We have been receiving a lot of questions regarding I Bonds lately, so I thought I would pull together what I know about them to share with everyone. I Bonds generally stay below my radar because I cannot buy them for client accounts, as they are not available for investment accounts. So, if you love what you read about them here, you will need to buy them directly from the Treasury. I Bonds are a form of Savings Bond issued by the US Government. Most people are more familiar with the Series EE Bonds that you can buy at your local bank. I will explain the two methods of purchasing I Bonds, one of which I recently learned. The old saying, you learn something every day, is true!
Many of you know that my early career was spent in the world of bonds. I learned how to trade them and then how to invest and manage bond portfolios. In my first job in a brokerage firm, all of the “cool” stockbrokers’ favorite saying was “bonds are for chumps.” Well, they have proven to be a great investment over the past 30 years as we have seen continual declining interest rates over that period. However, now inflation is rearing its ugly and painful head and interest rates are increasing, pushing bond prices down. Does that mean we should abandon them? No, but we do need to be intentional on what we buy.
What is the rate of return for an I Bond?
I Bonds returns are based on two rates: a “Fixed Rate” and an “Inflation Rate.” The two combined rates comprise the annual return of I Bonds. The reason no one has been talking about them until recently is the current Fixed Rate is 0%. I Bonds will literally pay you nothing to lend your money to the Federal Government if there is no inflation. With the spike in inflation, though, the Inflation Rate has been recently posted at a very sexy 9.62%. As with all investments, there are some nuances to understand. The 9.62% is an annual rate that is changed every six months. The next rate change announced in November of 2022 may be lower or higher, impacting whether you actually receive a 9.62% return over the next 12 months. (Update: As of May 2023, I Bonds now offer 4.30% return, including a 0.9% fixed rate.)
Is an I Bond the Same as a CD?
Another nuance is I Bonds do not act like Certificates of Deposits (CDs). CDs pay interest on the face amount purchased every six months. Instead, with I Bonds, the interest rate is credited to the face amount of the bond. Let’s say that you bought $10,000 of I Bonds and you did receive the full 9.62% return for 12 months. At the end of that 12 months, the face value of your bond would be $10,962. There would not be an interest check issued for $962. During the next six-month period interest would be calculated based upon the updated principal value of $10,962, so the value will compound nicely over time if the Inflation Rate stays high or even moderate.
Are there time limits to owning an I Bond?
The length of time that you can own an I Bond and have it accrue interest/value is 30 years, but you can cash the bond in earlier than that if you need access to the funds. You must hold the bond for 12 months and there is a three-month interest penalty if you cash in the bond before you have owned it for five years. So, you should consider the bond a five-year investment.
Will I lose money in an I Bond if inflation rates are negative?
The Inflation Rate can be a negative rate, so in cases where the Fixed Rate is higher than 0% (which it has been in the past, but not in recent years), a negative Inflation Rate due to recessionary pressures, can reduce your return to 0%, but your return will never fall below 0%. The inflation rate used to calculate the Inflation Rate of the Bond is CPI-U, Consumer Price Index-Urban, the inflation rate the average city dweller encounters.
Is there a limit to how many I Bonds I invest in?
There are annual limits per taxpayer on how much they can invest in I Bonds each year. You are allowed to purchase $10,000 per year via TreasuryDirect.gov. These bonds will be held in electronic form so you will need a TreasuryDirect account. You can also buy $5,000 per year with your tax refund, and this is in addition to the $10,000 limit. The I Bonds purchased with a tax refund are issued in paper form and you can purchase them in the taxpayer’s name or purchase them with your tax refund for someone else, such as gifting the amount to your child or grandchild. This is the part I just learned! If you want to buy I Bonds with your tax return, include IRS Form 8888 with your tax return.
What about taxes on I Bonds?
Speaking of taxes, you know there is a cost…. You have a choice between waiting to report the income accrued on the bond until the year you cash in the bond or reporting each year’s income as it accrues. It is far simpler to pay the tax in the year when you cash in the bond and receive a 1099-INT. Interest is subject to regular Federal taxes, but not State taxes. Their value is included in Estate tax calculations.
Should I be buying I Bonds?
If you are a person who holds a high balance in a savings or checking account and it is unlikely you will need to use all of that cash in the next five years, I Bonds may be worth considering. It is not outside of the realm of possibility that we will experience a recession sooner rather than later, as the Federal Reserve tries to get inflation under control by raising interest rates, so please be aware that your true return may be quite a bit lower than the current 9.62%. The good news is the return cannot be less than 0%, which is basically what we are all earning on cash balances at the moment!
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