3 Ways to Build an Inflation-Adjusted Pension. Yes, There’s Even an ETF for That

Advisors sometimes envy clients with a US government pension. 

They are protected from inflation, which is a major concern. It’s not that anyone can tell what future inflation will be, but high inflation over the next decade (or three) could compound and make any non-inflation-adjusted annuity virtually worthless. But, there are ways to build something similar to a pension. (Full disclosure: I’m doing the first two for my own portfolio, and the third solution is brand new.)

Almost all clients will have Social Security benefits, which hopefully will pay an inflation-adjusted monthly paycheck for life. Clients should think about it this way: Let’s use a 66-year-old client who can take $22,267 in annual Social Security benefits now or may collect 32% more if she waits another four years. She will be giving up $89,068 or, assuming 2% inflation, $92,689, while waiting. In return, however, she will be receiving an extra $7,125 of inflation-protected income every year for life. So delaying Social Security is actually buying a lifetime inflation-adjusted annuity. Go ahead and spend the money that could be collected during this four-year period, as you are really transferring the funds to a better financial vehicle.

Building a TIPS ladder

TIPS, Treasury inflation-protected securities, are US government bonds indexed to inflation. By buying as close as possible to bonds maturing each year, advisors can create a 30-year cash flow paying an inflation-adjusted average of $43,800, or 4.38% annually. As of October 9, it can now produce 4.55% annually. (I built and purchased a 30-year TIPS ladder with roughly $1 million of my own money. I wrote about four easy steps to build a TIPS ladder and probably exaggerated a bit how easy it was.)

Knowing that this cash flow is (virtually) guaranteed makes stock market plunges far less daunting. Essentially, this creates a 30-year-period inflation-adjusted annuity. While there is no longevity protection, one could protect for that by buying a low-cost stock index fund and not touching it for 30 years. And, unlike Social Security, TIPS offer a non-spousal survivor benefit for one’s heirs. 

While a TIPS ladder is often recommended, it’s not a monthly paycheck. The cash flow comes from a combination of interest being paid out plus bonds maturing with the original principal, plus the accumulated interest from past inflation. There are still four years in which TIPS don’t mature, known as the gap years (2036 – 2039). Thus, one needs to buy additional bonds maturing in 2035 and 2040. This gap will close over the next four years as the Treasury issues new 10-year TIPS. But this would require selling some existing TIPS and buying the newly issued TIPS to fill in the gap. 

Self-Liquidating TIPS Ladder ETF

Over two years ago, the fund industry was challenged to launch a self-liquidating TIPS fund to solve the 4% rule. Morningstar’s John Rekenthaler, TIPSwatch’s David Enna and The Wall Street Journal’s Jason Zweig made a case for such ETFs (I initiated the challenge in 2023). Recently, LifeX changed the objective of their inflation-protected ETFs to do just that. They have funds that provide 25, 30, 35 and 40 years of inflation protection. They are designed to deliver cash flow that adjusts annually based on inflation. With just a few clicks, one can buy a TIPS ladder. 

Advantages over the build-it-yourself include:

• A monthly paycheck instead of waiting until the TIPS mature or distribute income.
• A much more stable payment, as a build-it-yourself TIPS ladder will have variations in distributions each year, especially with smaller amounts invested.
• LifeX will fill in the gap years so there is nothing for the investor to do.
• You can buy in any amounts rather than be constrained to buying whole bonds issued at $1,000 par.
• You can even go beyond the 30 years TIPS are issued as they manage the duration to provide a relatively predictable distribution.

These funds have a relatively low 0.25% annual expense ratio. Nate Conrad, head of LifeX, said LifeX makes up some of that fee with lower institutional trading costs. One can compare the amount required to build an average $10,000 inflation-adjusted distribution over 30 years. For the LifeX 2055 Inflation-Protected Longevity Income ETF (LIAM), it required an investment of $237,869, which was the equivalent of about 7% more than the build-it-yourself solution. Over a 30-year period, that’s not bad, considering the advantages noted above. 

All new ETFs have some risk that they will close. Morningstar reports that 562 ETFs closed in 2024. But most of these were high-fee narrow ETFs that most advisors probably wouldn’t recommend to anyone. These inflation-adjusted LifeX funds help solve the 4% rule and LIAM produces a real 4.20% real cash flow for 30 years. There isn’t too much risk should it close as Conrad told me LifeX would sell the TIPS at net asset value and distribute the cash so the investor could then directly build a similar TIPS ladder.

Tipping the Scales. Savers find it very hard to spend. After a lifetime of accumulation, it’s difficult to suddenly start spending down a portfolio. And, of course, we underspend because we are afraid of market plunges, inflation or both. Inflation-adjusted paychecks are a license to spend. The traditional solution is an annuity, such as a single premium immediate annuity. The problem is the insurance industry no longer sells annuities that increase with the inflation rate. Insurance companies won’t take that inflation risk, and others shouldn’t do it either.

These three inflation-adjusted options can provide a spending floor, granting a license to spend more without being afraid of running out of money. Each provides a predictable inflation-adjusted cash flow that can go right into checking accounts. And the first and third option provide a steadier monthly paycheck, not all that different from when our employer auto-deposited our paycheck. 

The psychological benefit for these predictable monthly payments hitting our account, combined with the simplicity of creating the ladder with these ETFs, may be worth the 0.25% annual expense ratio.