EE Savings Bonds are an interesting investment vehicle that often gets overlooked for someone who is looking to retire early. The reality is that a lot of us are planning to retire a lot sooner than the Social Security eligibility age. Social Security being an income stream that we cannot start until age 62 at the earliest. It’s rather important to bridge the gap in between the day you declare early retirement and the day you begin that social security income stream. Can EE Bonds be a plausible strategy to bridge the Gap?

I am someone who, if doomed to wander the planet single for the rest of his life, thinks that he might reach financial independence in his early 40’s. I think that it could be financially rational to purchase EE bonds to the maximum limit every calendar year from around age 32 to age 42. This assumes the current rules remain the same over the next decade. By doing so, I will have an income stream of $20,000 each year from age 52 to age 62. You could double these these values as a couple.

I think this strategy also gives some emotional comfort in regards to exposure to sequence of returns risk. If you are a couple and your normal expenses are $40,000 per year and you have a decade of expenses in retirement that have already been covered by the savings bonds, this allows your portfolio to have an entire decade of potential compounded growth without touching it. Such a set up might might allow you to take more risk in your investments. That is, do EE Bonds make sense ot use instead of an actual bond mutual fund ? I’m not sure.

EE bonds are essentially an interest rate arbitrage opportunity that are only available to individual investors. The dollar limit probably isn’t worth bothering for super high net worth people. That’s why you don’t hear a lot about them.  EE Bonds only earn 0.2% of interest per year. However, the US Treasury has contractually agreed to do a one-time adjustment. They will double the value of the purchased bond after it has been held for 20 years. In years past, the time you had to wait for it to double was 17 years. Before that it was 12 years. For whatever reason, the Treasury has kept it at 20 years since 2003 despite interest rates continuing to plummet. This strategy would also be a hedge against deflation on your cash.

Doubling your money after 20 years comes out to a 3.53% interest rate averaged out over those 20 years. A “normal” 20 year Treasury bond currently has a rate of 2.58%, which is  quite a bit lower.

I suppose the best alternative opportunity for the individual investor would be going the CD route. I don’t know of any 20 year CD’s. A 10 Year CD at Discover Bank is currently paying out 2.2% per year.  You would ask yourself what your perceived probability of a 10 Year CD in the year 2026 being issued at a rate that is higher than 4.8% ?

You are definitely exposed to inflation risk with this strategy, but I’m assuming most people who pursue this strategy already have a pretty large basket of equities to hedge inflation. Is inflation going to average more than 3.5% per year in the twenty years between when you purchase the bond and when you redeem it? That probably depends on circumstantial factors such as what you are typically buying. If your house is paid for, you don’t need to worry about rising costs of rent. Consumer electronics have continually gone down in price. McDonalds still has the same crap on their Dollar Menu that they had 15 years ago. If you have chronic medical expenses or plan to pay for somebody else’s college tuition, then inflation is going to have a much greater effect on your future expenses.

If the interest rate environment changes, you could always buy I Bonds instead. When the fixed rate on an I Bond is more than 3.5%, then you’ve already beat the EE Bond. Unless there’s subsequent deflation which could reduce the interest rate on the I Bond. But at today’s rates, the EE Bond guaranteed doubling absolutely seems like a much better option.

So, if I bought $10,000 worth of EE Bonds in May 2017 and I redeem in May 2037, I now can redeem bonds that are worth $20,000. But, If I buy $10,000 worth of EE Bonds in May 2017 and I redeem them in April 2037, I only have around $10,407.69. It’s obviously a substantial difference. Bottom line, don’t be playing the EE Bond game if you are not 100% committed. Most people probably shouldn’t go this route. That’s an incredibly hard commitment to make with all the variables in one’s future finances.

There is a bonus perk for those who decide it’s not worth abandoning their high income tax state in retirement. EE Bonds are issued by the U.S. Treasury, and like all other treasury bonds, you don’t have to pay state taxes on that interest. My understanding is that it’s also tax free at the federal level if used to pay for education.

Obviously, it would be expected that an equity investment would absolutely crush the return of an EE Bond over the next 20 years. But financial independence isn’t about maximizing your wealth building opportunities. It’s more about looking at the various strategies you can use to maintain your current standard of living indefinitely. If you want to build a legacy or be the richest person in the graveyard, that’s going to take a lot more  capital. Especially if your lifestyle inflates over time.

I think there’s something to be said about funding a 10 year term annuity for yourself while you are working with the intention to redeem that income stream when you are done working. It’s delayed gratification at it’s core. People want to retire younger, but the government isn’t going to lower the Social Security age. Your early 50’s is is the time of your life where you might experience ageism should you want to find some extra income in addition to your investment portfolio.

The good news is that EE Bonds can actually be held for 30 years before you must redeem them. So, if you decided to keep working and not actually retire, you could theoretically wait to start redeeming them at 62 rather than 52. And maybe that allows you to delay starting your Social Security income until 70. The bad news being that if stocks don’t return 3.5% nominal over the next couple decades, then we’re all screwed.

What About Buying EE Bonds During Early Retirement ?

If you are extremely risk averse to volatile fluctations, and the rules stay the same, I suppose you could keep this going indefinitely. It’s not what I would do. But if you hate volatility and have low expenses, consider this scenario: A FIRE married Couple’s expenses are $40,000 per year and they have $1,500,000 in their investment portfolio.

The 4% safe withdrawal rate says that they can spend up to $60,000 pear year. They would use $40,000 per year for their taxes and expenses. They’d buy also $20,000 of EE Bonds which buys them a $40,000 per year income stream 20 years in the future. You’re basically creating your own indefinite nominal annuity and you’re cutting out the steep commissions of the insurance companies. Unlike a real annuity, your estate still gets to keep all the money you invest in creating that income stream.

Readers – What are your thoughts on an EE Bond strategy to bridge the gap in retirement? You can purchase EE Bonds at Treasury Direct.