EE Bonds as period certain annuity - revisited

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AlwaysLearningMore
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EE Bonds as period certain annuity - revisited

Post by AlwaysLearningMore »

In 1984 the New York Times published YOUR MONEY; SAVING BONDS AS AN ANNUITY https://tinyurl.com/yyr22npw

In 2013 Mr. Lindauer published the Forbes article A Simple Way To Build Your Own Annuity https://tinyurl.com/yxbybkx5 and a Bogelheads.org post on this topic https://tinyurl.com/y5b6fsgv

In the 2013 post on the topic, some posters asserted that "mortality credits" ("the dividend that comes from pooling your longevity risk with others and accepting the fact that other members of the pool might enjoy some of your savings after you die" https://tinyurl.com/y2yheg4q) were part and parcel of an immediate annuity. But the SEC defines an annuity as "...a contract between you and an insurance company that requires the insurer to make payments to you, either immediately or in the future. You buy an annuity by making either a single payment or a series of payments. Similarly, your payout may come either as one lump-sum payment or as a series of payments over time." https://tinyurl.com/y6nzs39p

Fast forward to July 2020. The 20-year Treasury Bond is yield is currently 1.03% https://tinyurl.com/hvq6x6y

Under the EE annuity scenario, a 65 y.o. male who's purchased $10k/year in EE bonds for the past 20 years can now begin drawing $1667 monthly ($20/yr) until age 85 and paid $200k to do so. According to ImmediateAnnuities.com (generic online quote) that $20k/yr 20-year period certain income stream will today cost a prospective annuitant $326,888 (please see BLS CPI numbers for past 20 years below). Interestingly $337,272 will get the annuitant a lifetime annuity -- so it appears insurers aren't worried about too many annuitants living past 85.

(BLS https://tinyurl.com/y3xbqdem CPI from 2000-2020: 2000=1.5, 2001=1.45, 2002= 1.43, 2003=1.4 2004=1.36, 2005=1.33, 2006=1.27, 2007=1.24, 2008=1.18, 2009=1.2, 2010=1.18, 2011=1.14, 2012=1.12, 2013=1.10, 2014=1.08, 2015=1.08, 2016=1.07, 2017=1.05, 2018=1.02, 2019=1.01 )

For those concerned about inflation, Mr. Lindauer also pointed out that I Bonds are also an option to supplement an EE bond annuity scenario. Annette Thau had this to say about I Bonds: "...this product is a sleeper...if you compare the features of I bonds to those of other products designed to provide tax-deferred income, such as annuities, I bonds are likely to be the superior product. I would suggest that if you are looking for a very safe, very predictable investment for some of the assets being put away for retirement, you should investigate I bonds before signing up for expensive and restrictive annuities, particularly if you are going to be investing in fixed-income instruments." The Bond Book, second edition 2001. (She presumably was not comparing I bonds to SPIA's but rather some forms of deferred annuities. Nevertheless, she extols the features of I bonds which are routinely discussed among Bogleheads.)

While annuity insurer insolvency appears to be uncommon (4 since 1990 per this source https://tinyurl.com/y2ysttg7 ) some investors might feel more comfortable with the income stream coming from Uncle Sam.
venkman
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Re: EE Bonds as period certain annuity - revisited

Post by venkman »

AlwaysLearningMore wrote: Sun Jul 26, 2020 4:56 pm Under the EE annuity scenario, a 65 y.o. male who's purchased $10k/year in EE bonds for the past 20 years can now begin drawing $1667 monthly ($20/yr) until age 85 and paid $200k to do so. According to ImmediateAnnuities.com (generic online quote) that $20k/yr 20-year period certain income stream will today cost a prospective annuitant $326,888 (please see BLS CPI numbers for past 20 years below). Interestingly $337,272 will get the annuitant a lifetime annuity -- so it appears insurers aren't worried about too many annuitants living past 85.
That $327k for the annuity is in 2020 dollars. The $200k spent on the EE bonds was purchased with earlier, more valuable dollars.

