Also, in 2025 I will purchase a 10 yr TIPS for $110k. When it matures in 2035, 80/110% of the maturity amount will be used as the floor income for 2035 and the remaining 30/110% will be used to purchase another 10 yr TIPS as a floor for 2045.

Hopefully this makes sense. It's kind of complicated to write it down, but very easy in practice.

Does anyone see a hole in this sequence of purchase that will provide a floor which will keep up with inflation for 20 years?

In this thread I am not interested in arguments on whether flooring makes sense or not. Assuming one wants to provide a floor, does this sequence make sense?

This way, as you notice I am starting to lay floors 6 years prior to retirement (about the time when many advice going with less riskier portfolio) and complete the floor building prior to calling it quits. So, I still have the option to work longer if accumulation doesn't go as planned with in the six years of retirement.

I am also interested in learning whether buying from the secondary market (with fees involved) may be a better option.

Thank you!
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Re: Logistics of puchasing TIPS ladder at auction for a retirement income floor

Post by stlutz »

I am also interested in learning whether buying from the secondary market (with fees involved) may be a better option.
I have no opinion as to whether it's a better option. It's not one to be feared, however. Spreads on TIPS are higher than with nominal treasuries, but still only amount to .01 or .02% in yield over the term of the bond. This is much less than the market "noise" of whether you would have gotten a better price buying at auction one day or in the secondary market a day later.

And to opine on something you didn't ask, if you are buying any of these in a taxable account, I would recommend doing this at a broker that you are 100% confident will correctly track/report income/cost basis etc. I think there is generally more confidence in Fidelity than Vanguard on this point around here. Both allow you to buy/sell with no commission.
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Re: Logistics of puchasing TIPS ladder at auction for a retirement income floor

Post by saltycaper »

I didn't work through the entire sequence to confirm your plan, but one potential hole is if the issues you plan to buy at auction are never auctioned. The 5-year TIPS has been discontinued before, as have the longer-dated issues. I don't think the 10-year was ever discontinued. One could argue it is unlikely the 5-year will be discontinued again, but, at the very least, if you plan to use this as a major part of your portfolio, I would have a backup plan just in case.

As for secondary market costs, you do not have to pay a commission for Treasuries traded at Fidelity--I'm guessing there are other brokers that are also commission free. That just leaves you with the bid/ask spread. I see stlutz already commented on this. I thought the bid/ask differences were a bit higher than 0.01-0.02% YTM, but not by much. Then again, I usually research after hours, so not sure if the spreads I'm use to seeing are accurate.
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Re: Logistics of puchasing TIPS ladder at auction for a retirement income floor

Post by gilgamesh »

stlutz wrote:
I am also interested in learning whether buying from the secondary market (with fees involved) may be a better option.
I have no opinion as to whether it's a better option. It's not one to be feared, however. Spreads on TIPS are higher than with nominal treasuries, but still only amount to .01 or .02% in yield over the term of the bond. This is much less than the market "noise" of whether you would have gotten a better price buying at auction one day or in the secondary market a day later.

And to opine on something you didn't ask, if you are buying any of these in a taxable account, I would recommend doing this at a broker that you are 100% confident will correctly track/report income/cost basis etc. I think there is generally more confidence in Fidelity than Vanguard on this point around here. Both allow you to buy/sell with no commission.
It will be purchased within an IRA.

What does it exactly mean by .01-.02% spread. Is the TIPS fairly priced within a loss of that much over the entire term of the bond. So, if I were to purchase a 30 year TIPS originally bought at auction 20 years ago, in the secondary market now which has a base yield of 2.5%. Say it has ten more years to mature. If today's ten year new issues are yielding 0%, I will be paying a premium. But, are you saying I can ignore all those changes in years remaining to mature, yield, whether it has been paid or not recently and just buy it as the worse I can do is lose around 0.02% in yield for the remainder of the term?

I am scared of the secondary market not just for the fees, but to try to calculate all of the variables.

Thanks!
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Re: Logistics of puchasing TIPS ladder at auction for a retirement income floor

Post by gilgamesh »

saltycaper wrote:I didn't work through the entire sequence to confirm your plan, but one potential hole is if the issues you plan to buy at auction are never auctioned. The 5-year TIPS has been discontinued before, as have the longer-dated issues. I don't think the 10-year was ever discontinued. One could argue it is unlikely the 5-year will be discontinued again, but, at the very least, if you plan to use this as a major part of your portfolio, I would have a backup plan just in case.

As for secondary market costs, you do not have to pay a commission for Treasuries traded at Fidelity--I'm guessing there are other brokers that are also commission free. That just leaves you with the bid/ask spread. I see stlutz already commented on this. I thought the bid/ask differences were a bit higher than 0.01-0.02% YTM, but not by much. Then again, I usually research after hours, so not sure if the spreads I'm use to seeing are accurate.
Yes, I will have plan B. Also, all of this depends on the interest rate environment. If it's poor at the time of purchase, I'll slow down with the amounts. If it's fairly high, I may not wait and lock in with secondary market purchase.

Again, say even if the spread is 0.05%, does that mean that's the ONLY amount I'll lose, other than fees if any, as compared to buying it in the auction (accounting for the yield difference between the auction offer and secondary market, it's payout history etc.)?

Great to know Fidelity doesn't charge. However I'm seriously considering consolidating all my account into one company in retirement. I was thinking either Vanguard or Schwab (I will have another traditional portfolio too). Wonder how Fidelity fees compare to the other two?
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Re: Logistics of puchasing TIPS ladder at auction for a retirement income floor

Post by saltycaper »

gilgamesh wrote:
Yes, I will have plan B. Also, all of this depends on the interest rate environment. If it's poor at the time of purchase, I'll slow down with the amounts. If it's fairly high, I may not wait and lock in with secondary market purchase.

