The new 5.51% rate might entice you to use I-bonds to create inflation-proof income in retirement
Your retirement savings need to keep up with inflation, and Series I bonds are designed to do just that.
The interest rates for Series I bonds reset every six months, on Nov. 1 and May 1, and at times when inflation is rising, these announcements become news events. However, if you're using I-bonds the way they were intended, as an inflation hedge, it shouldn't matter that much to you. Each year, no matter what, you'd be buying a set dollar amount - up to the $10,000-a-year limit for each Social Security number - and then letting it ride.
That's what Scott Cederburg has been doing for the past five years, in a very tortoiselike approach that he calls setting up his own "retirement annuity." It actually goes against his nature: Cederburg is a 44-year-old professor of finance at the Eller College of Management at the University of Arizona, and his best-known piece of research involves putting 100% of a retirement portfolio into stocks. He not only studies this, he also practices it with his own retirement funds, which are split between U.S. and international funds.
"All of my retirement is 100% equity," said Cederburg. "I think of the I-bonds as a supplement to Social Security. That's real income."
His game plan is to keep putting away $10,000 a year in I-bonds for the next 20 or so years, until retirement. He buys the bonds from TreasuryDirect.gov once a year, a 10-minute task he doesn't think about again until it's time to buy again the next year. When he started this process in 2021, the fixed rate on I-bonds was 0% and the inflation rate was minimal. He wasn't making much in terms of interest, but he wasn't losing ground, either.
The new rate available for sale as of Nov. 2 will be a fixed rate of 1.4% and an inflation rate of 4.08%, for an annualized combined rate of 5.51%. That rate is attractive compared with all the other options on the market right now, like CDs, high-yield savings accounts or short-term Treasurys.
But that's beside the point, really. The strategy for I-bonds is a long-term one. It's an inflation hedge for savings, not a way to chase yields. And that's exactly why Cederburg compares it to an annuity and doesn't even consider it part of his investing portfolio, which is invested quite aggressively.
The endgame with I-bonds
What matters most about I-bonds, if you save consistently over the years, is how you plan on withdrawing the money. Cederburg does not have a spreadsheet or software to plan out this process. He keeps it very simple: right now the money is going in, and later he will start taking it out. What he likes about I-bonds versus, say Treasury inflation-protected securities, is that you don't have to worry about redeeming at a particular maturity date.
If you buy TIPS directly from the government, you have to buy them in durations of 5, 10 or 30 years. If you buy maturity-based exchange-traded funds, you can build a ladder of the intervening years, but that means that each year, you have to commit to a certain amount coming due. The same goes for CDs or Treasury bills, bonds and notes, which don't have built-in inflation protection but do have maturity terms.
You can cash in I-bonds once you pass the one-year maturity lock-in. If you sell within five years, you lose three months of interest payments, but after five years, you are free to cash them in at any point at full value plus growth. You can also choose which I-bonds you cash in, so you have a lot of control. They reach full maturity after 30 years, after which they no longer earn interest. You pay federal ordinary income taxes on the interest upon redemption, but that interest is exempt from state and local income taxes.
"Once you get into retirement, you can choose which I-bonds to take out," said Cederburg. "At that point, it's optimal to take out the ones with the lowest rate. I have some at a zero percent fixed rate. I'd take those out first. If they raise the fixed rate on Nov. 1, that might be a bond that I hold onto longer."
Cederburg locked onto I-bonds because he was studying inflation and found I-bonds to be the best option for fixed-income savings. They beat TIPS for simplicity, ease of use, taxation and sometimes on rates. They also beat annuities on inflation protection. "Some annuities are suited to protect you from longevity risk, but a lot of annuities are not inflation protected. You get a set dollar amount a year, but it doesn't guarantee you buying power with that," he said.
While $10,000 may not sound like an enormous amount of retirement savings, it will add up over time. If Cederburg maintains this strategy for 25 years, he'll have $250,000 in principal, plus growth that equals the inflation rate. He has assured purchasing power. He can then start taking out money. If he ends up with a balance of around $400,000 at age 65, he could create an income stream for 30 years that is around $2,000 a month.
Not bad for 10 minutes of work a year. "From my perspective, that's the nice thing about it. Set it once and forget it, and come back 20 years later," Cederburg said.
Comments