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How would you categorize these savings bonds?

Posted: Sun Mar 04, 2018 3:44 pm
by barrett
Hey all,

I know that a lot of people on here like savings bonds for "deep cash" but I have a question.

I loaded up on EE-Bonds in the early 1990s and again on I-Bonds in the early aughts. Nearly all the bonds I have are paying at least 4% so I have been happy with them and plan to hold most to maturity. My issue in terms of figuring out a proper AA for all 'taxable" assets is that these bonds represent a little over 25% of all my taxable money. To add to that, just over 60% of the current value of the bonds is interest.

How would you all categorize these? As cash? Doesn't seem right with all the interest that is just waiting to be taxed. Also, selling them to buy something else is not at all the same as just using money from, say, a money market fund. In some ways I think of the I-Bonds as part LTTs because of their deflation protection (ditto for the EEs), and part gold for their inflation protection. But obviously they are neither of those assets.

The only approach that seems to make sense is to think of them as a sort of VP. Any attempt to fold them into a taxable PP just makes me way cash heavy even without considering the tax implications.

I also need to consider this... in order to take full advantage of the tasty 4% yield on the EEs, I would be cashing in a bunch of bonds in 2021 and again in 2022. Again, the interest they'll kick off in those years makes them very un-cash-y.

I realize this is a first-world problem but am curious to hear feedback.

Any thoughts? Thanks.

Re: How would you categorize these savings bonds?

Posted: Sun Mar 04, 2018 3:47 pm
by ochotona
I think of these as cash, because zero "duration". My portfolio categories I want to use to describe the kind of risk, I don't care if they're not genetically correct. They are very cash like because there is no default risk, either. They're just CDs with a special tax deferred feature and one has inflation adjustments.

Re: How would you categorize these savings bonds?

Posted: Sun Mar 04, 2018 5:08 pm
by Xan
Agreed, I consider them cash. Maybe it isn't quite as simple as normal cash, because you have to figure out how much you'd own after taxes if you cashed them out, but that amount is a cash amount.

Re: How would you categorize these savings bonds?

Posted: Mon Mar 05, 2018 5:39 am
by barrett
Thanks Xan & ocho...

Let me fill in a few details. I'll be retiring in three months at age 59.7 and hope to withdraw from taxable at a rate of, say, $4,000 per month, at least until I cash in those big whacks of 2021 and 2022 EEs. How would you set up a PP-like portfolio if we assume the numbers are $1M total and $270K in savings bonds? I'm using nice round figures so they are easy to work with.

AND, of that $270K, $170K is taxable interest.

I guess what I am imagining is a sort of Cash Butterfly portfolio where one wing is deep savings bonds cash, and the other is my dry powder as well as money that is available for living expenses.

And let's also assume that I am OK with holding stocks, long treasuries and gold in equal proportions.

With my retirement accounts, the most I would likely do for now is some Roth conversions in years when it makes sense to do so (wife is still working).

Again, thanks.

Re: How would you categorize these savings bonds?

Posted: Tue Mar 06, 2018 8:22 am
by sophie
I see your problem: no matter what you don't want to rebalance out of those savings bonds! And you don't want to start dipping into them for another 10 years - and certainly not before Medicare eligibility. I'd suggest setting up a Desert Portfolio, with the savings bonds substituted for part of the intermediate bond allocation.

Your tax bracket means that qualified dividends and gains won't cost you a cent for Uncle Sam, whereas interest from the bond ladder is going to be hit with the full ordinary income rate. If you go with the Desert Portfolio, you might consider dialing up the stock allocation for two reasons: the tax treatment will be way better, and you have those savings bonds to back you up in case of a stock market crash in the setting of inflation (i.e. 1970s style stagflation, where the 10% gold won't be enough to keep you out of the red) or deflation.

Re: How would you categorize these savings bonds?

Posted: Tue Mar 06, 2018 5:31 pm
by barrett
Thanks for your input, Sophie! I was hoping you might stumble on this thread. Some version of the Desert Portfolio is in fact what I have been contemplating and the savings bonds seem to fold into it nicely.

