Should Retired Firefighters Still Use Ladders?

Retirees may not want to physically climb ladders anymore, but TIPS Ladders can be used as a powerful tool well into retirement, especially for retirees that don’t have a pension beneficiary option.

Summary

The vast majority of FDNY retirees do not elect to take a pension beneficiary option because of the associated cost, and instead elect to purchase a term life insurance policy.  The thought is that given enough time, the investment portfolio will grow large enough to replace pension income beyond the term policy.  In this paper we go a step further and show how a TIPS ladder can be built out after the expiration of the term life policy to provide guaranteed inflation-adjusted income* to a spouse.

*Guaranteed by the US Government and Inflation indexed to CPI

What are TIPS

TIPS (Treasury Inflation Protected Securities) are issued by the US Treasury and are indexed to CPI inflation.  TIPS Ladders are a series of annual investments in TIPS and each year represents a rung in the ladder.  The principal amount of TIPS increases (decreases) with inflation (deflation). The interest payments also increase (decrease) as the principal amount increases (decreases).

A Case Study

James G. Bennett is 62 years old and is retiring after a long career of 40 years with the FDNY.  His wife Henrietta is also 62 years old.  A few years ago Mr. Bennett purchased a $2 million  term life insurance policy that expires at age 85.  After 40 years of dedicated service James has earned an annual pension of $96,000.  The price of a beneficiary option is $15,000 per year, and would reduce Mr. Bennett’s pension to $81,000 per year. Given the cost, James has declined the beneficiary option, and has decided to take the maximum pension amount because he has the term life policy in place.  However, Henrietta is nervous given the importance of the decision.  For years she has expected a secure retirement and now James isn’t taking an option that provides for her. The Bennetts want to be certain that Henrietta will have enough income if she outlives James.  Simply expecting that the portfolio will grow larger isn’t enough assurance for Mr. Bennett.

The Bennett’s explain to their adviser that:

  • They have a combined investment portfolio of $1.44 million
  • Henrietta will collect social security of $22,000 per year at age 66 (2021)
  • James will collect social security of $45,000 per year at age 70 (2025)
  • They have a low risk tolerance
  • Henrietta wants the same level of gross income from 85-92 if anything should happen to James

The Adviser explains that the Bennett’s can include a TIPS Ladder as part of a well diversified investment portfolio.  The term life policy expires when the Bennett’s turn 85 in 2040.  The Adviser recommends:

  • Implementing a TIPS Ladder beginning in 2040 through 2047
  • Purchasing TIPS today in the amount of $82,421 per year for 8 years
  • Dedicating 46% ($659,370) of the investment portfolio to TIPS

The Advisor explains that:

  • He is using a long-term inflation estimate of 2%
  • Has calculated the amount of TIPS necessary to replace the fixed pension and lost social security above the survivor benefit
  • The plan considers the scenario of Mr. Bennett passing away the day after term coverage expires

Without the TIPS Ladder

He provides the following income illustration to the Bennett’s before considering any income from the investment portfolio, and notes the drastic drop off of annual and monthly income as if James passed away in 2040.  The social security amounts have been inflated by 2% per year:

 

Term Life Coverage $2,000,000 NONE NONE NONE NONE NONE NONE NONE NONE
Year 2039 2040 2041 2042 2043 2044 2045 2046 2047
Age of the Bennetts 84 85 86 87 88 89 90 91 92
Max Pension $96,000  $               –  $               –  $               –  $               –  $               –  $               –  $               –  $               –
Social Security – Henrietta  $31,421  $60,564  $61,775  $63,011  $64,271  $65,557  $66,868  $68,205  $69,569
Social Security – James  $59,377  $               –  $               –  $               –  $               –  $               –  $               –  $               –  $               –
Gross Annual Income $186,798  $60,564 $61,775 $63,011 $64,271 $65,557 $66,868 $68,205 $69,569
Gross Monthly Income   $15,566 $5,047 $5,148 $5,251 $5,356 $5,463 $5,572 $5,684 $5,797

 

With the TIPS Ladder

The Adviser then provides the following illustration with the TIPS Ladder beginning in 2040.  The Adviser reminds the Bennett’s that the TIPS Ladder, and Social Security amounts have been inflated at 2%.  Since these amounts may appear large because they are in future dollars the Adviser provides another row with a present value calculation in today’s $.  The Bennett’s notice that each annual income stream is the same value ($10,069) in today’s $, which is exactly what the Adviser is trying to accomplish, an inflation adjusted income stream for Henrietta from 85-92:

 

Term Life Coverage $2,000,000 NONE NONE NONE NONE NONE NONE NONE NONE
Year 2039 2040 2041 2042 2043 2044 2045 2046 2047
Age of the Bennetts 84 85 86 87 88 89 90 91 92
Max Pension $96,000  $               –  $               –  $               –  $               –  $               –  $               –  $               –  $                    –
Social Security – Henrietta  $31,421  $60,564  $61,775  $63,011  $64,271  $65,557  $66,868  $68,205  $69,569
Social Security – James  $59,377  $               –  $               –  $               –  $               –  $               –  $               –  $               –  $                   –
TIPS Ladder     $129,970 $132,569 $135,221 $137,925 $140,684 $143,497 $146,367 $149,295
Gross Annual Income $186,798  $190,534  $194,345  $198,232  $202,196  $206,240  $210,365  $214,572  $218,864
Gross Monthly Income   $15,566 $15,878 $16,195 $16,519 $16,850 $17,187 $17,530 $17,881 $18,239
Present Value in Today’s $   $10,069 $10,069 $10,069 $10,069 $10,069 $10,069 $10,069 $10,069 $10,069

 

Conclusion

TIPS can be used in tandem with term life insurance to create inflation-adjusted income streams beyond the expiration of the term policy. This can be an especially useful tool for retirees that do not have a spousal beneficiary option.  Further, TIPS can be used as a basic building block of a diversified investment portfolio that provides an inflation hedge.  The remainder of the investment portfolio can be invested to create diversified layers of income.

It is important to recognize that a properly constructed TIPS ladder requires the use of individual TIPS and cannot be built with ETFs or mutual funds.

Disclosure

This article is educational and is not individual investment advice.  The TIPS allocation of 46% in the case study is hypothetical, and is not a recommended allocation weight.  Brave Eagle Wealth Management uses individual TIPS in client portfolios.

 

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