Again, say even if the spread is 0.05%, does that mean that's the ONLY amount I'll lose, other than fees if any, as compared to buying it in the auction (accounting for the yield difference between the auction offer and secondary market, it's payout history etc.)?
The spread is what you would lose if you made a round trip, buying at the ask price and then selling at the bid price. You can calculate the spread by looking at the difference between the bid and ask prices at your broker's website. (Note stlutz mentioned the .01-.02% not as a percent of principal invested but rather as a difference in the % yield to maturity. You should be able to browse bonds on your broker's website and see both bid/ask as price and bid/ask as yield to maturity. At least, at Fidelity that's possible.) Anyway, since you'll be holding the TIPS to maturity and not selling, it might be a fairer comparison to use half the spread as what you are "losing", but this is just an indication of trading costs, which will likely be trivial compared to the price change between the time of auction and the time you might purchase on the secondary market, for better or worse. I cannot think of any other trading costs other than the spread and the commission, and the latter should be zero.
gilgamesh wrote:Great to know Fidelity doesn't charge. However I'm seriously considering consolidating all my account into one company in retirement. I was thinking either Vanguard or Schwab (I will have another traditional portfolio too). Wonder how Fidelity fees compare to the other two?
Vanguard is also commission free. I just checked Schwab and their fee schedule says $0 for both auction and secondary Treasuries (under Fixed Income): http://www.schwab.com/public/schwab/inv ... s_minimums

Just a general comment: One could argue it's not an optimal strategy to buy a staggered mix of 5- and 10-year bonds for liability matching 15-25 years in the future. You are probably giving up some term premium by not simply purchasing bonds maturing in 15-25 years instead. In that strategy, for years without a maturing TIPS, you could buy enough TIPS maturing in the year before there is no maturing TIPS to last you through the "TIPS-less" years.

You may find the book, "Explore TIPS", useful. It's written by The Finance Buff, who is a Bogleheads member: https://thefinancebuff.com/explore-tips. It's worth the $7.95, IMO, even though there's a few pages of data that's out of date, as it describes how TIPS work quite clearly, including prices, index ratios, yield, etc.

There is one other thing to be aware regarding auction vs. secondary market, and that is the effects of potential deflation and how TIPS respond. I don't have time at the moment to comment further, but maybe someone else will chime in.
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Re: Logistics of puchasing TIPS ladder at auction for a retirement income floor

Post by gilgamesh »

You've been very helpful. I appreciate it very much. Ive ordered the TIPS book you've recommended. I need the paperback, not a fan of PDF. So, whatever that book deals with, I will know soon.

I've read about the impact of deflation before. As I understood, the yield could be less during periods of deflation as the principal they calculate the yield from is tied to inflation/deflation. I also understand the maturity amount will not go below the principal I invested no matter the deflation. My retirement income only depends on this maturity amount. I am planning my retirement with the thought, I will have zero yield anyways. If when it comes time to purchasing TIPS and the yield is above zero, it's just bonus money for me. I am retirement planning with TIPS as a zero coupon bond that keeps up with inflation with varying maturity dates. However, I don't know exactly how this works in the secondary market vs buying at auction. I was hoping the secondary market will calculate the exact fair impact of it and price it accordingly. I am hoping the book above will explain this to me.

Excellent point about 'term premium' I may lose by doing how I've outlined above. I've never heard of it and exactly the type of potential problems I want to be aware of, before executing anything. This information is extremely valuable to me, thanks!

I still need to educate myself on how to sell TIPS in the secondary market and the approximate fees involved. From what I understand, the secondary market for TIPS isn't great. However, the only reason to prefer TIPS over SPIA for me is this theoretical liquidity. So, definitely need to know how it works in the practical world and how much I'll lose if I have to sell TIPS in the secondary market. Hopefully the book above will explain this. I know Vanguard has a third part vendor they work with with to sell their clients TIPS. I need to check on Charles Schwab.

Thank you again for your gracious assistance.
saltycaper wrote:
gilgamesh wrote:
Yes, I will have plan B. Also, all of this depends on the interest rate environment. If it's poor at the time of purchase, I'll slow down with the amounts. If it's fairly high, I may not wait and lock in with secondary market purchase.

Again, say even if the spread is 0.05%, does that mean that's the ONLY amount I'll lose, other than fees if any, as compared to buying it in the auction (accounting for the yield difference between the auction offer and secondary market, it's payout history etc.)?
The spread is what you would lose if you made a round trip, buying at the ask price and then selling at the bid price. You can calculate the spread by looking at the difference between the bid and ask prices at your broker's website. (Note stlutz mentioned the .01-.02% not as a percent of principal invested but rather as a difference in the % yield to maturity. You should be able to browse bonds on your broker's website and see both bid/ask as price and bid/ask as yield to maturity. At least, at Fidelity that's possible.) Anyway, since you'll be holding the TIPS to maturity and not selling, it might be a fairer comparison to use half the spread as what you are "losing", but this is just an indication of trading costs, which will likely be trivial compared to the price change between the time of auction and the time you might purchase on the secondary market, for better or worse. I cannot think of any other trading costs other than the spread and the commission, and the latter should be zero.
gilgamesh wrote:Great to know Fidelity doesn't charge. However I'm seriously considering consolidating all my account into one company in retirement. I was thinking either Vanguard or Schwab (I will have another traditional portfolio too). Wonder how Fidelity fees compare to the other two?
Vanguard is also commission free. I just checked Schwab and their fee schedule says $0 for both auction and secondary Treasuries (under Fixed Income): http://www.schwab.com/public/schwab/inv ... s_minimums

Just a general comment: One could argue it's not an optimal strategy to buy a staggered mix of 5- and 10-year bonds for liability matching 15-25 years in the future. You are probably giving up some term premium by not simply purchasing bonds maturing in 15-25 years instead. In that strategy, for years without a maturing TIPS, you could buy enough TIPS maturing in the year before there is no maturing TIPS to last you through the "TIPS-less" years.

