For many investors having some measure of “guaranteed income” helps them establish and realize their long-term retirement plans. There is a sense of comfort knowing they have some basic level of income they can rely on that’s independent of the market fluctuations. This income could be used to help meet their essential needs, or to cover a gap in other income sources such as social security or provide an alternative to a pension (which few have anymore).
The financial industry would typically recommend an annuity to provide this income. In truth very few annuity products are good options for investors, with arguably a Single Premium Immediate Annuity (SPIA) as the only worthy option. Downsides of a traditional SPIA include losing your investment if you die shortly after purchasing the annuity, as the insurance company would keep all the annuitant’s money and the investor’s heirs would get nothing. While there are term-certain options available, these come at their own cost of lowering your income in exchange for a guarantee.
EE Savings Bonds offer an even better alternative for many investors, providing a nearly risk-free guaranteed income, where you always retain the full value of your investment.
What are EE Bonds?
First introduced in January 1980, EE Bonds are issued by the United States Treasury and newly issued EE Bonds are guaranteed to at least double if held for 20 years. If a married couple purchased $20,000 of EE Bonds today, and did so for the next 10 years, after 20 years they are guaranteed to get paid back at least $40,000 a year for 10 years. If they wanted to extend that for 20 years, simply buy for 20 years.
Many investors are scared off by the current 0.1% rate on EE Bonds set in May 2021. Dig deeper and you will realize the “superpower” of EE Bonds is they are guaranteed to at least double at 20 years. If you consider only the 0.1% rate, after 20 years an initial $10,000 purchase is worth roughly $10,202. But on reaching its 20-year maturity, an EE Bond (if it hasn’t yet) will become worth double its original purchase price – meaning in our $10,000 example above we essentially received a 1-day return of $9,798 (brining the total value to $20,000).
Like I Bonds, EE Bonds were designed primarily for small savers/investors. You can buy a maximum of $10,000 of EE Bonds a year for each Social Security number via TreasuryDirect (treasurydirect.gov).
You cannot hold them in a special retirement account, but the taxes due are deferred until maturity or the date they are redeemed. If you redeem EE Bonds prior to five years, you’ll lose the last three months’ interest. After holding them for five years, there is no penalty for redeeming EE Bonds before maturity, except that the federal tax on the interest must be paid in the same year as the redemption.
EE Bonds offer many benefits:
- Do-It-Yourself (DIY) Annuity. For every $1 invested in EE Bonds today, you will get back at least $2 in 20 years. This can be used to create a DIY Annuity, such as helping to offset expenses between the time you retire and the time you plan to collect social security – especially if you are delaying social security until 70. This could also help ensure you can cover any gap in “essential” expenses left from your expected social security and/or pensions. For clarity, EE Bonds are typically one [often small] part of a larger retirement savings.
- Annuity where you keep the money. Anything invested in EE Bonds remains your money. If you die before the EE Bonds reach their 20-year maturity, the EE Bonds are passed to the co-owner, beneficiary, or the estate’s heirs. This ensures your hard-earned money remains in your estate and does not become an insurance company’s money if you die prematurely.
- May simplify retirement planning. Some investors choose to retire before other income streams such as pensions and social security begin. Considering EE Bonds as an annuity to cover expenses during those years could reduce (or eliminate) the difference between their initial and later withdrawal rates. For example, let’s say a couple needs $90k/year of retirement income, and at 70 will receive $40k of social security/pensions/etc. meaning they’d need to withdraw $50k/year from 70+. If they retire at 60, they’ll need to withdraw $90k/year for 10 years, then $50k afterwards – which doesn’t align with typical Safe Withdrawal Rate (SWR) calculations. If the couple had purchased $20k/year of EE Bonds from ages 40 – 50, those would cover the first $40k (after doubling) of expenses, leaving them a more predictable $50k/year for all years of retirement. Note – they still need to account for inflation, so they may also want to purchase an inflation protected asset such as I Bonds if that is a concern.
- May reduce Sequence of Returns Risk (SORR). By reducing the withdrawal needed from the portfolio – especially during the initial retirement years – you may reduce SORR. Although much is still dependent on the rest of your portfolio and your flexibility.
- Guaranteed at least 3.53% return if held for 20 years. To double the initial investment in 20 years, the effective guaranteed return required is 3.53% (if held until 20-year maturity). Remember that at current rates, roughly 98% of that return happens in a single day when the EE Bonds reach its 20-year maturity. Conversely, holding for less than 20 years or longer than 20 years will not have the same return.
- They’re flexible (but at a cost). They offer a tax timing option. They can be redeemed any time between one and 30 years. As noted above, 98% of the return occurs on a single day, meaning as bonds near their 20-year maturity you are losing out on significant gains. So, while they are flexible, for most investors only for the first few years of holding EE Bonds, and only if circumstances changed such that you needed this money for something else. Otherwise, you should plan for holding them for minimally – and optimally – 20 years.
- They’re nearly risk-free. They are obligations of the U.S. Treasury, so they are even more secure than Social Security benefits. (It is possible for the U.S. Treasury to default on these bonds, so strictly speaking they are not completely free of default risk as explained above.) However, they are not inflation protected (see more below).
- They’re tax deferred. Even though you purchase EE Bonds with after-tax money for your taxable account, they offer tax deferral for up to 30 years. You can elect to report the interest annually if you prefer, but most investors choose the default tax deferral option and thus only pay tax on the accumulated interest when they eventually redeem the EE Bonds.
- They’re free from state and local taxation. This can mean higher after-tax returns for those investors who live in high-tax states, and they’re even better yet for folks who live in areas where they pay both state and local taxes.
- If used for qualifying educational expenses, the interest earned is free from federal taxes.
