Q. What is you opinion about investing for income in 20-year bonds with a 3.5 percent coupon, priced at par? Because I view individual long-term bonds as really a purchase for one's estate, they would be held to maturity with the income designated for living expenses. –R.S., by email
A. The arithmetic of bonds doesn’t work too well if providing an estate is an important goal. Let me explain. The purchase of the bonds will provide you with a constant income that will lose purchasing power every year. If you invest $100,000 in bonds at par your $3,500 of interest income will lose one-third of its purchasing power in 20 years, if inflation averages 2 percent. Worse, the same will be happening with the bonds that go into your estate. That $100,000 of bonds you purchased will lose one-third of their purchasing power, with a real value of $67,000 if inflation is an annualized 2 percent, less if inflation is higher.
Now consider equities. You could build a portfolio with the same yield (possible, but not easy) and enjoy a dividend that was taxed at a lower rate for 20 years. In addition, each company would be reinvesting a good portion of its earnings in the business, so it could expand earnings. As a result the dividends would grow over 20 years, likely offsetting inflation. The stock prices would likely grow as well. But upon your death the stocks would be revalued to their level at your death, so all capital gains tax liability would disappear.
Here are two examples. Intel (ticker INTC) pays a dividend of 96 cents for a yield of 2.8 percent. But that 96 cents is only a portion of its $2.33 in earnings. The company is reinvesting the remaining $1.37 for future growth.
Exxon (ticker XOM) currently earns $4.73 per share a year and pays out $2.92 in dividends. At a recent price of $77.46 a share that means a yield of 3.75 percent and reinvestment of $1.81 a share for future growth.
Investing in bonds pretty much guarantees a loss of purchasing power over the next 20 years and into your estate. Investing in stock is uncertain, but at least it isn’t a lead pipe cinch that purchasing power will be destroyed.
Q. I'm 65-years-old, male and single. I plan to wait until 70 before taking Social Security. I also have a pension that I'm eligible for at age 65. It will pay $1,492 a month. I can delay taking it, but unlike delaying SS the monthly payment will not go up. It will always be $1,492 a month, even if I delay. What the company does instead is pay out a lump sum when I would start payments that is the sum of the missed payments from 65 until the start date, with some added interest. They are not able to tell me the interest rate.
The company has a calculator and if I delay one year to 66, I would get $18,486 in a lump sum and $1,492 a month thereafter. If I delay 5 years to 70, I would get $104,293 in a lump sum and $1,492 a month thereafter.
Does it make as much sense to delay the pension as it does SS? I'm in good health and am currently living on taxable traditional IRA withdrawals, staying in the 15 percent bracket. That will help reduce required minimum distributions later. I supplement from savings if I need more. I also have a Roth. I could keep doing this for 5 years. Is it worth it? What is the interest rate they are paying? –F.B., by email
A. If the accumulation period is exactly 60 months, the implied interest rate on the deferral is an annualized 6.075 percent. That’s good, but not as attractive as deferring Social Security. So if you take the pension to make deferring Social Security easier, it will be a good choice.
A big issue here is income taxes. If you take the pension payments now, you’ll avoid taking the accumulated payments later when the amount could put you into a higher tax rate. Remember, the step from 15 percent to 25 percent is a big one. Along the way, you can take as much as you can from retirement accounts and remain within the 15 percent tax rate.
As a single you can expect a significantly higher tax bill when you finally take required minimum distributions and Social Security. But until then you’ll have managed your tax bill pretty well.