Updated on 01.16.07

The Treasury Note Retirement Plan

Trent Hamm

A few weeks ago, I wrote an overview of what treasury notes, bonds, and bills are and how they work. In the discussion, I dropped this little tidbit which turned out to be alluring to a few of my readers:

I know of at least one person with several million dollars sitting in treasury notes; he lives rather well off of the coupon payments and still has enough left over to occasionally buy more bonds, which enables him to keep up with inflation. He plays a lot of golf, incidentally.

Let me give you an example of how this works. Let’s call my friend Bill. Bill has taken all of his money and invested it in six $500,000 treasury notes. He bought them all at face value one month apart, and they each have a coupon rate of 4.625%. Every month, then, Bill receives a coupon payment from the federal government on one of these notes in the amount of $4,625. This is more than adequate to cover Bill’s living expenses, so he keeps rolling the excess into more treasury notes every few months as a hedge against inflation, and when a note finishes, he uses that amount to buy another note immediately.

Obviously, Bill set this up for himself over a long period of time and he did it in the days before great retirement accounts for individuals. He kept his money in a bank at first, but he realized that once his balance was sufficiently large, there were better opportunities to earn money without risk than a 0.5% savings account, so he purchased a treasury note, kept rolling the income over into more treasury notes, and added contributions over time. When the coupon payments added up to enough for him to retire, he did so.

4.625% is a pretty poor return… The return that Bill gets is based on what the government offers as a coupon rate over time and is also affected by market fluctuations. I won’t go into a lot of detail here except to say that when interest rates are low, Bill’s returns are low, and when interest rates are high, Bill’s returns are high. Thus, when rates are low, he only buys shorter term treasury notes (2 years), and when rates are pretty high, he buys longer term ones (10 years).

However, Bill knows that his investment will always make money, no matter what. His investments are backed by the federal government, and while the value of his notes might fluctuate, they’ll always bring in enough for him to live on. He buys longer term notes when the rates allow him to live large and buys shorter term notes when the rates aren’t so good, and over time, he’s beating inflation.

What about income tax? Treasury notes are completely exempt from state and local income taxes, so Bill files a “zero” return every year locally. For the federal tax, he just pays normal income tax on any income generated, as it’s not considered capital gains. Thus, his taxes each year are done in about fifteen minutes: how much did he bring in from his bonds, minus any deductibles he might have, then look up the number, write a check, and send it in.

What about his estate? His will is really simple, too: the face value of all of the notes is added to the estate with very little muss or fuss.

Basically, Bill’s finances are extremely simple and his income is very stable and will last in perpetuity. The expense up front is pretty high, but for a plan that lets you live as long as your body survives, it’s a good one.

Loading Disqus Comments ...
Loading Facebook Comments ...
  1. Gordon says:

    very good… im 22 and just signed up for 403b plan.. its time to learn how to invest… good site.. thx

  2. Would it really last forever though? It seems like 4.625% doesn’t beat inflation by much. I think it typically beats it by 1%, sometimes by even less. So if he’s living off his interest completely there will be a time when his principle doesn’t buy much and when that $4,625 of interest doesn’t get him through the month, he’ll start having problems. This may take quite some time, but overall, I don’t think it’s the best plan.

  3. Details Details says:

    What about accurate math? If Bill really bought $500,000 face value T-Notes they would pay 4.625% a year, split into two equal semiannual payments:

    $500,000 * 0.04625 = $23,125.00 (per year)
    $23,125.00 / 2 = $11,562.50 (every 6 months)

    In order to match the coupon payments cited of $4,625.00, Bill would have had to have purchased $200,000 T-Notes.

    $200,000 * 0.04625 / 2 = $4,625.00 (every 6 months)

    This is a huge difference in the amount of principal tied up, since as written Bill has six times $500,000 or a cool $3 million. In reality, though, I assume he only has $1.2 million in T-Notes.

    As far as inflation, Bill needs to add to his principal every year. Bill took home ($4,625.00/month)*(12 months) = $55,500.00 for the year (gross). Assuming the numbers given are for 2006, according to the Bureau of Labor Statistics inflation calculator Bill needs an annual income of $57,358.81 in 2007 just to match inflation.

    If he can maintain the 4.625% coupon interest then Bill needs to increase his T-Notes from $200,000 each to about $206,700, or his total invested principal from $1.2 million to $1.24 million.

    That’s a difference of $40,000. But Bill’s income was only $55,500! It is impossible for him to “beat inflation” or even “keep up with” it given these numbers unless he’s only living on $15,500 a year. And that doesn’t buy a lot of golf after living expenses.

    Of course if Bill really does have $3 million invested that gives him an annual income of $138,750, and if he is only living off of $55,500 of that then he has $83,250 left over to add to his principal. That means next year he’ll have an annual income of $142,600, of which he’ll still need $57,359 to live off of, leaving $85,241 to invest. This is just shy of the $86,038 ($83,250 adjusted for inflation) necessary to “last in perpetuity”. (Or at least another year, as I didn’t extend the analysis any further.)

    In reality, though, Bill doesn’t need an income stream from interest only that is immune to inflationary erosion. At some point he won’t be able to play golf anymore and eventually he will expire. (Hopefully not anytime soon!) Leaving “several million dollars” to his heirs is a wonderful gesture, but there’s no reason he can’t tap into his principal. The catch of course is to be able to have the principal’s lifetime not fall short of our own lifespan and leave us penniless.

    The overall premise is still interesting, though, especially as it avoids state and municipal (but not federal) income taxes. It would be interesting to compare this T-Note strategy to, for example, Fidelity Freedom Income Fund, a mutual fund designed for people who have retired before 1998. The asset allocation for this fund is 40% short term (money market and short-term bond), 20% domestic equities (stocks), and the balance in fixed income (bonds). It includes U.S. Treasury bonds such as T-Notes, to be sure, but only as a piece of a larger puzzle.

  4. bob says:

    This is not really the best Advice I could think of. If Bill was really worth that amount of money he could invest a small portion of it in much more lucrative ventures to secure himself a much better retirement. Why not trasnfer some of the money into an annuity or some form of life insurance to shield the money from probate when he dies.

  5. That’s a terrible investment plan. Even if you can’t stomatch any volatility in the markets you need to have a diversified portfolio including stocks so that you don’t outlive your money. A 50-75% stock allocation would work ok for Bill.
    Just because the inflaiton has been 3% on average, does not mean that it can’t spike up above 10%-15% in a single year.If double digit inflation picks up, Bill would have to stop playing golf and start looking for a job.

  6. Vicki in ABQ says:

    I’m really liking this idea…keeping money that you can’t afford to lose safe, no matter what. It’s not that I’m against stocks, but I think we’ve all learned that you need to play with stocks only with money you CAN afford to lose (that way you’re not forced to sell when stock prices are low to make ends meet). Not that any investment is free of risks, but if these Treasury notes become useless, so does our currency, so they’re pretty close to risk-free. I do have some questions:
    1. Can you do this inside a Roth IRA?
    2. Is there a way to automate this so that you don’t miss buying another note?
    3. What are the smallest denominations of treasury notes you can buy? (Can you start buying small or do you have to save up tens of thousands first?)

  7. robin says:

    The last comment appeared in Jan 2010. It’s now October 13th of 2010. Now that several people have had the time to chew over this scenario, I’d like to see the blog author revisit this. I’m curious to see whether he’d revise the math at all. Perhaps he’d make some suggestions for people who may (somehow) have the money to make some of these choices. Perhaps also he’d stack up this plan against, say, the annuity mentioned in one of the comments.

Leave a Reply

Your email address will not be published. Required fields are marked *