With the treasury yield curve being so flat and the Fed talking about raising rates at least another couple of times this year, I am tempted to go heavy on the short end of the curve. Still some things to ponder but I am getting closer.

Re: How would you categorize these savings bonds?

Posted: Wed Mar 07, 2018 7:14 pm
by jhogue
barrett,

After reading your post several times, I don’t think that you are describing a portfolio allocation dilemma. I think you are describing a tax efficiency dilemma.

Optimizing tax efficiency on maturing savings bonds depends on your retirement goals and your marginal tax rate. Some suggested uses:

1. Use savings bonds to fund higher education expenses for your children or 529s for your children and/or grandchildren. (Avoids all federal or state taxes).

2. Use savings bonds to pay off your mortgage. (If you still have a mortgage and your interest rate is higher than the 4% you currently get from your old EE bonds.)

3. Use savings bonds for current income for you and your wife rather than claim Social Security. (Current estimates are that each year you avoid claiming Social Security you increase your future benefits by 8% per year up to age 70.5).

4. Use savings bonds to pay taxes for Roth IRA conversions. (Lowers federal and state taxes on your annual Required Minimum Distributions for your traditional IRAs after you reach age 70.5).

5. Roll over your savings bonds, build a new bond ladder, and provide yourself another 30 years of inflation/deflation protected income.

Re: How would you categorize these savings bonds?

Posted: Thu Mar 08, 2018 7:37 am
by sophie
Those savings bonds are irreplaceable at the interest rates they're earning now, and there will be a big tax hit on selling them. Barrett, what dates and in what proportion did you buy those bonds? It would be useful to plan a selling schedule to follow jhogue's excellent suggestions.

If you wait until Medicare eligibility age in order not to miss out on Obamacare subsidies and delay social security, you should still have a 5 year window (age 65-70). That timing might work out perfectly for you. You can liquidate your savings bonds during that 5 years and stay in the <15% bracket, live off the proceeds, and let the rest of your investments grow undisturbed in the meantime. Then you just need a plan for getting from here to age 65. You could either go with the simple Desert Portfolio plan, or reserve a fixed amount of cash plus the savings bonds for living expenses, and invest the rest in a portfolio of your choice to wait until you turn 70 (and serve as an emergency reserve in the meantime).

Re: How would you categorize these savings bonds?

Posted: Fri Mar 09, 2018 7:22 am
by barrett
sophie wrote:Those savings bonds are irreplaceable at the interest rates they're earning now, and there will be a big tax hit on selling them. Barrett, what dates and in what proportion did you buy those bonds? It would be useful to plan a selling schedule to follow jhogue's excellent suggestions.

If you wait until Medicare eligibility age in order not to miss out on Obamacare subsidies and delay social security, you should still have a 5 year window (age 65-70). That timing might work out perfectly for you. You can liquidate your savings bonds during that 5 years and stay in the <15% bracket, live off the proceeds, and let the rest of your investments grow undisturbed in the meantime. Then you just need a plan for getting from here to age 65. You could either go with the simple Desert Portfolio plan, or reserve a fixed amount of cash plus the savings bonds for living expenses, and invest the rest in a portfolio of your choice to wait until you turn 70 (and serve as an emergency reserve in the meantime).
Hey Sophie,

I plan to delay taking SS until age 70 as my wife is 8.5 years younger and didn't start really contributing to her own SS until she was in her early forties. We reevaluate once a year, but, so far it would make sense for her to take half of my benefit versus 100% of her own. Delaying as long as possible seems to be the best strategy for us unless she keeps working and earning a pretty good income.

But the maturity dates of the savings bonds don't necessarily line up with what you have laid out above. The EE-Bonds mature (hit the 30-year mark) between the ages of 62 and 64 for me, and the greatest concentration of I-Bonds mature from ages 70 to 73 as my RMDs would be kicking in. BUT your post got me to really look at what the numbers are. I'll have about $88,000 in gains from 2021 to 2023, but I can cash out some a few months early (in late 2020) to spread out the interest over four years. It's not an insignificant number of dollars per year, but it's hardly something that should by itself screw up our tax/health insurance planning.