You may find the book, "Explore TIPS", useful. It's written by The Finance Buff, who is a Bogleheads member: https://thefinancebuff.com/explore-tips. It's worth the $7.95, IMO, even though there's a few pages of data that's out of date, as it describes how TIPS work quite clearly, including prices, index ratios, yield, etc.

There is one other thing to be aware regarding auction vs. secondary market, and that is the effects of potential deflation and how TIPS respond. I don't have time at the moment to comment further, but maybe someone else will chime in.
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Re: Logistics of puchasing TIPS ladder at auction for a retirement income floor

Post by Aptenodytes »

The general approach makes sense to me, but I would implement it solely with 10-year TIPS, partly because as saltycaper says you can't count on the 5-year TIPS always being available, and partly because in general the 10-year TIPS tend to be better located on the yield curve.

Then the plan would also be simpler: If X is your spending target, then buy 10-year TIPS of 2X every year 2019 through 2029 and 1X every year 2030 through 2039.
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Re: Logistics of puchasing TIPS ladder at auction for a retirement income floor

Post by #Cruncher »

The purchase schedule in your original post looks workable, gilgamesh. But I would probably use something a little simpler. For illustration I'll assume you begin collecting SS in 2039 and that you want an additional $300K maturing in 2049 to fund purchasing an annuity. Your requirements are then:

Code: Select all

                           Total
                           -----
2029 - 2038  80K per year   800K
2039 - 2048  30K per year   300K ( 50K / year from SS)
2049        330K            330K (300K to purchase annuity)
                          ------
                          1,430K
This could be obtained as follows:

Code: Select all

                                                                        Total
                                                                        -----
2016        Buy  30K of 30-year at auction      to mature in 2046         30K
2017        Buy  30K of 30-year at auction      to mature in 2047         30K
2018        Buy  30K of 30-year at auction      to mature in 2048         30K
2019        Buy 330K of 30-year at auction      to mature in 2049        330K
2019 - 2028 Buy  80K of 10-year at auction      to mature in 2029-2038   800K
2029        Buy  30K of 10-year at auction      to mature in 2039         30K
Anytime     Buy  30K of 30-year in after-market to mature in 2040-2045   180K
                                                                       ------
                                                                       1,430K
Here are some other points to consider:
  • I would not recommend building this ladder in a taxable account for two reasons:
    • A diminishing after-tax real return for greater Consumer Price Index (CPI) increases. (See this post.) Applies both to individual TIPS and TIPS funds.
    • Tax reporting would be complicated with 21 separate maturities. (See this post.) Not an issue with TIPS funds.
  • Auction yields generally a little better than after-market. (See this post.)
  • Use something like my TIPS Ladder Builder for effect of coupons in reducing requirements for earlier years. (I hope to still be around in 2029 to update this spreadsheet. :wink: ) This especially applies if you're going to buy a big chunk of the 30-year bond maturing in 2049 to fund purchase of an annuity.
  • For simplicity, I assumed you'd buy a big TIPS maturing the last year of the ladder (2049) to fund the annuity to buy in that year. But a better plan would be to purchase one maturing a few years after 2049 in order to duration match the annuity. For an explanation, see this post by bobcat2.
gilgamesh in [url=https://www.bogleheads.org/forum/viewtopic.php?p=2771595#p2771595]this post[/url] wrote:I've read about the impact of deflation before. As I understood, the yield could be less during periods of deflation as the principal they calculate the yield from is tied to inflation/deflation.
If held to maturity the real yield on a TIPS will always be at least what it was at the time of purchase. However, in the extremely unlikely event that the CPI falls over the entire term of a TIPS, its real yield may be higher. I call this the "deflation floor bonus". For example, assume you buy a 5-year TIPS at the initial auction with a yield of 1%. If the CPI stays the same or rises during the 5 year term (as it almost certainly will), you will get a 1% pretax real return. However, in the extremely unlikely event the CPI falls over the 5 years, you will earn more than a 1% real return. The benefit of this deflation floor bonus diminishes for a TIPS bought after the initial auction the larger the positive inflation adjustment it has accumulated. For more, see this post.
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Re: Logistics of puchasing TIPS ladder at auction for a retirement income floor

Post by gilgamesh »

#cruncher, I'm glad you looked at my plan. I've benefited from many of your old posts as well. You made a great point in an earlier thread on how one can liquidate longer maturities in low interest rate environment with a ladder and if the interest rates are high liquidate closer maturities. Bobcat2's post on duration matching was one of the first posts I read via a Google search which made me join this forum.

The reason why a 30 year TIPS will not work for my situation is this - First of all, I don't have the funds to buy all of this now. My accumulation phase is just now accelerating with it peaking in 4 years. The last ten years will see a huge growth in my portfolio. Also, most importantly I want to capitalize on market risk as long as possible. My plan is to cut to part time in 2024 and completely retire in 2029. It just requires a 5% nominal return for the next 14 years (assuming an inflation of about 2.5% and taxes remains the same) to achieve my nest egg. However, if I get more return the better. So, I want to be in the market for the possibly higher reward and not tie up in TIPS too early. I do not hate my job, so I can work longer full time and delay my retirement if the risk doesn't reward me. I'm however willing to tone down the risk closer to retirement and thus a gradual TIPS purchase starting around 6 years away from retirement works better for me. Does this make sense.

In regards to duration matching my TIPS to the SPIA I will be purchasing (you earned your name on that post), here is my thinking. I think a TIPS that mature on the year of the SPIA purchase will not be too far off. TIPS will keep up with inflation, interest rates is related to inflation and thus TIPS should track interest rates fairly well. I am also hoping to have about 40% of my portfolio in a traditional asset allocation. I will be drawing 2.5% adjusted to CPI from it for luxury needs. With only a 2.5% withdrawal which can be adjusted to 0%, I will have a healthy amount there to make up for any differences between the maturity payout of the TIPS and the purchase price of the SPIA ( for contingency and late age health and long term care needs as well).

