The biggest downside to savings bonds has been that the interest rate has always been very low.  Often it’s not even kept us with inflation.  That’s why the Government introduced the Series I (for inflation) savings bond.

The interest on a Series I bond is divided into 2 parts.  There is a fixed rate that remains the same for the life of the bond.  In addition, there is an inflation-adjusted adder rate that changes every 6 months, based on the Consumer Price Index.

The US Treasury changes the fixed rate periodically, but once you’ve bought your Series I bond, it’s locked in.  Over the last 5 years, the fixed rate component has ranged from a high of 3.6% in 2000 to a low of 1% in 2004.

Series I bonds are worth taking a look at as part of your overall retirement savings plan, but you should also consider other alternatives.  The average rate for an insured 6-month CD is 4.69% when this is written.  You can check the current rate at Bankrate.com.  Since this is the average, some banks are obviously offering more and some less.  Our local bank is currently paying 4.4%.  Online, E-Loan’s bank is currently offering 5.5%. You can check out what they are currently offering here.  E-Loan

Series I bonds have some advantages.  They are exempt from state and local taxes, and you don’t have to pay federal taxes on the earnings until you cash in the bond.  On the other hand, unlike a 6-month CD, you must keep a Series I bond at least a year before you can cash it in.  Also if you cash in a Series I bond before you’ve had it at least 5 years, you won’t get the last 3 months interest.

You may be able to do better on interest at your local bank or online, but those rates aren’t guaranteed to adjust with inflation.  Check it out and compare.  In addition to federal tax deferred interest, there may be other things to consider.  Where you live and whether you must pay state and local income taxes can make a big difference.  So check with you tax advisor to see if adding Series I bonds to your retirement investments makes sense for you.

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Step 5 - Adjust for Social Security. You’ll notice I left a discussion of Social Security to last. Much has been written recently and much has been said recently, especially by politicians, about the future of Social Security. If you’re within a few years of retirement age, Social Security may be as close as it gets to guaranteed for you. If you’re in your 20’s or early 30’s, it’s anyone’s guess. That makes it a purely personal decision whether to take Social Security into consideration when making your retirement investment plans. Regardless, the math is simple. If you haven’t received a statement from Social Security recently showing your projected payments at retirement, you can call 800-722-1213, you can visit your local Social Security Office to submit a request, or you can go to www.ssa.gov/mystatement.

Let’s say that your payments are estimated to be $1,100 per month. Because of tax savings, that might be worth $1,300 per month of ordinary income. So if your calculations show you need $5,000 a month in income, you could reduce that to $3,700 per month or $44,400 per year. From Step 4, if your pension plan is going to cover $30,960, that means you have to save to make up the $13,440 difference. Once again that’s $13,440/8 x 100 = $168,000 as your savings goal. From the FinAid.org calculator, that would require saving $175 per month. Now this is beginning to sound very doable.

Finally, what about inflation? It does reduce the buying power of your dollars in the future. We already adjusted for inflation in using only an 8% real return after inflation rather than the 13% you often hear quoted for the gain in stocks over the last 50 years, which does include inflation. Still if your pension plan payments are fixed once you retire, the value of your payments will be less each year. So to be conservative for inflation, you can reduce the value of your pension plan payments by 30% when you do your calculations.

There are 2 other simple ways to do address inflation. First, the calculations in the steps above are based on building up money in a 401(k) plan or other tax deferred investment program. The calculations shown in the example are also based on drawing out interest and leaving the principal alone. 401(k) plan rules require that you begin drawing out money by the time you’re 72, if you haven’t begun already. Withdrawing some principal will help cover some of the cost of inflation.

Second, you can always adjust for inflation by using a lower rate of return than the 8% we used in our example for your own retirement savings plan calculations. It’s not an exact science. No one can predict the rate of inflation for the next 10 or 20 years with any degree of certainty. We can only predict trends for the future based on the past. So use prudent judgment and adjust the assumptions for how conservative you want to be.

Finally, what do you do if your calculations show you need to save say $500 a month, and you can only save $200 a month? What you do next is critical! Don’t put off getting started until you can afford to save the entire $500 a month! If you put off saving until you can afford it some time in the future, that time may never come, but retirement will eventually come. So - whatever amount you can put aside, get started today!

I hope this brief series has been helpful. Any comments or thoughts you have are certainly welcome and will be appreciated.

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