Morningstar evaluation: These are the 3 top guaranteed retirement incomes

Treasury Bonds vs. TIPS Ladder vs. Annuities: Which Strategy Is Best For Retirement Income

Generating enough income in retirement to meet your spending needs is crucial. While Social Security provides inflation-protected retirement income, it’s simply not enough for many retirees.

If you need help planning for retirement, consider working with a financial advisor.

John Rekenthaler, director of research at Morningstar, recently evaluated three other ways to generate guaranteed retirement income – Treasury bonds, TIPS ladders and annuities – to see which is best. The answer? It all depends on inflation and life expectancy.

Guaranteed Retirement Income Options

Retirees seeking guaranteed sources of income have to look beyond Social Security and pensions.

According to the Social Security Administration, the average monthly benefit check in May 2023 was worth approximately $1,700. Pensions, meanwhile, have gone from being commonplace to increasingly rare. There were more than 100,000 defined benefit plans in existence in 1975, but that number dwindled to less than 46,000 by 2020, Department of Labor data shows.

The three retirement income options that Morningstar recently evaluated include:

Treasury bonds. Debt instruments issued by the U.S. Department of Treasury, these bonds are long-term securities that take up to 30 years to mature. Until then, Treasury bonds pay a fixed interest rate twice a year.

TIPS ladders. Treasury Inflation-Protected Securities or TIPS are another kind of U.S. government investment. TIPS, however, are designed to protect against rising inflation. While the interest rate is fixed, the principal or face value of a TIPS bond is indexed to inflation. As the principal value increases with inflation, your interest payments will increase as well.

A TIPS ladder is a strategy for building a portfolio of bonds with varying maturity dates. The idea is to hold a TIPS bond that reaches maturity every year over the course of your time horizon, protecting the purchasing power of your money during that time.

Single-premium immediate annuities. Also known as SPIAs, these insurance contracts turn a lump sum of cash into a series of guaranteed periodic payments that start typically within one year of purchase.

Treasury Bonds vs. TIPS Ladder vs. Annuities

Retirement strategies that rely on Treasury bonds, a TIPS ladder or single-premium immediate annuities can all be good ways to generate guaranteed income. The best option, however, often hinges on inflation and a retiree’s life expectancy, according to Rekenthaler.

Using a hypothetical 20-year retirement – the approximate remaining life expectancy of a 65-year-old woman – Rekenthaler assessed how each strategy would perform under different rates of long-term inflation. To do this, he calculated the growth of $100,000 invested evenly in each strategy over a 20-year period.

Under moderate annual inflation (2.4%), he found that Treasury bonds would generate nearly $127,000 after 20 years while the TIPS ladder would deliver almost $118,000. Annuities, however, would only generate approximately $113,500.

If inflation averaged 5% per year over the 20-year period, the TIPS ladder strategy would outperform Treasury bonds and annuities by 29% and 32%, respectively. Meanwhile, if inflation hovered at just 1% per year during that time, Rekenthaler found that Treasury bonds would generate $155,000 – significantly more than an annuity or TIPS ladder strategy.

But what if a retiree lives longer than 20 years? Assuming moderate inflation (2.4%), Rekenthaler found that annuities become the best income option over a 30-year period – delivering $153,000.

“The annuity under that inflation assumption surpasses the TIPS ladder during Year 21, then Treasury bonds in Year 25,” he wrote. “Should inflation be pleasantly low, annuities will also prosper, although they will take another few years to catch Treasury bonds.”

Bottom Line

Retirees looking for guaranteed income beyond Social Security may consider strategies that rely on Treasury bonds, TIPS laddering or annuities. Morningstar’s John Rekenthaler found that over a 20-year time horizon, Treasury bonds are best if inflation remains low or moderate. A TIPS ladder generates the highest return if inflation averages 5% per year. An annuity, on the other hand, is best if a retiree ends up living more than 20 years.

Retirement Planning Tips

Retirement planning can be complicated and confusing but a financial advisor can help guide you through the process. Finding a financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with up to three vetted financial advisors who serve your area, and you can have a free introductory call with your advisor matches to decide which one you feel is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
How much money do you anticipate having saved by the time you retire? SmartAsset’s retirement calculator can help you estimate how much your savings will be worth when your golden years arrive.
Social Security remains a vital component of many people’s financial plan for retirement. SmartAsset’s Social Security calculator can help you get a sense of how much your benefits will be worth.