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Create predictable retirement income with Treasury bond ladders
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One way to help address the need for steady, predictable retirement income is with a bond ladder composed of zero-coupon Treasuries. For financial professionals helping clients navigate the complex transition from accumulation to decumulation, this approach can be simple, capital efficient and easy to explain.
What is a zero-coupon bond?
A zero-coupon bond, or 鈥渮ero,鈥� is a financial instrument typically purchased at a steep discount and, if held to maturity, pays its full face value. Unlike other bonds, it pays no regular interest.
Like any sustainable income strategy, it requires that your client answer two fundamental questions:
- How much money will you need each year?
- How many years will you need it?
You can solve for the first by simply calculating current and planned expenses. The second, however, is less straightforward because it involves pricing longevity risk. Put simply, longevity risk is the cost of outliving your money. It鈥檚 complex, speculative by nature and may involve conversations your client is reluctant to have.
Why laddering zero-coupon Treasury bonds might make sense for your client
The appeal of a zero-coupon Treasury bond ladder is not hard to grasp. Unlike bond mutual funds or ETFs 鈥� which expose investors to variables like investment and interest rate risk that can erode income over time 鈥� a ladder of individual Treasury zeros, funded upfront, locks in known cash flows at known dates.
Sequence-of-returns risk associated with equity portfolios is largely eliminated when a ladder is held to maturity and matched to anticipated spending needs. Each rung matures on schedule, paying a predetermined amount regardless of what intermediate rates do.
For retirees who need stable, predictable income to cover housing, health care and other essential expenses, that kind of certainty has tangible value. A bond fund, by contrast, introduces volatility that may limit a financial professional鈥檚 ability to state with confidence how much upfront capital is needed to generate a given income stream over a given period of time.
However, a bond fund can provide diversification, liquidity and professional management, with no need to manage individual maturities.
| Consideration |
Individual Treasury bond ladder |
Bond fund |
| Income predictability |
Known cash flows at known maturity dates when held to maturity |
Income and value may fluctuate |
| Management |
Individual maturities must be selected and managed |
Professionally managed |
| Liquidity and diversification |
Depends on the structure and individual bonds selected |
Can provide liquidity and diversification |
| Planning endpoint |
Finite and constructed to end on a specific date |
No predetermined income endpoint, but future income is not guaranteed |
How many rungs in the ladder?
Here鈥檚 where things get complicated. To structure and fund a bond ladder with upfront capital, you need to know how many rungs to add. In other words, how long your client expects to live in retirement.
The problem is structural. A ladder is finite, built to a specific endpoint. If the retiree outlives it, the income stops. Research indicates that even carefully designed bond ladders may leave some retirees with up to a 50% probability of outliving savings by age 90.1
For a healthy, higher-income retiree 鈥� who may be more likely to live longer than average 鈥� this is an important planning consideration.
Capital requirements can compound the challenge
According to the research, funding $2,000 of monthly income to age 100 with less than a 10% probability of depletion requires approximately $425,000 invested today. Add a 1% management fee and that figure rises to roughly $485,000 for the same income target.2 Future income must be prefunded, with no equity market participation to supplement returns.
Up to 50%
Probability that some retirees could outlive savings by age 90, even with a carefully designed bond ladder.1
$425,000
Approximate upfront investment needed to fund $2,000 of monthly income to age 100 with less than a 10% probability of depletion.2
$485,000
Approximate upfront investment needed for the same income target when a 1% management fee is included.2
Comparing retirement income strategies
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Where an annuity helps fill the gap
An annuity with a Guaranteed Lifetime Withdrawal Benefit (GLWB) serves the same core function as a bond ladder 鈥� providing a guaranteed, predictable income stream in retirement 鈥� with one strategically important difference: the annuity continues to pay income even after its account value has been fully depleted, assuming no excess withdrawals are taken.
The longevity risk that a bond ladder requires the retiree to absorb individually is transferred to an insurer鈥檚 claims-paying ability.
Mortality pooling can improve capital efficiency
The mechanism behind this efficiency is called 鈥渕ortality pooling.鈥� An annuity鈥檚 lifetime income benefit is collectively funded by a large number of annuity holders, meaning those with shorter retirements help support those with longer ones. As a result, participants in the pool may be able to allocate less capital than if each bore the risk individually.
The capital savings are material
A fixed indexed annuity with a GLWB can fund the same $2,000 monthly income with $135,000 less than a bond ladder requires.3
Compared to a bond fund, the gap widens further: funding a $2,000 monthly income goal through bond funds requires nearly 40% more than a fixed indexed annuity with a GLWB for a retiree willing to accept no more than a 10% probability of outliving their money.4
The annuity also helps protect the retiree from the interest rate and credit risks inherent in traditional bond fund strategies.5
| Retirement income consideration |
Zero-coupon Treasury bond ladder |
Annuity with a GLWB |
| Predictable income |
Provides predetermined payments through the ladder鈥檚 final maturity date |
Provides guaranteed lifetime income, subject to the terms of the contract |
| Longevity risk |
The retiree bears the risk of living beyond the ladder鈥檚 endpoint |
Longevity risk is transferred to the insurer鈥檚 claims-paying ability |
| Account depletion |
Income stops after the final bond matures |
Income can continue after the account value is depleted, assuming no excess withdrawals are taken |
| Upfront capital |
Future income must be prefunded |
Mortality pooling may allow the same income goal to be funded with less upfront capital |
The bottom line
Zero-coupon Treasury bond ladders deliver on their primary promise: stable, predictable income with limited exposure to interest rate and credit risk. The limitation is not the tool 鈥� it is the unresolvable uncertainty of how long any individual will need it to work.
An annuity with a GLWB addresses that limitation directly, providing the income certainty associated with a ladder while transferring longevity risk to an insurer and doing so with meaningfully less capital.6
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This article references Maximize Retirement Lifestyle Income with Less Capital by Michael Finke, Ph.D., of The American College of Financial Services.
1Maximize Retirement Lifestyle Income with Less Capital, p. 3.
2Maximize Retirement Lifestyle Income with Less Capital, pp. 6鈥�7.
3Maximize Retirement Lifestyle Income with Less Capital, p. 3.
4Maximize Retirement Lifestyle Income with Less Capital, p. 18.
5Maximize Retirement Lifestyle Income with Less Capital, p. 18.
6Maximize Retirement Lifestyle Income with Less Capital, p. 2.