TIPS will definitely be inside my IRA

Good to know auction yields are usually better than secondary market. Thank you very much for the TIPS ladder calculator, which will definitely help me quantify the yield (to me a bonus) over the term of each TIPS. Cool!

Good point about the TIPS bonus over a deflationary period.

Thanks again for looking over my plans and giving your valuable advice.
#Cruncher wrote:The purchase schedule in your original post looks workable, gilgamesh. But I would probably use something a little simpler. For illustration I'll assume you begin collecting SS in 2039 and that you want an additional $300K maturing in 2049 to fund purchasing an annuity. Your requirements are then:

Code: Select all

                           Total
                           -----
2029 - 2038  80K per year   800K
2039 - 2048  30K per year   300K ( 50K / year from SS)
2049        330K            330K (300K to purchase annuity)
                          ------
                          1,430K
This could be obtained as follows:

Code: Select all

                                                                        Total
                                                                        -----
2016        Buy  30K of 30-year at auction      to mature in 2046         30K
2017        Buy  30K of 30-year at auction      to mature in 2047         30K
2018        Buy  30K of 30-year at auction      to mature in 2048         30K
2019        Buy 330K of 30-year at auction      to mature in 2049        330K
2019 - 2028 Buy  80K of 10-year at auction      to mature in 2029-2038   800K
2029        Buy  30K of 10-year at auction      to mature in 2039         30K
Anytime     Buy  30K of 30-year in after-market to mature in 2040-2045   180K
                                                                       ------
                                                                       1,430K
Here are some other points to consider:
  • I would not recommend building this ladder in a taxable account for two reasons:
    • A diminishing after-tax real return for greater Consumer Price Index (CPI) increases. (See this post.) Applies both to individual TIPS and TIPS funds.
    • Tax reporting would be complicated with 21 separate maturities. (See this post.) Not an issue with TIPS funds.
  • Auction yields generally a little better than after-market. (See this post.)
  • Use something like my TIPS Ladder Builder for effect of coupons in reducing requirements for earlier years. (I hope to still be around in 2029 to update this spreadsheet. :wink: ) This especially applies if you're going to buy a big chunk of the 30-year bond maturing in 2049 to fund purchase of an annuity.
  • For simplicity, I assumed you'd buy a big TIPS maturing the last year of the ladder (2049) to fund the annuity to buy in that year. But a better plan would be to purchase one maturing a few years after 2049 in order to duration match the annuity. For an explanation, see this post by bobcat2.
gilgamesh in [url=https://www.bogleheads.org/forum/viewtopic.php?p=2771595#p2771595]this post[/url] wrote:I've read about the impact of deflation before. As I understood, the yield could be less during periods of deflation as the principal they calculate the yield from is tied to inflation/deflation.
If held to maturity the real yield on a TIPS will always be at least what it was at the time of purchase. However, in the extremely unlikely event that the CPI falls over the entire term of a TIPS, its real yield may be higher. I call this the "deflation floor bonus". For example, assume you buy a 5-year TIPS at the initial auction with a yield of 1%. If the CPI stays the same or rises during the 5 year term (as it almost certainly will), you will get a 1% pretax real return. However, in the extremely unlikely event the CPI falls over the 5 years, you will earn more than a 1% real return. The benefit of this deflation floor bonus diminishes for a TIPS bought after the initial auction the larger the positive inflation adjustment it has accumulated. For more, see this post.
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Re: Logistics of puchasing TIPS ladder at auction for a retirement income floor

Post by gilgamesh »

Aptenodytes wrote:The general approach makes sense to me, but I would implement it solely with 10-year TIPS, partly because as saltycaper says you can't count on the 5-year TIPS always being available, and partly because in general the 10-year TIPS tend to be better located on the yield curve.

Then the plan would also be simpler: If X is your spending target, then buy 10-year TIPS of 2X every year 2019 through 2029 and 1X every year 2030 through 2039.
Thank you very much. If the 5 yr TIPS are not available, I may have to consider a CD. Even if 10 year TIPS yield are better than the 5 yr, I am looking at it as 5 years in the equity market followed by a 5 yr TIPS vs 10 yr TIPS and I am willing to take that risk for a potentially an even higher yield. Hope this makes sense.

Like mentioned above, I want to be in the equity market until close to retirement.

Thank you for your kind help.
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Re: Logistics of puchasing TIPS ladder at auction for a retirement income floor

Post by Artsdoctor »

Gilgamesh,

Use #Cruncher's ladder builder. It'll definitely point you in the right direction.

The real rates are low now, and no one knows what they might be 5-10 years from now (for example, on new purchases). Just remember that the bonds maturing in the distant future will also be throwing off coupons while you're living on the bonds maturing earlier. If you need $30,000 each year, you're longer bonds' coupons will allow you to buy less than $30,000 in face value for the earlier years. #Cruncher's spreadsheet will help you illustrate this.
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Re: Logistics of puchasing TIPS ladder at auction for a retirement income floor

Post by stlutz »

Vanguard is also commission free. I just checked Schwab and their fee schedule says $0 for both auction and secondary Treasuries (under Fixed Income): http://www.schwab.com/public/schwab/inv ... s_minimums
Since #cruncher has offered the most helpful info, let me again jump in with another relatively unimportant note: At Schwab you cannot sell Treasury securities online. So, it's $0 to buy and $25 to sell there.

Since you are buying in an IRA, I would probably go for Vanguard given your stated preference for one of these two firms.

