According to the U.S. Treasury, an I bond is “a savings bond that earns interest based on combining a fixed rate and an inflation rate.” The Treasury first issued the bonds in 1998, so this is not a new product, but suddenly financial headlines, a chat with a neighbor or any other conversation around personal finance seems to include a mention of this very basic investment tool. Why all the buzz?
How about a 9.62% interest rate?
In a year where the market has been disappointing to say the least, rising costs, rising interest rates and banks seeming slow to raise savings rates despite being quick to raise lending rates, the search for any kind of positive yield is a frustrating one. I bonds have been a tiny oasis in the desert that has been 2022 to date.
Before jumping to liquidate your savings accounts to purchase these bonds, it is important to learn more about the limitations of this investment and consider both the pros and cons.
Investment Limits
Each person can invest up to $10,000 each year in I bonds. You can invest an additional $5,000 if you buy using your federal income tax refund by filing IRS Form 8888 with your return. These tax refund bonds will be received in paper form but can later be converted to an electronic bond, if desired.
This limit is per person, meaning married couples can each invest $10,000. Children can open accounts with the Treasury as well, but those investments would be considered as a gift from the parent and must be used for the benefit of the child.
Businesses and trusts can invest in I bonds up to the $10,000 limit, so there are some strategies out there for those who are self-employed, own businesses or have living trusts to expand their exposure, but it’s important to make sure you don’t run afoul of the rules.
As an example, a married couple each with their own living trusts, two children and a business could theoretically open an account for each entity and invest up to $70,000 in any given year without consideration of their tax refund status.
It’s also worth noting that I bonds cannot be held in retirement accounts such as 401(k), 403(b), IRAs or Roth IRAs, so the money to fund these investments would need to come from non-retirement savings.
Time Restrictions
Buying an I bond does mean tying up your money for a while. You must hold the bond for a minimum of one year and redeeming the bond any time before year five means forfeiting the prior three months interest. The bonds mature after 30 years.
Rate Changes
The rate paid by the bond is made up of two components, a fixed rate currently set at 0% and a semi-annual inflation rate currently set at 4.81% (or 9.62% per year). The bond changes rates every six months based on the month a bond is issued. In other words, if you purchased an I bond on August 1, the 9.62% rate would hold until the rate would change again on February 1.
As you can see in this chart going back to 1998, the rates have not always been nearly this high. In fact, the bonds have had extended periods where they’ve paid less than 1% interest or no interest at all.
While unlikely, there could be an instance where inflation cools off quickly and the second half of the year you’re required to hold the bond could negatively impact your total return. That said, the rate cannot drop below 0%.
Tax Benefits
I bonds do have some attractive tax benefits. The interest earned on the bonds can be deferred until maturity or redemption, meaning you don’t have to pay tax on the interest while you continue to hold the bond if you choose.
Low- and middle-income families are also exempt from tax on these bonds, if they’re used to pay for college tuition.
Treasury Direct
One drawback is that I bonds can only be purchased from the Treasury at their website, TreasuryDirect.gov. To say that the 20+ year old website is clunky would be kind. Online reviews of the site range from this New York Times critique from earlier this year to rants from users I am precluded from linking here as this blog is a family-friendly space.
It’s important to make sure that trustees, executors and advisors are aware of any Treasury holdings as there are few ways to access that information outside of contacting the Treasury directly. These holdings are often missed in estate proceedings.
So, is an I bond right for you? It depends on your circumstances, your tolerance for the hoops involved in establishing and the materiality of the interest from such an investment. If you have questions, feel free to reach out to your advisor to discuss whether it makes sense for you.