Is buying I Bonds a good idea? Here’s a balanced view.
Inflation continues to be a primary topic on both local and national financial news. With interest rates and inflation rising, a common question we are receiving is, “Should I be buying I Bonds right now?” We explore that question in this article.
What is an I Bond?
One inflation-linked investment that is available to investors is the Series I savings bonds from the U.S. government sold through TreasuryDirect. I Bonds pay an interest rate that is a combination of a fixed rate and an inflation rate. The inflation factor is set by semi-annual inflation figures based on CPI-U and it resets every six months in May and November.
Currently (as of June 2022), the I Bond fixed interest rate is 0% and the inflation interest rate is 9.62% on an annualized basis. As the rate is semi-annual, an investor will earn 4.81% (half of 9.62%) over the next 6 months in interest at which point a new inflation factor will be calculated and applied to the I Bond investment.
Here is a chart showing historical I Bond returns dating back to 1998 and the return that has been received based upon when the I Bond was purchased.
Important things to know before buying I Bonds
Below are some of the important I Bond features to know before purchasing:
The bond’s price will not fluctuate. They are not marketable, meaning that they can only be purchased and redeemed directly with TreasuryDirect, not with other investors. The bond is purchased for a specific face value and then increases in value as interest is accrued.
Interest compounds semi-annually, meaning earnings are added to the bond’s value; the “new value” is equal to the principal paid plus interest earned.
I Bonds can be held for up to 30 years.
Interest earned is federally taxable but is not taxed at the state or local level.
Taxes on this interest can be delayed until the bond is redeemed/matures; the owner can receive potentially up to 30 years of tax deferral.
Interest is tax exempt if used to pay for higher education in the year the bond is redeemed.
An I Bond is not redeemable for 1 year after purchase. If an I Bond is redeemed prior to being 5 years old, 3 months of interest will be forfeited.
There’s an annual purchase limit.
Each calendar year, an individual or trust can purchase up to $10,000 of I Bonds. This also includes a revocable living trust.
An additional $5,000 (total) can be purchased or gifted using Form 8888 to receive paper I Bonds in lieu of a portion of a tax refund. This limit is in addition to the $10,000 noted above.
Minors can also purchase I Bonds via an adult’s custodial account. Minors cannot open their own accounts via TreasuryDirect.
Combining these limits, a family of four (two parents, two children) with a living trust could conceivably purchase $50,000 of I Bonds each year (2 parents, 2 children & 1 trust x $10,000 each). In addition, this family could purchase an additional $5,000 via a tax return refund (or more depending upon the number of tax returns filed) for a total of $55,000+ annually.
What are the risks of investing in I Bonds?
As with any bond, there is a risk of not being repaid. While the U.S. has not intentionally defaulted on a loan obligation in its history, it is a risk worth noting that it could do so in the future.
Before you go about buying I Bonds, consider that there is a lockup on the money for a year. This should not be your cash emergency fund. It should be money that you do not intend to touch for a year, and possibly up to five years (to avoid having to forfeit three months of interest).
An I Bond cannot lose its redemption value, but it certainly can lose purchasing power because everyone’s personal experienced inflation rate is different. CPI-U is one measure of inflation, but it does not match the exact basket of goods and services that each person purchases or uses each year. It is also likely that an individual’s experienced inflation rate will change year-to-year as their needs change over time.
The redemption value of an I Bond could be lower than initially projected at the time of purchase. If inflation drops after you purchase an I Bond, the interest received for at least one of the 6-month inflation windows will be reduced and the total value of the bond plus accrued interest could be lower than anticipated. However, even though the value is reduced, the bond’s purchasing power should remain constant because the interest received is lowered in conjunction with the inflation experienced. As we stated above, a CPI-U that is below an individual’s personal inflation experience will result in diminished real returns. Investors in I Bonds may need to reassess the validity of the investment in such scenarios.
How does a person go about buying I Bonds?
If you are interested in buying I Bonds, you can create an account on the TreasuryDirect website. Once you have registered and connected your bank account, you will be able to purchase I Bonds and other types of government bonds through this portal.
Concluding thoughts on buying I Bonds
I Bonds, like any investment, require extensive diligence before investing. Any investment decision should take your risk and return preferences, as well as your goals, into account. The information contained in this article is general in nature and may not be construed as advice specific to any one person.
If you are considering buying I Bonds and have questions, please reach out to us to talk.
CONTRIBUTOR
Andrew Hoffarth, CFP® is a Lead Advisor with Financial Alternatives. When he’s not enjoying outdoor activities with his family, he excels at finding solutions for complex financial situations, allowing successful families to focus on what is most important to them. Schedule a time to chat with Andrew.
Sources
TreasuryDirect. Series I Savings Bonds. https://www.treasurydirect.gov/indiv/research/indepth/ibonds/res_ibonds.htm