Instead of relying on comments here on question like spreads and the like, I would just look at their website for yourself to understand the costs of buying an selling: https://personal.vanguard.com/us/FixedIncomeHome
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gilgamesh
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Re: Logistics of puchasing TIPS ladder at auction for a retirement income floor

Post by gilgamesh »

Artsdoctor wrote:Gilgamesh,

Use #Cruncher's ladder builder. It'll definitely point you in the right direction.

The real rates are low now, and no one knows what they might be 5-10 years from now (for example, on new purchases). Just remember that the bonds maturing in the distant future will also be throwing off coupons while you're living on the bonds maturing earlier. If you need $30,000 each year, you're longer bonds' coupons will allow you to buy less than $30,000 in face value for the earlier years. #Cruncher's spreadsheet will help you illustrate this.
Yes, I see that now. That's a good chunk of income. I need to calculate that. Thanks!
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gilgamesh
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Re: Logistics of puchasing TIPS ladder at auction for a retirement income floor

Post by gilgamesh »

stlutz wrote:
Vanguard is also commission free. I just checked Schwab and their fee schedule says $0 for both auction and secondary Treasuries (under Fixed Income): http://www.schwab.com/public/schwab/inv ... s_minimums
Since #cruncher has offered the most helpful info, let me again jump in with another relatively unimportant note: At Schwab you cannot sell Treasury securities online. So, it's $0 to buy and $25 to sell there.

Since you are buying in an IRA, I would probably go for Vanguard given your stated preference for one of these two firms.

Instead of relying on comments here on question like spreads and the like, I would just look at their website for yourself to understand the costs of buying an selling: https://personal.vanguard.com/us/FixedIncomeHome
I actually saw the Vanguard stuff and in fact Schwab page as well. Still wasn't sure whether all pertinent info is there. Even though I think I have a good grasp of TIPS, I feel like I have some holes in my knowledge. The book will definitely help.

Thank you again.
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Re: Logistics of puchasing TIPS ladder at auction for a retirement income floor

Post by Bill M »

Buying the TIPS at auction, and holding them until maturity (matching the year you need the floor) is a good plan. One part that might simplify the calculating is to use a multiple of the current CPI figure for the par amount to buy. So if the ref-CPI for the TIPS auction is 237.61129 (like for the 1/15/2026 TIPS just auctioned), using a multiplier of 336 would have you submit a bid for 79,837 (rounded to $80K). This keeps the "real" figures correct.

The only troublesome part I see is the SPIA purchase in 2049. You know the "real" income desired, but not the cost of the SPIA. The income generated will depend on interest rates in 2049, which are hard to predict. You might look into buying the SPIA now, with CPI-based inflation adjustments, and recalculate the TIPS to be the additional income above the SPIA.
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Re: Logistics of puchasing TIPS ladder at auction for a retirement income floor

Post by magellan »

Bill M wrote:The only troublesome part I see is the SPIA purchase in 2049. You know the "real" income desired, but not the cost of the SPIA. The income generated will depend on interest rates in 2049, which are hard to predict. You might look into buying the SPIA now, with CPI-based inflation adjustments, and recalculate the TIPS to be the additional income above the SPIA.
Given that the OP will have been retired for 20 years by 2049, I'm assuming they'll be older when they purchase the SPIA, perhaps 80 or 85. If that's true, the level of interest rates at the time of the SPIA purchase won't matter much. SPIA payouts for older annuitants are dominated by mortality credits and interest rates barely have any impact.

IMO, using TIPS in to fund safe income during early retirement and delaying the SPIA purchase until 80 or 85 is a better plan compared to buying a SPIA or longevity insurance earlier. For the same cost or less, you get to keep control of your money for longer and you completely avoid insurer credit risk during the early years. When you finally do make the SPIA purchase, you'll need a much smaller lump sum, which makes it easier to stay below state guaranty association limits.
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Re: Logistics of puchasing TIPS ladder at auction for a retirement income floor

Post by Bill M »

magellan wrote:
Bill M wrote:The only troublesome part I see is the SPIA purchase in 2049. You know the "real" income desired, but not the cost of the SPIA. The income generated will depend on interest rates in 2049, which are hard to predict. You might look into buying the SPIA now, with CPI-based inflation adjustments, and recalculate the TIPS to be the additional income above the SPIA.
Given that the OP will have been retired for 20 years by 2049, I'm assuming they'll be older when they purchase the SPIA, perhaps 80 or 85. If that's true, the level of interest rates at the time of the SPIA purchase won't matter much. SPIA payouts for older annuitants are dominated by mortality credits and interest rates barely have any impact.

IMO, using TIPS in to fund safe income during early retirement and delaying the SPIA purchase until 80 or 85 is a better plan compared to buying a SPIA or longevity insurance earlier. For the same cost or less, you get to keep control of your money for longer and you completely avoid insurer credit risk during the early years. When you finally do make the SPIA purchase, you'll need a much smaller lump sum, which makes it easier to stay below state guaranty association limits.
Unfortunately there is no good solution in buying a SPIA in 30+ years. If you buy it now (as a deferred income annuity) you can know the nominal dollar amount of the annual payments, but not know the real dollar amount. If you wait, you'll know the amount available for premiums, but not know the payment amount. While true that mortality credits dominate at higher ages, I don't think 80-85 has reached that point yet.

You can use Vanguard's annuity marketplace to get quotes for SPIAs (just "adjust" the birthdates so that you are currently 80-85). It tells you payouts based on today's interest rates; repeat at various times with different interest rates and get an idea of the fluctuation. Factor of 2 since 2008. About 25% since 2012. Its more fluctuation than I ever expected.

Balance that with the observed reduction in retiree spending with increased age, and it isn't as clear that the real payments from the SPIA are that critical to lifestyle.