If, instead of EE bonds, one had put $10k per year ($2500 quarterly) into Vanguard's Total Bond Fund, starting in Jan. 2000, the balance at the end of 2019 would be around $302,000. If one had been more aggressive and put the same amount of money into Vanguard's Lifestrategy Moderate Growth Fund (40/60 AA, certainly not overly risky for a 20-year horizon), the ending balance in 2019 would have been $368,000--enough to pay for the lifetime annuity, with $30k left over.
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AlwaysLearningMore
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Re: EE Bonds as period certain annuity - revisited

Post by AlwaysLearningMore »

venkman wrote: Sun Jul 26, 2020 10:38 pm
AlwaysLearningMore wrote: Sun Jul 26, 2020 4:56 pm Under the EE annuity scenario, a 65 y.o. male who's purchased $10k/year in EE bonds for the past 20 years can now begin drawing $1667 monthly ($20/yr) until age 85 and paid $200k to do so. According to ImmediateAnnuities.com (generic online quote) that $20k/yr 20-year period certain income stream will today cost a prospective annuitant $326,888 (please see BLS CPI numbers for past 20 years below). Interestingly $337,272 will get the annuitant a lifetime annuity -- so it appears insurers aren't worried about too many annuitants living past 85.
That $327k for the annuity is in 2020 dollars. The $200k spent on the EE bonds was purchased with earlier, more valuable dollars.
That's why I included the BLS CPI figures. If my arithmetic is correct, the CPI-adjusted purchase price in today's dollars is $242,100.
(a $10k purchase in 2000 would cost $15K today, a $10k purchase in 2001 would cost $14.5K today, etc.). Even with the CPI adjustments, the EE bond 20 year period certain payout costs $84K less than the SPIA purchased today.
venkman wrote: Sun Jul 26, 2020 10:38 pm If one had been more aggressive and put the same amount of money into Vanguard's Lifestrategy Moderate Growth Fund....
The vicissitudes of the stock and bond markets prompt some investors to look for a plank of guaranteed income in their portfolios. Annuities, EE bonds and I bonds fill a different role in their portfolios.
venkman wrote: Sun Jul 26, 2020 10:38 pm If, instead of EE bonds, one had put $10k per year ($2500 quarterly) into Vanguard's Total Bond Fund, starting in Jan. 2000....
That's certainly a possibility if one has the tax-advantaged space to dedicate to the approach. Otherwise the tax inefficiency could impede such a plan. https://tinyurl.com/y5vbofn3 Additionally, the EE bonds and I bonds are state level tax exempt.
Last edited by AlwaysLearningMore on Mon Jul 27, 2020 9:04 am, edited 1 time in total.
Lyrrad
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Re: EE Bonds as period certain annuity - revisited

Post by Lyrrad »

venkman wrote: Sun Jul 26, 2020 10:38 pm
That $327k for the annuity is in 2020 dollars. The $200k spent on the EE bonds was purchased with earlier, more valuable dollars.

If, instead of EE bonds, one had put $10k per year ($2500 quarterly) into Vanguard's Total Bond Fund, starting in Jan. 2000, the balance at the end of 2019 would be around $302,000. If one had been more aggressive and put the same amount of money into Vanguard's Lifestrategy Moderate Growth Fund (40/60 AA, certainly not overly risky for a 20-year horizon), the ending balance in 2019 would have been $368,000--enough to pay for the lifetime annuity, with $30k left over.
Back in 2000 the 20 year Treasury rate was over 5.50%, compared with 1.03% as of Friday July 24, 2020.

EE Series bonds issued back in 2000 doubled after 17 years, offering a guaranteed 4.17% rate. Now they double after 20 years, offering 3.53% if held through the doubling period.

So back in 2000, these bonds offered a guaranteed return about 1.3% less than the risk-free rate, whereas now it's about 2.5% more. I think this makes these bonds significantly more attractive since it's well above the market return.

Since Total Bond Market contains some long term securities including long term Treasuries, I think one can get a higher risk-adjusted return by offsetting part of one's US bond allocation with EE Series bonds, if one is comfortable with the limitations of these bonds and their tax treatment.

