Moving future EE purchases to nominals

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jstorz
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Moving future EE purchases to nominals

Post by jstorz »

I have been purchasing EE bonds for a few years with the intention of having a "poor man's annuity" as a backstop for the 10 years prior to taking Social Security. As has been discussed a lot here, due to the 20y adjustment EE bonds have an effective guaranteed return of 3.53%. This has been reasonable during a long period of low rates, but that time has ended.

We are not to the point where current rates come close to touching EE bonds that are already 2+ years in (as in selling to buy before 20y), but we are at just about the same overall rate for 20y treasuries. Today on Fidelity I am seeing 20y secondaries at 3.51%.

For someone building a bond ladder starting at 20y out, at what point does it make sense to stop EE bond purchases and simply buy treasuries? EE bonds still offer two advantages for someone able to commit to the lock up:
  1. Interest tax deferred until redeemed (up to 30y)
  2. Compound growth of 3.53% (interest is reinvested)
But if the 20y climbs much past 3.5% there is a point where the flexibility of owning a marketable security that also earns more is the clear winner.
exodusNH
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Re: Moving future EE purchases to nominals

Post by exodusNH »

jstorz wrote: Fri Jun 10, 2022 12:31 pm I have been purchasing EE bonds for a few years with the intention of having a "poor man's annuity" as a backstop for the 10 years prior to taking Social Security. As has been discussed a lot here, due to the 20y adjustment EE bonds have an effective guaranteed return of 3.53%. This has been reasonable during a long period of low rates, but that time has ended.

We are not to the point where current rates come close to touching EE bonds that are already 2+ years in (as in selling to buy before 20y), but we are at just about the same overall rate for 20y treasuries. Today on Fidelity I am seeing 20y secondaries at 3.51%.

For someone building a bond ladder starting at 20y out, at what point does it make sense to stop EE bond purchases and simply buy treasuries? EE bonds still offer two advantages for someone able to commit to the lock up:
  1. Interest tax deferred until redeemed (up to 30y)
  2. Compound growth of 3.53% (interest is reinvested)
But if the 20y climbs much past 3.5% there is a point where the flexibility of owning a marketable security that also earns more is the clear winner.
My uneducated guess would be when the rates hit 3.53%/(1 - your marginal federal tax rate + your projected retirement tax rate). Since you'll pay income tax on the Treasury as you go, you need enough extra return to justify paying that tax now vs later.

The EE bonds are always redeemable $1 for $1, which may offer better flexibility if you think you might need the money sooner.
z3r0c00l
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Re: Moving future EE purchases to nominals

Post by z3r0c00l »

Are you also getting I bonds? That is a superior product to EE bonds but I love the idea of a ladder of both if you earn enough. This way you are covered if inflation stays high, but if it falls flat you might even beat inflation with EE bonds. I wouldn't hazard a bet if EE bonds will beat inflation over the next 20 years but I wouldn't rule it out at all.
70% Global Stocks / 25% Bonds / 5% cash
Walkure
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Re: Moving future EE purchases to nominals

Post by Walkure »

exodusNH wrote: Fri Jun 10, 2022 12:45 pm My uneducated guess would be when the rates hit 3.53%/(1 - your marginal federal tax rate + your projected retirement tax rate). Since you'll pay income tax on the Treasury as you go, you need enough extra return to justify paying that tax now vs later.
It's not just marginal rate now vs later, it's also the tax drag on the compounding of reinvested coupons.
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jstorz
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Re: Moving future EE purchases to nominals

Post by jstorz »

exodusNH wrote: Fri Jun 10, 2022 12:45 pm My uneducated guess would be when the rates hit 3.53%/(1 - your marginal federal tax rate + your projected retirement tax rate). Since you'll pay income tax on the Treasury as you go, you need enough extra return to justify paying that tax now vs later.

The EE bonds are always redeemable $1 for $1, which may offer better flexibility if you think you might need the money sooner.
Interesting, I like that formula at first glance. Of course predicting a retirement tax rate is difficult since both future income and future tax rates are unknown. I'm not one to hyper-optimize and I like to follow a plan/keep things simple, so I will probably just continue buying EE bonds unless the 20yr breaches 4%. If it does, I may just start purchasing treasury bonds too (assuming I have the extra cash).