Using TIPS for the floor is likely (certainly??) not the most cost efficient method, but it has the advantage of being worry-free and safe. Just need to balance that with the unknowns of the later SPIA purchase, which are likely (certainly??) less than the unknowns with market fluctuations.
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Re: Logistics of puchasing TIPS ladder at auction for a retirement income floor

Post by gilgamesh »

Bill and Magellan. I appreciate the feedback very much.

I don't want to tie myself up with an SPIA early on. I am planning to retire at 60 and get the SPIA (If needed) at 80. However, at 80 I may decide not to get an SPIA at all. I want that option.

I understand interest rates 20 years later and thus the cost of the SPIA is unpredictable. But, this is my thought process and correct me if I am wrong. Interest rate and inflation are tied. As TIPS keep up with inflation, it's maturity amount is related to the interest rate changes over time. Therefore, I would think the maturity amount of the TIPS and the purchase price of the SPIA 20 years later will be somewhat close (at least not too far off). On top of that, I also have a separate growth portfolio (35-40% of my total portfolio). I will only be withdrawing about 2.5% from that portfolio. I can make up the difference from this portfolio.

Bill, I don't understand all the figures you mentioned in regards to the 01/21/2016 10yr TIPS that was in auction just recently. I know the interest rate was 0.625% for that 10 yr TIPS. I do not understand why you have 237.61129 (I tried google search and I understand ref-CPI of 100 is 0% interest rate). But, I am not familiar with how you came up with the multiplier of 336 and the $79,837 either. If you don't have time, that's ok!...I will be studying the TIPS book soon.

Thank you both for your help.
Last edited by gilgamesh on Mon Jan 25, 2016 1:41 pm, edited 1 time in total.
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Re: Logistics of puchasing TIPS ladder at auction for a retirement income floor

Post by gilgamesh »

Also, as I get closer to the time frame of purchasing the TIPS, this is how I plan to change my asset allocation. I will be keeping at least the next five years of TIPS purchase amount in a bond fund (possibly intermediate US bond fund). I will be adjusting this number based on how much cash I will be investing on that year too (If I am planning to invest $50k on a year and need to purchase $110k of TIPS the absoluter minimum in a bond fund will be $60k for that year).

Just wanted to know whether keeping at least the next 5 years of TIPS purchase in a bond fund as I get closer to retirement is ok!...I know it depends on each individual's risk tolerance. But, is it a reasonable idea?

I know by asking this I am going into a possible discussion on laying floor vs not, but at this point I am ok with that.
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Re: Logistics of puchasing TIPS ladder at auction for a retirement income floor

Post by Bill M »

RefCPI is probably explained in the TIPS book, but I haven't seen the book. In case it isn't in the book....

The par value of a TIPS bond increases with inflation, as measured by the Consumer Price Index (CPI-U). Values of CPI-U are published monthly by the Bureau of Labor Statistics, and available online (see http://www.bls.gov/data/home.htm). So if the CPI value published for 1/15/2026 happens to be 391.345, you take that value divided by the CPI value for 1/15/2016 (in the auction notice as "Ref-CPI") of 237.61129, and find that $10K of TIPS is worth $10K*391.345/237.61129 = $16469.97.

There is a three month lag between the value of a TIPS and the published CPI. So the CPI published on 1/20/2016 was for December 2015 (actually the value for 12/1/2015). That CPI value (for 12/1/2015) will determine the TIPS value on 3/1/2016. So the CPI value used for the auction on 1/15 was the CPI dated 10/15/2015, 0.48387 of the way between the value for 10/1/2015 and 11/1/2015 (strange fraction because October has 31 days, so divide the difference by 31 and multiply by 15). So now you know how to calculate the par value of a TIPS bond.

And that 336 multiplier... If you wanted $80K (for example) of "real dollars" maturing each year from TIPS bonds, how much do you buy at auction? Peg the $80K as 1/15/2016 dollars (with CPI 237.61129), and when an auction comes up on 1/15/2020 with Ref-CPI 272.75, purchase amount is 336*272.75 (or $80K*272.75/237.61129), or $92K.

As for "keeping the powder dry" for future TIPS purchases, I'd use CDs instead of bond funds. Either are probably OK, but I'd rather not worry about loss of principle in a bond fund if interest rates go up. Shorter term bonds would be more stable than long term ones. My 401k offered a "stable value fund" which has been ideal for this.

Inflation expectations and short-term interest rates are tied. But neither has much correlation with past inflation. The value of maturing TIPS bonds will match past inflation; cost of a SPIA will depend on current short-term interest rates.
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Re: Logistics of puchasing TIPS ladder at auction for a retirement income floor

Post by magellan »

gilgamesh wrote:Therefore, I would think the maturity amount of the TIPS and the purchase price of the SPIA 20 years later will be somewhat close (at least not too far off).
If the TIPS matures exactly when you want to purchase the annuity, it'll mature at par (adjusted for inflation) and won't include any adjustment for changes in interest rates. OTOH, this is where bobcat2's idea to add extra years onto the maturity date of your TIPS comes into play. The idea is to adjust the maturity date of the TIPS based on the average duration of the annuity income stream you plan to purchase.

