EE Bonds and Sequence of Returns Risk

[ThisTimeItsDifferent]

It's like a 20 year CD where the early withdrawal penalty is nearly 100% of accrued interest.

My bottom line, the YTM on EE Bonds can really work to the benefit of an investor who is around 20 years out from retirement in the current Fixed Income marketplace. Whether the final YTM is 94.1%, 96.238% or a rounded, but inaccurate, 100%, the basic point is same: investors who understand the YTM chart for EE Bonds may well become much more comfortable with creating a bond ladder with them.

I know that is what happened for my wife and I. Once we understood this YTM chart, it clicked and we became more open to EE Bonds as a way to boost our income floor in retirement.

That's interesting. The YTM chart makes me personally less likely to buy EE bonds because if inflation or interest rates rise I would not redeem the EE bonds unless those rates increased above the YTM, which seems unlikely. So if they increase but to less than the EE bond's YTM, I would keep the EE bond but would still get just the overall 3.5% average yield after 20 years.

I just think personally if I were to lock in an investment for 20 years, I would want more than 3.5% nominal or would want inflation protection like an I bond. A 10 year MYGA pays 3.6% now and is also tax deferred (not too important at these low rates) but does not have a full faith and credit of the the US government and has different early withdrawal penalties (higher at least in the early years than the effective early withdrawal penalty of almost all the (average 20 year 3.5%) interest of the EE bonds).
New ones in 10 years may pay more or less than that so there is reinvestment risk, but I don't see the yield curve compensating me sufficiently with EE bonds for locking in the money for 20 years instead of 10.

If I have to lock in for 20 years I would rather invest in the total stock market although if one has to withdraw earlier than 20 years one may very well lose principle there, rather than just get back the principle (plus woo hoo 0.1% per year!) like the EE bond.

The other thing is that if the $10k/year/person limit is a small part of one's overall portfolio, I just don't see it moving the needle enough to justify the complexity. Maybe if one wants to contribute that amount or less to an asset class that is less volatile than stocks, tax deferred, and easier than chasing CD yields, and does not re-balance to/from the EE, then it's better than ordinary bonds due to their low yields? Bonds will decrease in value if interest rates rise but they have paid a higher annual dividend that the investor gets to keep unlike EE bonds.

Like I said, that's just me. Others may have different conclusions.

[Tingting1013]

That's interesting. The YTM chart makes me personally less likely to buy EE bonds because if inflation or interest rates rise I would not redeem the EE bonds unless those rates increased above the YTM, which seems unlikely. So if they increase but to less than the EE bond's YTM, I would keep the EE bond but would still get just the overall 3.5% average yield after 20 years.

But that is the whole point of the YTM perspective. You are no worse off for holding the EE bond to maturity. In the end you get 3.5% CAGR for 20 years but that is the best you could have gotten.

A 10 year MYGA pays 3.6% now and is also tax deferred (not too important at these low rates) but does not have a full faith and credit of the the US government and has different early withdrawal penalties (higher at least in the early years than the effective early withdrawal penalty of almost all the (average 20 year 3.5%) interest of the EE bonds).

EE bonds are also state tax exempt, unlike MYGAs

[cjg]

While I am a big fan of EE bonds, I currently do not own any because I have room in my tax deferred accounts. I also have not reached the point where I have need of a taxable account. from what I've read here, these should be funded first. Do you agree?

In effect, savings bonds ARE tax deferred accounts. So no need to giving up some tax-differed space in an IRA or 401k to purchase EE bonds, just as long as you don't put yourself in a position of HAVING to redeem them while you're still employed if you can avoid it. Starting at age 40 or 42 seems a safe strategy to me.

If you maintain the same tax-rate for your entire life, a Traditional IRA is the equivalent of all gains being tax-free. For EE-Bonds, it is the equivalent of interest on interest being tax free. In both cases if you're at a 10% lower tax rate when withdrawing, you end up an additional 10% further ahead. For EE Bonds held 20 years, about 70% of the earnings are from simple interest and 30% are from compounding.

If you're still in the accumulation phase and might be maxxing out retirement accounts in 20 years, there's additional disadvantages.

[Mel Lindauer]

One thing that hasn't been mentioned yet, and that's that a younger couple could also build a 20-year EE Bond ladder to help pay for their young (or even unborn) children's later college expenses. Since it could be tax-free, their only concern would be meeting the then-current income limits for the tax-free exemption.

[SantaClaraSurfer]

1. If I have to lock in for 20 years I would rather invest in the total stock market although if one has to withdraw earlier than 20 years one may very well lose principle there, rather than just get back the principle (plus woo hoo 0.1% per year!) like the EE bond.

2a/b. The other thing is that if the $10k/year/person limit is a small part of one's overall portfolio I just don't see it moving the needle enough to justify the complexity.

1. Our AA has plenty of exposure to equities.

2a. We pay estimated taxes quarterly. We purchase our US Savings Bonds every quarter at the same time. It's not hard or overly complex.

2b. EE bonds move the needle by my estimate. I'm 50 and my estimated inflation-adjusted SSI pencils in at around $4,000 monthly, or $48,000 per year. An investment that creates an additional $20,000 per year guaranteed on top of that is definitely beneficial from an income floor point of view.

$20,000 guaranteed income streams in retirement do not grow on trees. Especially ones that you can purchase one small piece at a time and lock in as you go.

Now, your pov is that the return (3.5%) is too small and the investment too much of a hassle.