Personally, while there is a large interest rate differential, I plan to use EE as a significant portion of my US bond allocation, mostly replacing my long term bond allocation. If the 20 year yield approaches the guaranteed return of EE Series bonds in the future, I plan to reduce the allocation of these bonds as appropriate.
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Re: EE Bonds as period certain annuity - revisited

Post by Uncorrelated »

The "if you had brought EE bonds for the last 20 years" argument sounds like market timing and survivorship bias to me. EE bonds are essentially long term bonds with a twist. The past 20 years, the interest rate declined steeply. In that environment, it is no surprise that EE bonds performed well. As a cross reference, if you would have invested $200k in VUSTX (20 years treasury bonds) 20 years ago, you would have $955,769 now.

The real question is whether EE bonds are a better deal than bonds with future expected returns. Given that EE bonds currently seem to have a significantly higher yield than ordinary treasury bonds, the answer appears to be yes, if the retiree can guarantee sufficient liquidity is available.

Case closed? Not yet. According to aacalc.com, life annuities significantly outperform ordinary bonds past age 50 or so. should retirees use EE bonds instead of life annuities? Unless they retired prior to age 50, they probably shouldn't.
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Re: EE Bonds as period certain annuity - revisited

Post by #Cruncher »

AlwaysLearningMore wrote: Sun Jul 26, 2020 11:41 pm
venkman wrote: Sun Jul 26, 2020 10:38 pmThat $327k for the annuity is in 2020 dollars. The $200k spent on the EE bonds was purchased with earlier, more valuable dollars.
That's why I included the BLS CPI figures. If my arithmetic is correct, the CPI-adjusted purchase price in today's dollars is $242,100. (a $10k purchase in 2000 would cost $15K today, a $10k purchase in 2001 would cost $14.5K today, etc.). Even with the CPI adjustments, the EE bond 20 year period certain payout costs $84K less than the SPIA purchased today.
Forget about the CPI over the past 20 years. An easier and more useful comparison would to use the cost of buying an annuity starting in 20 years instead of the cost if it began today. Immediate Annuities shows that $1,667 per month for 20 years beginning in 20 years would cost $183,419. This works out to a 2.72% internal rate of return compared to the 3.53% IRR for the EE bonds [*] (as computed with the Excel IRR function).

Code: Select all

Row Col A     Col B      Col C
  1   IRR     3.53%      2.72%  = IRR(C3:C42)
  2  Year   EE Bond    Annuity
  3     1  (10,000)  (183,419)
  4     2  (10,000)         0 
  5     3  (10,000)         0 
  6     4  (10,000)         0 
  7     5  (10,000)         0 
  8     6  (10,000)         0 
  9     7  (10,000)         0 
 10     8  (10,000)         0 
 11     9  (10,000)         0 
 12    10  (10,000)         0 
 13    11  (10,000)         0 
 14    12  (10,000)         0 
 15    13  (10,000)         0 
 16    14  (10,000)         0 
 17    15  (10,000)         0 
 18    16  (10,000)         0 
 19    17  (10,000)         0 
 20    18  (10,000)         0 
 21    19  (10,000)         0 
 22    20  (10,000)         0 
 23    21   20,000     20,000 
 24    22   20,000     20,000 
 25    23   20,000     20,000 
 26    24   20,000     20,000 
 27    25   20,000     20,000 
 28    26   20,000     20,000 
 29    27   20,000     20,000 
 30    28   20,000     20,000 
 31    29   20,000     20,000 
 32    30   20,000     20,000 
 33    31   20,000     20,000 
 34    32   20,000     20,000 
 35    33   20,000     20,000 
 36    34   20,000     20,000 
 37    35   20,000     20,000 
 38    36   20,000     20,000 
 39    37   20,000     20,000 
 40    38   20,000     20,000 
 41    39   20,000     20,000 
 42    40   20,000     20,000
* This assumes that the EE bonds issued in the future continue to double in 20 years.
Last edited by #Cruncher on Mon Jul 27, 2020 7:29 am, edited 1 time in total.
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Re: EE Bonds as period certain annuity - revisited