For example, say the average duration of the annuity income stream for someone age 80 is 6 years. Instead of buying a TIPS that will mature in 2049, you buy one that matures in 2055. You'll still sell it in 2049, but buy extending the maturity a bit, the value you'll get for the TIPS in 2049 will be adjusted for the impact of changes in interest rates. If interest rates fall, which means that the annuity payout will be lower, the TIPS market value will be a bit higher, and the extra amount will buy you some extra annuity payout. OTOH, if interest rates have risen, the TIPS value will be a bit lower, but that's ok, because the lower lump sum that the TIPS provides will still buy you an annuity with the desires payout.
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Re: Logistics of puchasing TIPS ladder at auction for a retirement income floor

Post by #Cruncher »

Bill M in [url=https://www.bogleheads.org/forum/viewtopic.php?p=2774844#p2774844]this post[/url] wrote:Values of CPI-U are published monthly by the Bureau of Labor Statistics, ... That CPI value (for 12/1/2015) will determine the TIPS value on 3/1/2016. So the CPI value used for the auction on 1/15 was the CPI dated 10/15/2015, 0.48387 of the way between the value for 10/1/2015 and 11/1/2015 (strange fraction because October has 31 days, so divide the difference by 31 and multiply by 15).
Bill, this is not quite how it works. First the Bureau of Labor Statistics (BLS) releases only monthly values for the Consumer Price Index (CPI). So for example, on January 20th it released the CPI for the month of December, not for December 1st. The BLS does not publish the daily Reference (Ref) CPI figures that adjust TIPS principal value. They can be computed by anyone using the following procedure defined by the Treasury:
  • The CPI for month M becomes the Ref CPI for day 1 of month M+3, and the CPI for month M+1 becomes the Ref CPI for day 1 of month M+4.
  • The Ref CPI for all other days in month M+3 is calculated as a linear interpolation between the Ref CPI on day 1 of months M+3 and M+4, based on the number of days in month M+3.
This is easier to see with an example:
  • The non-seasonally adjusted CPI-Us are 237.838, 237.336, and 236.525 for October CPI, November 2015, and December 2015.
  • These become the Ref CPI values for 1/1/2016, 2/1/2016, and 3/1/2016 respectively.
  • The Ref CPIs for 1/15/2016 and 2/15/2016 are then calculated as

    Code: Select all

    237.61129 = 237.838 + (14 / 31) * (237.336 - 237.838)
    236.94448 = 237.336 + (14 / 29) * (236.525 - 237.336)
    Note that the numerator of the interpolation fraction is 14, not 15. Also note that the denominator is the number of days in month M+3, not the number of days in month M. This makes no difference in the first case since October and January have the same number of days. But it does make a difference in the second case since November and February do not.
You can see all the daily Ref CPIs for 2016 computed by this procedure on this web page and the underlying monthly CPI-Us on this web page.
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Re: Logistics of puchasing TIPS ladder at auction for a retirement income floor

Post by stlutz »

OP--

In terms of the interaction between maturing TIPS and buying an SPIA later in life, this post by bobcat2 is well worth reading. The discussion that follows will hopefully make it more clear if the original post seems confusing.

viewtopic.php?t=174991
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Re: Logistics of puchasing TIPS ladder at auction for a retirement income floor

Post by gilgamesh »

Thank you for all the replies.

Now, I am having second thoughts about investing in TIPS to purchase an SPIA, twenty years later. With 35-40% of the portfolio still in a traditional asset allocation it may not make much sense.

Sequence of return risks affects a portfolio mostly in the beginning stages. 20 years into retirement it is irrelevant. Twenty years is long enough term to be fairly certain equities will outperform other options.

Therefore my current plan is instead to invest in say a target retirement fund.

Say I wanted to purchase TIPS for $300k in 2030 to purchase an SPIA in 2050. I am now thinking of investing the $300k in a target retirement fund with a target date of 2050 or to be more conservative 2045. This can be changed to be even more conservative by moving funds into mostly bonds nearing 2050.

I know this essentially eliminates a floor starting out at age 80. However, 20 years into retirement I am more comfortable given the long term involved, being out of the sequence of return sensitivity zone and having a sizable side discretionary portfolio.

Does this make sense?
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Re: Logistics of puchasing TIPS ladder at auction for a retirement income floor

Post by castlemodesto »

Gilgamesh
you may find it interesting to read a post from this week by Michael Kitces . It is not exactly answering your question, but I think it may give some pointers. The article is about using 20 years of TIPS and then comparing using a longevity annuity to using a stocks fund for beyond 20 years. He also dicusses how SPIAs might fit in the mix.
https://www.kitces.com/blog/calculating ... b-48067837

one quote
"In other words, to the extent that cash flows can be addressed sufficiently to cover the first half of retirement, the time horizon is long enough that an equity-centric portfolio can fund the “long-term” spending needed in later retirement (for the subset of retirees who even live long enough to need it) without using a longevity annuity. Sequence of return risk isn’t an issue for a retiree who’s already committed to not touch this portion of funds for 20 years (whether in a longevity annuity or an equity portfolio)."
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Re: Logistics of puchasing TIPS ladder at auction for a retirement income floor

Post by gilgamesh »

castlemodesto wrote:Gilgamesh
you may find it interesting to read a post from this week by Michael Kitces . It is not exactly answering your question, but I think it may give some pointers. The article is about using 20 years of TIPS and then comparing using a longevity annuity to using a stocks fund for beyond 20 years. He also dicusses how SPIAs might fit in the mix.
https://www.kitces.com/blog/calculating ... b-48067837

one quote
"In other words, to the extent that cash flows can be addressed sufficiently to cover the first half of retirement, the time horizon is long enough that an equity-centric portfolio can fund the “long-term” spending needed in later retirement (for the subset of retirees who even live long enough to need it) without using a longevity annuity. Sequence of return risk isn’t an issue for a retiree who’s already committed to not touch this portion of funds for 20 years (whether in a longevity annuity or an equity portfolio)."
That's the article. Which made me change my plans :)..... Running by the forum to see whether it makes sense.
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Re: Logistics of puchasing TIPS ladder at auction for a retirement income floor

Post by alec »

gilgamesh wrote:Thank you for all the replies.

Now, I am having second thoughts about investing in TIPS to purchase an SPIA, twenty years later. With 35-40% of the portfolio still in a traditional asset allocation it may not make much sense.