Your second point though is great: we talk a lot about how EE bonds "lock you in" because the fixed rate has been so low, but if rates rise further they would actually preserve value better vs having to sell treasuries early.
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jstorz
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Re: Moving future EE purchases to nominals

Post by jstorz »

z3r0c00l wrote: Fri Jun 10, 2022 12:47 pm Are you also getting I bonds?
Yes definitely, and I very much regret not starting before last year. EE appealed to me as an SS bridge and I never really considered holding I bonds with low fixed rates for 10+ years. But as I re-evaluate my assumptions and expectations I can definitely see a strong argument for having both long term, even if you can't afford to max both.
exodusNH
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Re: Moving future EE purchases to nominals

Post by exodusNH »

jstorz wrote: Fri Jun 10, 2022 12:57 pm
The EE bonds are always redeemable $1 for $1, which may offer better flexibility if you think you might need the money sooner.
...

Your second point though is great: we talk a lot about how EE bonds "lock you in" because the fixed rate has been so low, but if rates rise further they would actually preserve value better vs having to sell treasuries early.
Right -- you could redeem all of your EE bonds -- with minimal interest due to the low fixed rate -- and buy the Treasuries. The only downside with doing it all at once would be that they'd mature all around the same time, potentially causing a big tax hit and possibly subjecting you to additional taxes on Social Security and getting hit with IRMAA.
toddthebod
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Re: Moving future EE purchases to nominals

Post by toddthebod »

Zero-coupon treasuries with a 20-year maturity are currently being sold with a 3.6% return, so these eliminate tax drag and seem like a no-brainer instead of EE bonds. They do have interest rate risk, but if you need the money in 10 years, they should be worth more than a ten year-old EE bond at that time (unless interest rates really shoot way up).
Backtests without cash flows are meaningless. Returns without dividends are lies.
Walkure
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Re: Moving future EE purchases to nominals

Post by Walkure »

toddthebod wrote: Fri Jun 10, 2022 2:33 pm Zero-coupon treasuries with a 20-year maturity are currently being sold with a 3.6% return, so these eliminate tax drag and seem like a no-brainer instead of EE bonds. They do have interest rate risk, but if you need the money in 10 years, they should be worth more than a ten year-old EE bond at that time (unless interest rates really shoot way up).
I thought you still had to report original issue discount (OID) as taxable interest as it "accrues" for a zero coupon bond?
Angst
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Re: Moving future EE purchases to nominals

Post by Angst »

Here's a basic yield to maturity (YTM) tool to help assess any decision for possibly bailing on one's older EE Bond holdings. Remember that as the years left until maturity decline, so must the years decline for a comparison zero coupon bond rate. Over time, unless nominal rates shoot up much higher, one's not likely to easily justify selling off most existing EE Bonds.

Code: Select all

Year  YTM     Years left
1     3.53%   20    
2     3.72%   19    
3     3.93%   18    
4     4.16%   17    
5     4.43%   16    
6     4.73%   15    
7     5.08%   14   
8     5.48%   13  
9     5.95%   12  
10    6.50%   11    
11    7.18%   10    
12    8.01%    9    
13    9.05%    8    
14   10.41%    7   
15   12.25%    6   
16   14.87%    5    
17   18.92%    4
18   25.99%    3
19   42.42%    2
20  100.00%    1
exodusNH
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Re: Moving future EE purchases to nominals

Post by exodusNH »

toddthebod wrote: Fri Jun 10, 2022 2:33 pm Zero-coupon treasuries with a 20-year maturity are currently being sold with a 3.6% return, so these eliminate tax drag and seem like a no-brainer instead of EE bonds. They do have interest rate risk, but if you need the money in 10 years, they should be worth more than a ten year-old EE bond at that time (unless interest rates really shoot way up).
You pay tax on the imputed interest (phantom income.)

That's the convenient thing about bond funds, they pay out dividends by selling some of the holdings to generate the taxable events. At least you have a change to keep some of that to pay it.

