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Building Your Own TIPS Annuity

Building a CubeI got an interest payment from one of my TIPS recently.  It feels pretty good to watch your income automatically go up with inflation.  As I mentioned in the article: “Introducing Treasury Inflation Protected Securities (TIPS)“, these bonds pay out interest on your inflation adjusted principle.  The percentage of interest stays the same, but the bond amount itself goes up as it is adjusted for inflation.  That means that your income goes up too.

What I feel when I get my inflation adjusted income, may be a result of the fact that I’m so used to being charged an inflation premium.  All I’m really experiencing is consistency.  I’m just getting the same purchasing power from my money as I had when I purchased my bond.  As I considered the fact that loaning out money is capable of producing an ongoing, inflation protected income, I realized that this could be used to create a reliable income and preserve the principal at the same time.

Considering the Possibilities

I don’t talk very much about the income from TIPS because I primarily focus on their ability to protect our savings, but if you have enough money and don’t want to risk it somewhere else, you could use TIPS as a way of getting inflation adjusted income for the rest of your life while also protecting your principal.

You’re intention would be to preserve the principal for the rest of your life.  Perhaps you already have a large sum that is intended for your heirs or for charitable giving in your will.  You could be using that money to generate an income while keeping the principle safe and adjusted for inflation.

Even if you don’t really need the income, you could generate it and give it away while you are still alive.

Making Your Own Annuity

There’s really nothing new to creating your own “annuity” with TIPS.  It’s just a frame of mind.  The only difference is that you are using TIPS for the purpose of generating income.  If you do plan to use them in this way, you might consider getting the 30 year TIPS.  Not only will the income stay consistent for 30 years, you usually get the highest amount of income from the longer term bonds.

Keeping it Real

You might be wondering why you wouldn’t just use CD’s for this purpose.  Remember, that the interest rate for TIPS is a “real” interest rate.  That means that inflation has already been calculated into the TIPS interest.  You have to subtract the inflation rate from your CD’s current interest rate and then compare it to the TIPS rate.

If, for instance, the interest rate on your CD is 2.04%, and inflation is currently at 1.90%, your real interest rate for the CD is only  .14%.  If you compare that to a 1% interest rate on a TIPS, you would see that you would earn .86% more “real interest.”  That’s a whopping 614% more income on the same principal.

Fee Considerations

There really aren’t any fees when you buy a TIPS, but I like to consider any bond premiums and taxes as fees when you make an annuity out of them.

A premium is when you pay more than the face value for the bond.  This happens when you buy a TIPS at auction and the price for the TIPS goes above the TIPS amount itself.  It can also happen when you buy a TIPS from someone else on the market.  For instance, you may end up buying a $1000 TIPS for $1100 at auction.  If you do, you are paying a premium of $100 to get a $1000 TIPS.  That $100 is like a fee because you had to pay it up front just to get the bond.  It could take a while to recover that fee, but if you are doing it to protect a future income stream from inflation, it may not matter much to you.  You are paying for a guarantee, just like you would with insurance.  As long as you are still working, you can pay that fee with current income.  This is a way of protecting future income while you have current income.

Taxes are a similar kind of thing.  With TIPS, taxes are like an annual fee.  You could think of it as a fee to the government for using their system to protect your money.  The fee is paid at your tax rate.  The bad thing about this fee is that it goes up with inflation.  That makes this fee pretty expensive in a high inflation environment.

These fees may still be acceptable to you for protecting your income stream.  With a commercial annuity, you may end up in the same place when you calculate in the loss of principal to your heirs.

If you were to put this annuity in an IRA or 401k, you would completely remove the tax “fee” and if you were careful to only buy your TIPS at a discount instead of a premium, you would also not have to pay the premium “fee.”

You’re the Boss

The thing that makes this so much better than a commercial annuity, is that you have complete control over the principal.  The terms are very clear and your investment is backed by the full credit of the United States.  All of the money is still under your control.

If you are wondering why you’ve never heard of this before, it might be because there is no money in this kind of annuity for anyone else but you.  When you build your own TIPS annuity, you get to decide what to do with the principal and your heirs get it all back in the end without any exposure to the markets.


I have a spreadsheet that tracks your TIPS and helps you see your inflation protection in action.  Learn more here

Copyright © Troy Taft 2018

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