I Bonds
With inflation jumping so quickly recently, Series I Savings Bonds (I Bonds) have become a topic of conversation with many clients.
What are I Bonds? I Bonds are a type of savings bonds, backed by the U.S. Government. Their interest rate is affected by inflation. The “I” in I Bonds stands for inflation. You can purchase them electronically or in paper form (paper form I Bonds can only be purchased with your tax refund).
Currently, I Bonds are paying interest of 9.62% through October 31st. This number is calculated using both a fixed interest rate (currently 0%) and a variable rate based on current inflation. Because of the variability of inflation, the interest rate of I Bonds changes every 6 months (November and May). We should note that, because the fixed rate is currently zero, the high interest rate of I Bonds is directly due to current high inflation. When inflation numbers fall again, the I Bond interest rate will likely fall too. The interest rate of I Bonds is guaranteed to never fall below zero.
Each month, your I Bond earns interest. Every 6 months, those 6 monthly interest payments are added (or compounded) to the current principal value to create a new, higher principal value. Thus, your bond value grows over time as the interest payments are added onto your beginning amount.
It’s hard to pass up a 9.62% interest rate. But are I Bonds right for you? Like all investment decisions, depends on your goals.
The duration of an I Bond is 30-years. However, don’t let that number scare you. You do not need to hold the bond for 30 years. Once you have purchased the bond, you can not cash it in for at least 12 months. If you cash it after 12 months, but prior to 5 years, there will be a penalty of 3-month’s interest. Thus, it makes sense not to purchase I Bonds unless you are willing to part with that money for a minimum of 12 months, but ideally for 5 years. I have had clients ask if they should use I Bonds to house their cash reserve. While they may make sense for a portion of your bond holdings, a cash reserve should be easily accessible in case of emergency, which makes I Bonds a less-than-ideal candidate for that purpose, at least for the first 12 months.
The amount of I Bonds you can purchase is also limited. You are allowed to purchase up to $10,000 in electronic I Bonds, per Social Security number, per calendar year. These can be purchased in any amount, starting at $25 up to $10,000. You can also purchase up to $5,000 in paper I Bonds, per Social Security number, per calendar year. Paper bonds (as stated above) can only be purchased using your tax refund. Paper bonds are only offered in 6 denominations, $50, $100, $200, $500, $1,000 and $5,000.
Interest on I Bonds is free of state and local tax but is subject to federal tax. While it is an option to claim the interest annually, typically the interest is deferred until redemption (when you cash in your bond). You may not have to pay any tax on the interest if you use the money for qualified higher education expenses.
Electronic I Bonds are only purchased online by creating an account at www.treasurydirect.gov. Paper I Bonds can be purchased using Tax Form 8888 - Allocation of Refund, when you file your tax return.
I Bonds are another potential tool in your investment toolbox. With today’s current climate of high inflation, they may make sense as a piece of your overall financial picture. As always, your planner is available to help assess if I Bonds are right for you.
Michelle Carter, CFP®
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