For modest holdings, most people can cash flow the taxes, but if you're sitting on $100,000s bonds, it can add up.
toddthebod
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Re: Moving future EE purchases to nominals

Post by toddthebod »

Walkure wrote: Fri Jun 10, 2022 4:26 pm
toddthebod wrote: Fri Jun 10, 2022 2:33 pm Zero-coupon treasuries with a 20-year maturity are currently being sold with a 3.6% return, so these eliminate tax drag and seem like a no-brainer instead of EE bonds. They do have interest rate risk, but if you need the money in 10 years, they should be worth more than a ten year-old EE bond at that time (unless interest rates really shoot way up).
I thought you still had to report original issue discount (OID) as taxable interest as it "accrues" for a zero coupon bond?
Yup, I didn't know that. It still solves the problem of finding something else to invest your coupon payments in.
Backtests without cash flows are meaningless. Returns without dividends are lies.
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jeffyscott
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Re: Moving future EE purchases to nominals

Post by jeffyscott »

Walkure wrote: Fri Jun 10, 2022 12:54 pm
exodusNH wrote: Fri Jun 10, 2022 12:45 pm My uneducated guess would be when the rates hit 3.53%/(1 - your marginal federal tax rate + your projected retirement tax rate). Since you'll pay income tax on the Treasury as you go, you need enough extra return to justify paying that tax now vs later.
It's not just marginal rate now vs later, it's also the tax drag on the compounding of reinvested coupons.
At a constant 12% tax rate, and assuming the reinvestment rate is also 3.53% (or using zero coupons), $100 in an EE bond results in $188 after tax, while the treasury bond results in $184 and at 22%, it's $178 vs. $172. To be equal, the treasury rate would need to be paying about 3.75% at the 22% tax rate or 3.65% at 12%. A simple spreadsheet can be used to determine this equivalence, by trial and error, for other tax rates and for tax rates that differ in retirement vs. accumulation.

As one example, suppose you "know" that your tax rate in retirement will be 12%, but 22% during accumulation. The $188 net after tax from the EE is equivalent to earning ~3.2% compounded annual after tax return, therefore the treasury bond yield would need to be such that you get 3.2% after tax. So if your tax rate during accumulation will be 22%, then then the yield needs to be about 4.1% in order to provide an after tax return equivalent to the EE.
And so it goes, And so it goes, And so it goes, And so it goes, But where it's goin' no one knows
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jstorz
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Re: Moving future EE purchases to nominals

Post by jstorz »

With the 20yr hitting 4% I think I'm going to move away from future EE bond purchases, but I don't think I will sell any I bought in the past few years unless we hit 5%+. Crazy.
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spencydub
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Re: Moving future EE purchases to nominals

Post by spencydub »

I'm also doing a EE ladder. But now I'm seeing the 3 year hit 4.17%

https://fixedincome.fidelity.com/ftgw/fi/FILanding

Might have to rethink my strategy...
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Mel Lindauer
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Re: Moving future EE purchases to nominals

Post by Mel Lindauer »

spencydub wrote: Thu Sep 22, 2022 8:27 pm I'm also doing a EE ladder. But now I'm seeing the 3 year hit 4.17%

https://fixedincome.fidelity.com/ftgw/fi/FILanding

Might have to rethink my strategy...
I Bonds and/or 20-year Treasury issues that pay more than the EE Bond doubling rate can be used for rungs on your ladder.
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jeffyscott
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Re: Moving future EE purchases to nominals

Post by jeffyscott »

jstorz wrote: Thu Sep 22, 2022 7:55 pm With the 20yr hitting 4% I think I'm going to move away from future EE bond purchases, but I don't think I will sell any I bought in the past few years unless we hit 5%+. Crazy.
Unless they increase the short term rates on them by quite a bit in November, they certainly would not seem to me to be worth buying at this time.

You can determine the yield through the 20 year doubling point, to help decide which to keep. But since 4% would about double in 18 years, it's probably not worth selling any except pretty recently purchased ones.

The few EEs that I have are 9-10 years old and the yield from now to year 20 is around 6.5% and rising every month, so pretty sure I'll be keeping those until they double.
And so it goes, And so it goes, And so it goes, And so it goes, But where it's goin' no one knows
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jstorz
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Re: Moving future EE purchases to nominals

Post by jstorz »

jeffyscott wrote: Fri Sep 23, 2022 7:44 am You can determine the yield through the 20 year doubling point, to help decide which to keep. But since 4% would about double in 18 years, it's probably not worth selling any except pretty recently purchased ones.

The few EEs that I have are 9-10 years old and the yield from now to year 20 is around 6.5% and rising every month, so pretty sure I'll be keeping those until they double.
Agreed, I have a column in my spreadsheet that makes this clear. Unfortunately I've only been building the ladder since 2020 so even my earliest are only up to ~4%. Worst part is that I still have half in the gift box since my wife has not been able to get a medallion sig yet - I just don't think it's worth the effort (yet) to sell. But I'm definitely going to pause on new ones unless/until the 20yr yield drops.
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