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Creating a Government Pension

For people expecting little or no social security, retirement will be riding mainly on your savings. As our clients get closer to retirement, one of the strategies we use is a bond ladder using US Treasury bonds. Our goal with this strategy is to lock in government guaranteed cash flow, to help you stop worrying about money for retirement.

We typically use ‘Stripped Treasuries’ which pay out no interest, but are sold at a discount, and at maturity they can be cashed in at face value. For example, a $50,000 face value 10-year Treasury STRIP costs ~$39,000 based on current interest rates. The difference in price is interest earned by holding until maturity. This type of bond is sometimes called a ‘zero-coupon bond.’

‘Bond Ladder’ refers to a series of bonds which are bought with sequential maturities. Similar to the rungs of a ladder – the bonds mature (pay out) each year during your retirement. As a simplified example, if you need $100,000 a year during retirement, while pensions and social security contribute $25,000, we would build a bond ladder with $75,000 of bonds maturing over a 15-year period beginning at retirement. During retirement, we would extend the bond ladder and/or consider products such as lifetime annuities.

The Function of Bonds
Bonds should protect your assets during economic weakness – such as during recessions or an economic depression. This is one of the reasons we focus on US Treasury bonds for the bond ladder. Municipal and corporate bonds may offer higher returns, but they also have higher risk of default, lower liquidity, and sometimes have call features. Holding the safest bonds provides greater peace of mind when stocks are falling.

The Function of Stocks
Stocks grow during periods of economic prosperity, which helps us maintain bond ladders during retirement. When stocks perform well, we would sell stocks and extend your bond ladder further into the future. When the stock market drops, maturing bonds would cover your annual expenses as planned, giving stocks a long time to recover.

Interest Rates
You should be building your bond ladder in the years leading up to retirement (and during retirement) to reap the benefits of dollar cost averaging. If interest rates fall further (as we have seen happen in Germany, Switzerland and Japan), we will have at least some bonds already in place at current rates. If interest rates increase, future bond purchases become cheaper. And regardless if interest rates go up or down - the US government guarantees to pay face value for your bond ladder as long as you hold the bonds to maturity.

To make the bond ladder more tax efficient, focus it within retirement accounts before building it in taxable accounts. Doing so will also help with required minimum distributions for IRA accounts.

As retirement gets closer, you will need to convert your savings into a retirement income. Some retirees hold a few years of expenses in cash or short-term bonds and invest the rest in riskier assets. If the next bear market lasts longer than a few years – retirees using that strategy will feel serious pressure to make big changes. Our approach to the bond ladder is better for retirees expecting little social security because it provides greater peace of mind.