I'd flip that around to say that you'd be hard pressed to find as good a fixed income investment that costs as little upfront and offers such an ironclad confidence in the return.

This biggest risk outside of unexpected runaway inflation, to me, is that we are saying that we're confident that we aren't touching the money for 20 years. Which, due to the rising YTM, gets easier and easier as we go.

But that does mean:

a) we're not rebalancing with this money and
b) we will have to use other resources if we want to make a "big move" like moving from renting to owning our own residence

The two biggest advantages are:

a) much more flexibility in the decade preceding retirement and
b) less worry about equity markets around and esp. after our retirement date, which is relevant if we are going to rent our primary residence for the long haul

Since the above may not appeal to you, I'd also share the perspective that smart fixed income investing is one way to lay a great foundation for staying the course with long term equity investing.

[spdoublebass]

It should also be pointed out that currently many bank account are paying .1% or less. Of course people on Bogleheads know of Ally and other places, but Ally is currently getting .8%. So if God forbid you cash the EE bonds out early, it's not ideal, but it's not catastrophic and going to wreck your retirement either.

[ThisTimeItsDifferent]

All good points. Thanks for your perspectives.

[ArtsyProf]

My wife and I have done similar for i-bonds over the past decade, as one form of longevity insurance for our 80's (and 90's if we continue) with guaranteed inflation protection, less federal-only taxes on earnings. $25k/yr including the $5k tax refund allowed. The actual rates have been low, though.But a good place for safety and inflation protection in one corner of our planning. Not hyped by investment houses, since no fees for them, though.

Same for EE's in the future as you are doing, as long as the rules for new EE's don't change soon. But you are betting that inflation does not eat your return, and that you will not need the money for 20 years. Good luck!

Is the main difference between EE and I bonds the # of years until you can cash them ? 20 years for EE and 5 years for iBonds, right?

[Thesaints]

No. All savings bonds can be cashed out after 12 months and all have a 3-month interest penalty before 5 years after their issuance. EE bonds also have a principal reset at the 20-year mark, which is what many are discussing in this thread.
The reset can be seen as equivalent to a 3.5% annual interest for the first 20 years of the bond, but is is not the same thing by a long shot.
There is a substantial difference between a bond paying 3.5% for 20 years and another one paying 0.1% for 19 years and 11 months plus a one time 96% bonus at the expiration of year 20.
I’m not sure everyone here is appreciating it correctly.

[Hubris]

Anyone here in late 50's and beyond currently purchasing EE's? At what age would you stop building the EE ladder?

Just started our ladder last year at ages 57 (working) & 60 (semi-retired), and planning on doing for 5-10 years depending on rates for other fixed income, etc.

[Noobvestor]

Did I use this calculator correctly? I plugged in 3.53% (doubles in 20 years), and 1.24% 20-year treasury yield. What does this tell us? EE Bonds are 40% more

It tells us that for a security with a coupon rate of 3.53% that compounds semi-annually and will have a redemption value of $1,000 in 20 years, $1,404.52 is the market price that results in it having a yield to maturity of 1.24%. A market price that is not meaningful for Savings Bonds because they are not marketable securities.

If you need to sell your bonds before 20 years is up, then the comparison is moot - agreed. If you're investing for 20 years, though, the difference is huge.

Here's how I look at it: the EE bonds I hold are less than 10% of my portfolio, and also the last thing I would sell on my deathbed. The odds of me needing to cash them in ahead of 20 years are vanishingly small - I'm counting on them to be 20-year bonds, and if I have a heart attack tomorrow, so be it.

[ivgrivchuck]

Does it make sense to buy them at age 35?

I think it does. I'm in my late 30s and started building my EE ladder not too long ago.

It's possible that you are in a high income tax bracket at age of 55. But I see this as a form of risk balancing:
- If you are in a high tax bracket at the age of 55, you probably have done really well in life (at least career-wise) and the extra tax is insignificant compared to your total net worth. If you are in a low tax bracket, then you are getting a really good deal for your investment that you badly need.
- Also even with the tax, it's very likely to beat other safe investments at 20 year time horizon.

[runninginvestor]

Does it make sense to buy them at age 35?

I think it does. I'm in my late 30s and started building my EE ladder not too long ago.

It's possible that you are in a high income tax bracket at age of 55. But I see this as a form of risk balancing:
- If you are in a high tax bracket at the age of 55, you probably have done really well in life (at least career-wise) and the extra tax is insignificant compared to your total net worth. If you are in a low tax bracket, then you are getting a really good deal for your investment that you badly need.
- Also even with the tax, it's very likely to beat other safe investments at 20 year time horizon.

The other optionality if you are younger when you start (>24 yo) is depending on if and / or when you have kids, you can exclude the interest if used on qualified education and if you meet the other requirements, right?

[Noobvestor]

Does it make sense to buy them at age 35?

I think it does. I'm in my late 30s and started building my EE ladder not too long ago.

It's possible that you are in a high income tax bracket at age of 55. But I see this as a form of risk balancing:
- If you are in a high tax bracket at the age of 55, you probably have done really well in life (at least career-wise) and the extra tax is insignificant compared to your total net worth. If you are in a low tax bracket, then you are getting a really good deal for your investment that you badly need.
- Also even with the tax, it's very likely to beat other safe investments at 20 year time horizon.

+1

I started doing this around age 30 - kept telling myself I could sell if other, clearly better options became available. They never did. Instead, the EE bonds I thought were just a temporary holding have become an amazing doubling engine in an era of low rates. It's a decade plus later, I still max out annually.