Post by aristotelian »

venkman wrote: Sun Jul 26, 2020 10:38 pm
AlwaysLearningMore wrote: Sun Jul 26, 2020 4:56 pm Under the EE annuity scenario, a 65 y.o. male who's purchased $10k/year in EE bonds for the past 20 years can now begin drawing $1667 monthly ($20/yr) until age 85 and paid $200k to do so. According to ImmediateAnnuities.com (generic online quote) that $20k/yr 20-year period certain income stream will today cost a prospective annuitant $326,888 (please see BLS CPI numbers for past 20 years below). Interestingly $337,272 will get the annuitant a lifetime annuity -- so it appears insurers aren't worried about too many annuitants living past 85.
That $327k for the annuity is in 2020 dollars. The $200k spent on the EE bonds was purchased with earlier, more valuable dollars.

If, instead of EE bonds, one had put $10k per year ($2500 quarterly) into Vanguard's Total Bond Fund, starting in Jan. 2000, the balance at the end of 2019 would be around $302,000. If one had been more aggressive and put the same amount of money into Vanguard's Lifestrategy Moderate Growth Fund (40/60 AA, certainly not overly risky for a 20-year horizon), the ending balance in 2019 would have been $368,000--enough to pay for the lifetime annuity, with $30k left over.
Not surprising since you are picking a sequence of returns where interest rates bottomed out at record lows. There is no guarantee bonds will perform that well over the next 20 years.
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Re: EE Bonds as period certain annuity - revisited

Post by AlwaysLearningMore »

Uncorrelated wrote: Mon Jul 27, 2020 3:33 am The "if you had brought EE bonds for the last 20 years" argument sounds like market timing and survivorship bias to me. EE bonds are essentially long term bonds with a twist. The past 20 years, the interest rate declined steeply. In that environment, it is no surprise that EE bonds performed well. As a cross reference, if you would have invested $200k in VUSTX (20 years treasury bonds) 20 years ago, you would have $955,769 now.

The real question is whether EE bonds are a better deal than bonds with future expected returns. Given that EE bonds currently seem to have a significantly higher yield than ordinary treasury bonds, the answer appears to be yes, if the retiree can guarantee sufficient liquidity is available.

Case closed? Not yet. According to aacalc.com, life annuities significantly outperform ordinary bonds past age 50 or so. should retirees use EE bonds instead of life annuities? Unless they retired prior to age 50, they probably shouldn't.
Since Mr. Lindauer's Forbes article focuses on using EE bonds as a period certain annuity, I though it would be an interesting comparison for sometime entering retirement this summer. Thank you for the aacalc link. But (1) I was referencing a 20-year period certain annuity, not a life annuity; (2) not sure the "liability matching bonds" in the aacalc figure are directly comparable to EE bonds (are they TIPS? are they nominal bonds? are they STRIPS?); (3) in this low interest rate environment, what will the cost of the inflation-indexed SPIAs be? (Interestingly, here's a link to an article on COLA riders published 3 days ago on ImmediateAnnuities.com https://tinyurl.com/y36vr7nf )
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AlwaysLearningMore
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Re: EE Bonds as period certain annuity - revisited

Post by AlwaysLearningMore »

#Cruncher wrote: Mon Jul 27, 2020 7:22 am Forget about the CPI over the past 20 years. An easier and more useful comparison would to use the cost of buying an annuity starting in 20 years instead of the cost if it began today. Immediate Annuities shows that $1,667 per month for 20 years beginning in 20 years would cost $183,419. This works out to a 2.72% internal rate of return compared to the 3.53% IRR for the EE bonds [*] (as computed with the Excel IRR function).