Sequence of return risks affects a portfolio mostly in the beginning stages. 20 years into retirement it is irrelevant. Twenty years is long enough term to be fairly certain equities will outperform other options.
And what if this doesn't happen? How your standard of living be affected?
"It is difficult to get a man to understand something, when his salary depends upon his not understanding it!" - Upton Sinclair
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Re: Logistics of puchasing TIPS ladder at auction for a retirement income floor

Post by gilgamesh »

alec wrote:
gilgamesh wrote:Thank you for all the replies.

Now, I am having second thoughts about investing in TIPS to purchase an SPIA, twenty years later. With 35-40% of the portfolio still in a traditional asset allocation it may not make much sense.

Sequence of return risks affects a portfolio mostly in the beginning stages. 20 years into retirement it is irrelevant. Twenty years is long enough term to be fairly certain equities will outperform other options.
And what if this doesn't happen? How your standard of living be affected?
It depends on the performance of my side discretionary portfolio and this dedicated annuity purchase portfolio. If the equity market crashes and destroys both portfolios, then it will definitely affect my retirement standard of living (Exactly what I want to avoid). I am delaying SS, which will be enough for the bare essentials, however that's not good enough for me, and thus the floor strategy in the first place.

However, I am probably withdrawing around 4% adjusted to inflation, of my discretionary portfolio (may be even VPW) and the side portfolio solely for the SPIA purchase will be untouched. Given these, isn't it almost impossible not to have the funds for the SPIA in 20 years?

I could even keep the $300k in the equity market for 10 years and over the next ten years gradually move to TIPS.

I think there will be a sweet spot where exposing the $300k to the equity market to parts of the twenty years will yield better than a 20 YR TIPS without increasing risk. Or is it impossible? That's the question.
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Re: Logistics of puchasing TIPS ladder at auction for a retirement income floor

Post by Watty »

It don't know if it has been mentioned yet but there is an old thread about building a TIPs ladder that mentions several other resources.'

viewtopic.php?t=128677

There is also a more general wiki on building a ladder of bonds or CD's

https://www.bogleheads.org/wiki/Laddering_bonds_or_CDs
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Re: Logistics of puchasing TIPS ladder at auction for a retirement income floor

Post by gilgamesh »

Watty wrote:It don't know if it has been mentioned yet but there is an old thread about building a TIPs ladder that mentions several other resources.'

viewtopic.php?t=128677

There is also a more general wiki on building a ladder of bonds or CD's

https://www.bogleheads.org/wiki/Laddering_bonds_or_CDs
Thank you!, that thread is very helpful.
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Re: Logistics of puchasing TIPS ladder at auction for a retirement income floor

Post by castlemodesto »

there seem to be too many variables looking 20 years out.
personally I think just as we diversify our investments in the accumulation stage. In the retirement stage there is something to be said for diversifying your income sources.
Since there is no one answer that covers all the risks, perhaps you could hedge your bets by diversifying your 20- year -out income.
Delaying social security is one. A QLAC is another. A stock /bond portfolio with the option to purchase SPIAs at around 80 to 85 is another. Starting to purchase 10 year TIPS each year at auction , 10 years out from when you need them is another. A LTC insurance policy should be considered.
Choosing just one may simplify things, but puts all your risk eggs in the one basket
There is no magic formula for which any person should choose, or in what proportion . Everyones situation is different. But I think you should at least consider diversifying your income after the 20 years of TIPS are consumed.
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Re: Logistics of puchasing TIPS ladder at auction for a retirement income floor

Post by gilgamesh »

castlemodesto wrote:there seem to be too many variables looking 20 years out.
personally I think just as we diversify our investments in the accumulation stage. In the retirement stage there is something to be said for diversifying your income sources.
Since there is no one answer that covers all the risks, perhaps you could hedge your bets by diversifying your 20- year -out income.
Delaying social security is one. A QLAC is another. A stock /bond portfolio with the option to purchase SPIAs at around 80 to 85 is another. Starting to purchase 10 year TIPS each year at auction , 10 years out from when you need them is another. A LTC insurance policy should be considered.
Choosing just one may simplify things, but puts all your risk eggs in the one basket
There is no magic formula for which any person should choose, or in what proportion . Everyones situation is different. But I think you should at least consider diversifying your income after the 20 years of TIPS are consumed.
I very much appreciate your response. When I started out building a ladder, I definitely wanted to include other income streams. I absolutely did not want to include all the eggs in one basket. In fact when I was reading an older thread on TIPS lincome, I was thinking the same thing. But, in the mean time this fit into by plans so well, and my aversion to purchasing in the secondary market (fear of paying unfairly without knowing the true costs and return) made me forget all about it.

Feds can easily change the rules on these. I definitely have to diversify, you are absolutely right. You have no idea how much your reply helped me.

I was planning to include zero coupon strips and I-bonds and I will build a new ladder with those. With I-bonds my wife and I will be limited to $30k/ yr. With zero coupon strips I will assume a set inflation and buy based on that. May even consider EE bonds, but gets complicated with yield calculations, so much easier with zero coupon.

I am pretty sure I can self insure and an LTC will not fit into my plans. QLAC may be an option if I need to defer RMD, but I doubt it.

But, I am back to my original plan to build a ladder with TIPS, I-Bonds, Principal and Interest zero coupon strips and possibly EE bonds ( Zwecher style)

I will have all these tentative ladders planned out in the books and when it comes time to purchase it, I will pick which ever makes the most sense given the interest rate/yield. But I definitely don't want to rely on just one.


Thanks for the reminder.

P.S: However, (now I remember why I didn't include I bonds), I-bonds interest is unlikely to go up (according to Booglehead's guide to investing, page 58), as the Feds know any significant increase in interest rates will result in the sale of previous issues with low interest to purchase new. However, if the rates stay competitive to I- bonds when I near retirement, it will definitely help. EE-bonds and strips with nominal yields will only play a small role in my diversification as I really want to hedge against inflation. That's why I went solely with TIPS. However, for my future plans, I need to keep these as potential candidates as well.
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