Thanks, jhogue, for your post as well. Im just waking up and won't get to answering that for a few days as I have to rush off and act important!

Re: How would you categorize these savings bonds?

Posted: Fri Mar 09, 2018 8:39 am
by ochotona
They stop earning interest after 30 years.

Re: How would you categorize these savings bonds?

Posted: Fri Mar 09, 2018 12:23 pm
by ochotona
MangoMan wrote:So older I-bonds that are earning above market interest should be held for the whole 30 years then, correct?
I plan to do that, unless current interest rates rise higher than the bonds.

Re: How would you categorize these savings bonds?

Posted: Fri Mar 09, 2018 3:16 pm
by jhogue
Pugchief,

The total interest rate on an I bond consists of a fixed rate plus a variable rate. I bonds mature thirty years from the month of purchase. The fixed rate is established at the time of purchase and remains in effect throughout those 30 years. The variable rate is re-set every six months, on 1 November and 1 May.

Based on your post, I estimate that your I bond is currently yielding 1-2% (fixed rate) + 2.48% (variable rate) = 3.48%-4.48% (total). The tax equivalent yield is even higher, depending upon your state and local residence at the time of redemption. That rate is considerably higher than anything now available from the U.S. Treasury with unbeatable safety, liquidity, and tax deferral for the life of the I-bond. If I were you, I would hang onto them until finally maturity.

P.S.:
Tax is owed on accrued interest in the final year of maturity, whether you redeem your I bonds or not, so there is no point of holding any savings bond past its final date of maturity.

Re: How would you categorize these savings bonds?

Posted: Thu Mar 15, 2018 9:03 am
by barrett
Xan wrote:Agreed, I consider them cash. Maybe it isn't quite as simple as normal cash, because you have to figure out how much you'd own after taxes if you cashed them out, but that amount is a cash amount.
Xan (or anyone else!),

Isn't that the same for all assets, though? If I sell stocks, bonds or a gold ETF in a taxable account, aren't the gains a "cash amount?"

With almost all of these saving bonds I am looking at about $3 of gains for every dollar invested. I have always viewed PP cash as dry powder for purchasing other assets, an emergency fund, money for paying recurring bills, college tuition, car payments, etc.

Again, I have good problem, but I just don't view these bonds the same as cash.

Re: How would you categorize these savings bonds?

Posted: Thu Mar 15, 2018 10:07 am
by Xan
barrett wrote:
Xan wrote:Agreed, I consider them cash. Maybe it isn't quite as simple as normal cash, because you have to figure out how much you'd own after taxes if you cashed them out, but that amount is a cash amount.
Xan (or anyone else!),

Isn't that the same for all assets, though? If I sell stocks, bonds or a gold ETF in a taxable account, aren't the gains a "cash amount?"

With almost all of these saving bonds I am looking at about $3 of gains for every dollar invested. I have always viewed PP cash as dry powder for purchasing other assets, an emergency fund, money for paying recurring bills, college tuition, car payments, etc.

Again, I have good problem, but I just don't view these bonds the same as cash.
Of course if you were to sell any of those assets, you'd end up in cash. But I don't think that means you can consider the current value you own in dollars as a "cash amount". I think you can do that with these bonds.

Re: How would you categorize these savings bonds?

Posted: Thu Mar 15, 2018 1:25 pm
by jhogue
Barrett,

You are correct, in the strict sense that savings bonds are not "the same as cash." I love I bonds, but I can't take one down to the grocery store and exchange it for a gallon of milk. On the other hand, the greenbacks in my safety deposit box won't earn interest.

What makes savings bonds suitable for inclusion in the PP Cash quadrant is that they have the same safety, stability, and liquidity as Uncle Harry's proverbial Treasury Money Market Fund. But with much a much better rate of return and unbeatable tax treatment.

Re: How would you categorize these savings bonds?

Posted: Mon Mar 26, 2018 8:51 am
by ochotona
Latest paper I-Bonds came 2.5 weeks after my taxes were e-filed !!!

Out the door for electronic conversion in 14 hours!