- You can’t lose money in nominal terms. If interest rates rise, normal bond holdings will be worth less as investors don’t want lower paying bonds. EE Bonds cannot be traded or resold on an open market (aka they are not “marketable”), thus EE Bonds will never return less in nominal terms than you invested. Conversely, EE Bonds won't gain value if interest rates fall, but they will still double in value even in a deflationary period.
While EE Bonds offer many benefits, they may not be suitable to all investors – or at least not to all stages of their investment life cycle.
Common scenarios where EE Bonds are not appropriate for your needs:
- You cannot commit to a 20-year investment. At current rates, for their first 19 years, 11 months, and roughly 30 days EE Bonds have an abysmal return. The payoff happens at exactly 20 years when they are guaranteed to have at least doubled. If you are unable or unwilling to commit to a 20-year investment, EE Bonds are not for you.
- You do not have an adequate emergency fund. Investors are always recommended to establish an adequate emergency fund before investing in other options. An investor at this stage could consider I Bonds as a choice as part of their emergency fund. Recommend reviewing the I Bonds Manifesto found here: https://retirementincomejournal.com/art ... ?pdf=13017
- You do not have enough other investments. As good as EE Bonds are – they will not provide the type of growth that most investors will require to meet their retirement needs. You should first prioritize investments into tax-advantaged accounts such as IRAs, 401ks, HSAs, etc. (ideally low-cost broadly diversified index funds following principles such as https://www.bogleheads.org/blog/who-are ... rinciples/).
- You do not yet have other bond investments for rebalancing. Investors are recommended to establish their own Asset Allocation (AA) and rebalance by selling/buying assets to maintain their AA as needed. EE Bonds are never suitable for this purpose, thus are not recommended for your first bond investments.
- You expect average inflation to be higher than 3.53% over the next 20 years. EE Bonds are not inflation protected. While they have some interest rate protection, such that you are guaranteed $10,000 invested will be worth at least $20,000 in 20 years, you do not know how much purchasing power that $20,000 will provide in 20 years. If the US Government is successful in sustaining their 2% inflation goal, EE Bonds beat inflation. But if average inflation over 20 years ends up being higher than 3.53%, while you’ll still get at least double your original investment – the funds would purchase less goods and services than your original investment. Note, one could consider purchasing some I Bonds in addition to EE Bonds to add in an inflation protection element as well.
- You will be in a higher tax-bracket in 20 (to 30) years. As taxes can be deferred (for up to 30 years), ideally you align your EE Bond purchases to hit their 20-year maturity during lower taxed years (such as while you are retired). While you could delay redeeming EE Bonds for up to 30 years from purchase, those last 10 years are likely to earn far less interest. You do not want to purchase EE Bonds if you are expecting to be still working in your peak-earning (and thus taxed) years 20-30 years from now.
- You want to get as rich as possible or die broke. EE Bonds are a conservative investment, they are best used to provide some level of guaranteed income to help provide for your needs regardless of what the world and its markets are doing. By purchasing EE Bonds, you are effectively deciding to exchange some potential upside for some downside protection against market conditions. In other words, EE Bonds will never make you rich, nor are they suitable as your only retirement investment, but they can increase your chances of a successful retirement under less-than-ideal conditions at the tradeoff of potentially having less money remaining when you die under perfect conditions. EE Bonds are thus not likely acceptable to investors who want to take on as much risk as possible and are comfortable with an AA of 100/0.
Now let’s explore the mechanics of purchasing and redeeming EE Bonds and talk a bit about how they work. You must first open an individual account at TreasuryDirect.gov and link it to your bank account. Once your account is open, you can then make your purchases online and the Treasury will deduct the purchase price from your linked bank account.
Purchase limits. There is an annual purchase limit of $10,000 in EE Bonds in electronic form per Social Security number. A married couple could, therefore, purchase a total of $20,000 per year.
Interest - first 20 years. According to https://www.treasurydirect.gov/indiv/re ... r.htm#when, for EE Bonds issued after May 2005, interest is added monthly, compounded semiannually. TD does not show the monthly changes, but updates the value every 6 months after compounding has occurred. There is an open question on what happens if you sell during months 1 - 5 of the compounding cycle, I've reached out for clarification - but if anyone has done this and confirm - I'd welcome the input. At their 20 year mark, if needed a one-time adjustment will be applied to reach the guaranteed doubling of the initial purchase.
Interest - years 20 - 30. According to [url]https://www.treasurydirect.gov/indiv/re ... er.htm#buy, for EE Bonds issues after May 2005, the interest rate - or the way EE Bonds earn interest - may be changed in their final 10 years, but such changes would be made before the final 10 years start.
Timing your purchases. Interest is earned on the last day of each month and is posted to your account on the first day of the following month. So, if you own your EE Bonds on the last day of any month, you’ll earn that full month’s interest. Therefore, it’s best to buy your EE Bonds near the end of the month, since you can earn a full month’s interest while only owning the EE Bonds for perhaps a day or two. On the other hand, when redeeming EE Bonds, you’ll want to do so on or near the first business day of the month (ideally the month they hit their 20-year maturity and double), since redeeming them later in the month won’t earn you any additional interest.
Redeeming electronic EE Bonds. You can redeem your EE Bonds (or any portion of your bond holdings, so long as you leave at least $25 in your account) using your online account. The money is then transferred into your linked bank account.
Avoiding probate. EE Bonds don’t qualify for a step-up in cost basis at one’s death as many other investments, such as stocks and real estate, do. (EE Bonds are like bank-CDs in that regard.) But you can title them in such a way as to avoid having them included in your estate subject to probate—by having either a second co-owner or a beneficiary listed on your EE Bonds.