Code: Select all

Row Col A     Col B      Col C
  1   IRR     3.53%      2.72%  = IRR(C3:C42)
  2  Year   EE Bond    Annuity
  3     1  (10,000)  (183,419)
  4     2  (10,000)         0 
  5     3  (10,000)         0 
  6     4  (10,000)         0 
  7     5  (10,000)         0 
  8     6  (10,000)         0 
  9     7  (10,000)         0 
 10     8  (10,000)         0 
 11     9  (10,000)         0 
 12    10  (10,000)         0 
 13    11  (10,000)         0 
 14    12  (10,000)         0 
 15    13  (10,000)         0 
 16    14  (10,000)         0 
 17    15  (10,000)         0 
 18    16  (10,000)         0 
 19    17  (10,000)         0 
 20    18  (10,000)         0 
 21    19  (10,000)         0 
 22    20  (10,000)         0 
 23    21   20,000     20,000 
 24    22   20,000     20,000 
 25    23   20,000     20,000 
 26    24   20,000     20,000 
 27    25   20,000     20,000 
 28    26   20,000     20,000 
 29    27   20,000     20,000 
 30    28   20,000     20,000 
 31    29   20,000     20,000 
 32    30   20,000     20,000 
 33    31   20,000     20,000 
 34    32   20,000     20,000 
 35    33   20,000     20,000 
 36    34   20,000     20,000 
 37    35   20,000     20,000 
 38    36   20,000     20,000 
 39    37   20,000     20,000 
 40    38   20,000     20,000 
 41    39   20,000     20,000 
 42    40   20,000     20,000
* This assumes that the EE bonds issued in the future continue to double in 20 years.
Thank you for the suggestion, that's a good way of looking at the situation.

(I used the yearly aliquots of $10K/yr over the past 20 years because that was the premise of Mr. Lindauer's original Forbes article and a general premise of the 1984 NYT article. It's going to be interesting to see how insurers price SPIAs if these very low interest rates persist.)
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Re: EE Bonds as period certain annuity - revisited

Post by Uncorrelated »

AlwaysLearningMore wrote: Mon Jul 27, 2020 8:34 am
Uncorrelated wrote: Mon Jul 27, 2020 3:33 am The "if you had brought EE bonds for the last 20 years" argument sounds like market timing and survivorship bias to me. EE bonds are essentially long term bonds with a twist. The past 20 years, the interest rate declined steeply. In that environment, it is no surprise that EE bonds performed well. As a cross reference, if you would have invested $200k in VUSTX (20 years treasury bonds) 20 years ago, you would have $955,769 now.

The real question is whether EE bonds are a better deal than bonds with future expected returns. Given that EE bonds currently seem to have a significantly higher yield than ordinary treasury bonds, the answer appears to be yes, if the retiree can guarantee sufficient liquidity is available.

Case closed? Not yet. According to aacalc.com, life annuities significantly outperform ordinary bonds past age 50 or so. should retirees use EE bonds instead of life annuities? Unless they retired prior to age 50, they probably shouldn't.
Since Mr. Lindauer's Forbes article focuses on using EE bonds as a period certain annuity, I though it would be an interesting comparison for sometime entering retirement this summer. Thank you for the aacalc link. But (1) I was referencing a 20-year period certain annuity, not a life annuity; (2) not sure the "liability matching bonds" in the aacalc figure are directly comparable to EE bonds (are they TIPS? are they nominal bonds? are they STRIPS?); (3) in this low interest rate environment, what will the cost of the inflation-indexed SPIAs be? (Interestingly, here's a link to an article on COLA riders published 3 days ago on ImmediateAnnuities.com https://tinyurl.com/y36vr7nf )
I don't really like the narrow view of comparing EE bonds to any other 20-year investment. EE bonds are specialized instruments for investors that can guarantee they will not have liquidity issues for the next 20 years. With life annuities offering significantly more lifetime utility and bonds being significantly more liquid, I don't see a clear use case for EE bonds. The question isn't whether EE bounds outperform 20 year bonds, the question is whether the optimal portfolio contains EE bonds. Calculating this is very difficult and computationally expensive.

aacalc.com uses liability matched bonds. I believe these are TIPS with the duration optimally matched to your expected consumption. He states ordinary bond funds will do just fine. I'm not sure what method aacalc uses to calculate annuity pricing on that page, but in his paper he combines mortality tables with the money's worth ratio computed from immediateannuities.com.

