Much of the bond world is a sleepy backwater…no offense to our bond team. But in the face of rising rates and inflationary pressures, inflation-protected US savings bonds, often referred to as I-bonds, have become more mainstream. In today’s Street$marts, we will dive into the world of I-bonds and hopefully inform you to make the choice as to whether they should be an addition to your financial toolkit.
I-Bonds are a bit of unique animal. I-bonds are issued by the U.S. Treasury to protect your money from losing value due to inflation. The Interest rates on I-bonds are adjusted twice per year to keep pace with rising prices. In addition, series I bonds are exempt from state and local income taxes which makes them an even better low-risk investment for investors who live in high-tax states and cities.
An I bond’s rate combines two different rates: a fixed rate and an inflation rate. The fixed interest rate remains the same throughout the bond’s life, and its inflation rate is announced by the Bureau of the Fiscal Service and can change twice a year in May and November and is tied to the rise or fall of the Consumer Price Index for All Urban Consumers, or CPI-U.
The combination of an I-bond’s fixed rate and inflation rate creates its composite rate. This is the interest rate an I bond will actually earn. Currently, I-bonds are offering a composite rate of 9.62%.
To summarize in plain English, the I bond’s yield is a reflection of inflation. If inflation continues to remain strong, the bond will be provide a higher yield. If inflation falls, the bond’s rate will also fall.
While they offer a great rate in today’s environment (about 9.6%), you can only buy them on TreasuryDirect.com and must have a Treasury Direct Account. While the site looks very old, it’s fairly straight forward to use. We cannot do this for you nor can any custodian like Charles Schwab or Fidelity. Each year, you are limited to $10,000 in I-bond purchases per individual plus an additional $5,000 per year in paper I-bonds with your federal tax refund using IRS Form 8888. If you make estimated quarterly federal income-tax payments, consider intentionally overpaying them, then taking up to $5,000 of the resulting refund as paper I bonds. (The amount needs to be a multiple of $50.) You can then convert them to electronic form.
A couple key points to think about. I-bonds do not trade in the secondary market, so if you need to convert them back to cash, you redeem them through your Treasury Direct Account. I-bonds have a maturity of 30 years. They carry a 20-year original maturity period immediately followed by a 10-year extended maturity period.
It’s important to note that I-bonds cannot be cashed for one year after purchase. If a bond is cashed in year two through five after purchase, the prior three months of interest are forfeited. There is no interest penalty for cashing in the bonds after five years.
If you do have excess cash that you are confident you will not need within 1 year, it may make sense to lock in the nice current yield.
Like I said at the beginning, we cannot purchase these for you (neither can Fidelity), but the pushback generally from other clients is that they are annoyed about having to use the TreasuryDirect site or the fact that the cash outlay is basically illiquid for 1-year. Other than that (which to me seems like a petty reason to not generate some solid interest), they are a good tool to have in your tool box, especially in this inflationary environment.
Thanks for joining us on this episode of Street$marts!