In order to build an EE bond ladder, treasury must continue to issue EE bonds with a duration of 20 years for the next 20 years. I believe this has approximately zero chance of actually happening. If rates stay this low, treasury will probably increase the duration. If you want to use EE bonds, don't plan too far ahead.
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Re: EE Bonds as period certain annuity - revisited

Post by Mel Lindauer »

Three points I'd like to make:
1. A couple could actually buy $20,000 per year and end up with a $40,000 per year annuity.
2. EE and I Bonds increase one's tax-deferred space, since they're tax-deferred until redeemed. That's a huge factor for investors who need/want additional tax-deferral.
3. The income at maturity is free from state and local taxation.
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Re: EE Bonds as period certain annuity - revisited

Post by JamesSFO »

Mel I still credit you for this idea and think it's a good one.
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Re: EE Bonds as period certain annuity - revisited

Post by Mel Lindauer »

JamesSFO wrote: Mon Jul 27, 2020 5:54 pm Mel I still credit you for this idea and think it's a good one.
It's just another tool that investors can choose to use if it makes sense for them. Since there's no money to be made by pushing EE or I Bonds, they're basically ignored by those advisors looking to get paid for selling investments that pay them a commission.
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Re: EE Bonds as period certain annuity - revisited

Post by AlwaysLearningMore »

Uncorrelated wrote: Mon Jul 27, 2020 5:21 pm I don't really like the narrow view of comparing EE bonds to any other 20-year investment. EE bonds are specialized instruments for investors that can guarantee they will not have liquidity issues for the next 20 years. With life annuities offering significantly more lifetime utility and bonds being significantly more liquid, I don't see a clear use case for EE bonds. The question isn't whether EE bounds outperform 20 year bonds, the question is whether the optimal portfolio contains EE bonds. Calculating this is very difficult and computationally expensive.

aacalc.com uses liability matched bonds. I believe these are TIPS with the duration optimally matched to your expected consumption. He states ordinary bond funds will do just fine. I'm not sure what method aacalc uses to calculate annuity pricing on that page, but in his paper he combines mortality tables with the money's worth ratio computed from immediateannuities.com.

In order to build an EE bond ladder, treasury must continue to issue EE bonds with a duration of 20 years for the next 20 years. I believe this has approximately zero chance of actually happening. If rates stay this low, treasury will probably increase the duration. If you want to use EE bonds, don't plan too far ahead.
Interesting points. While the yield prior to the 20-year anniversary EE bond doubling is paltry, there's no real liquidity problem and they can be redeemed after 1 year https://tinyurl.com/y9zrv6jz

As per the title of my post, I found it interesting to look at what's played out since the 1984 NYT article, and Mr. Lindauer's Forbes article. From what I can find on the CDC website, the average life expectancy is currently 78.6 years https://tinyurl.com/y4llz4ot . So for many people, a 20-year payout starting at age 65 will see them through. And an EE bond annuity could only be one part of their "floor" income.
Of course individual longevity is quite variable, but from the insurance actuaries' standpoint it can't be too far off the mark since a 20-year period certain annuity of $20/k year costs $326,888, and a lifetime annuity for the same amount costs only about $10k more.

EE bonds are aimed at the small investor, and I don't think anyone can prognosticate what might happen to the program. For as along as they're available, it seems like a reasonable option. And an investor using Mr. Lindauer's EE bond 20-year period certain annuity method would have saved $84,788 (CPI adjusted) for the same $20/k per year payout vs. paying a commercial insurer for an SPIA.
Last edited by AlwaysLearningMore on Mon Jul 27, 2020 7:22 pm, edited 1 time in total.
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Re: EE Bonds as period certain annuity - revisited

Post by flyingcows »

The concern I had with EE and I bonds are that, when purchased through treasuries direct, there is no stated warrenty regaurding unauthorized account access. If a hacker liquidates your account, there appers to be no recourse. Meanwhile, brokerages will provide guarentees for unauthorized access

Someone correct me if Im wrong, because I would otherwise be interested
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Re: EE Bonds as period certain annuity - revisited

Post by ctfish »

#Cruncher wrote: Mon Jul 27, 2020 7:22 am .

(I used the yearly aliquots of $10K/yr over the past 20 years ...
Learned a new word today
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