There’s been a lot of buzz lately about I-Bonds after the Treasury announced in November that I-Bonds issued through April 2022 will earn an interest rate of 7.12%. So how do you get in on this historically high rate, and is it the right type of investment for you? As with most investment questions – it depends. Read on to get answers to some of the questions you may have before jumping on the I-Bond train.
Why is the rate so high for I-Bonds?
Series I savings bonds (I-Bonds) are intended to protect the bondholder against inflation. I-Bond interest rates are a “composite rate” made up of two different interest rates: the fixed and the inflation rates. The fixed rate of your bond never changes (although the fixed rate for new bonds changes each year), whereas the inflation rate is determined and changed by the Treasury every six months. Since inflation has been so high in the last year, the Treasury has increased this portion of the rate to keep up. If inflation continues to rise, so may the interest rate.
How much can I purchase in I-Bonds?
Over the course of one calendar year, you can purchase up to $10,000 in electronic I-Bonds through the Treasury’s website, and up to $5,000 in paper I-Bonds through your federal income tax refund (talk to your tax preparer about this option), making the maximum $15,000 a year. This limit is also applicable for Bonds you receive as gifts, unless the Bond was inherited due to the death of the original owner.
If you want to buy I-Bonds as gifts, those gift amounts do not count toward your own personal annual amount, but they do apply to the personal annual maximum of the receiver. In other words, if someone has already purchased $15,000 of their own I-Bonds in a calendar year, they cannot accept additional I-Bond gifts from anyone else within that calendar year.
How long do I have to wait before cashing in an I-Bond?
You may cash in your I-Bond after 12 months, however, if you cash in the bond before it is five years old, you lose the last three months of interest. After five years you can cash in your bond with no interest penalty. The bond can earn interest for up to 30 years if you don’t cash them in early. There are some special provisions to these rules, such as being affected by a disaster, but for the most part you should plan to hold on to your I-Bond for at least five years to receive the full interest earned.
Is the earned interest taxable?
Yes and no. The interest earned on an I-Bond is subject to federal income taxes, but it is not taxed by state and local governments. While interest compounds semiannually, interest is paid when the bond is redeemed. Interest income is taxable annually or may be deferred until redemption at the option of the bondholder. This is an important thing to consider when deciding when to cash in an I-Bond, particularly if you are about to make a retirement plan and your tax bracket may be about to drop.
Why would I purchase I-bonds rather than equity stocks or bonds?
Treasury bonds and savings bonds are backed by the US Government and will never be defaulted on. They are a great way to diversify your portfolio with extremely low risk. While these bonds are considered to be free of default risk, they still have interest rate risk, reinvestment risk, and purchasing power risk. However, because the I-bonds adjust to changes in inflation rate, they are less exposed to purchasing power risk than a bond that does not adjust to inflation. Because of the lower risk, I-Bonds will typically earn a lower return than higher risk investments like equity stocks or high yield corporate bonds. If you are nearing the end of your working years and will be retiring soon, government backed bonds may be a good way to stabilize your portfolio.
How do I buy an I-Bond?
Savings bonds must be purchased through the Treasury’s website or with your federal tax return funds (for paper bonds). Electronic bonds can be purchased in any amount over $25. Paper bonds only come in five denominations: $50, $100, $200, $500 and $1,000. Your financial advisor cannot process this transaction for you, and they will also not be able to manage those funds for you. All bond purchasing and selling must go through the Treasury, using their online TreasuryDirect ® system.
What is the deadline to buy?
You can purchase an I-Bond at any time, but in order to receive the current rate of 7.12%, you must purchase your bonds before the end of April 2022. In May of 2022, the Treasury will announce the new inflation portion of the rate for the next six months. At that time, your I-Bond will begin to earn that amount of interest. Remember, each composite rate is only good for six months at a time. So, in this case, the earlier you purchase a bond, the more you can make of this particularly high rate.
How can we help?
While we cannot manage or purchase savings bonds on your behalf, we will be happy to talk to you about how you might want to incorporate them into your overall investment portfolio. Bonds can be a great tool for your retirement savings in many cases, but it’s important to keep all the rules and regulations in mind to determine the amount of impact it can have on your financial position and tax strategy. Contact Tull Financial Group on 757.436.1122 today with any questions you may have about incorporating this or other investment tools into your financial plan.
Disclosures and Definitions
The information contained in this document is based on sources believed to be reliable. However, accuracy and completeness cannot be guaranteed.
Past performance does not guarantee future results. As with any investment strategy, there is potential for profit as well as the possibility of loss. Tull Financial Group does not guarantee any minimum level of investment performance or the success of any portfolio or investment strategy. All investments involve risk and investment recommendations will not always be profitable. This document does not constitute a complete description of our investment services and is for informational purposes only. It is in no way a solicitation or an offer to sell securities or investment advisory services. All investments involve risk, including foreign currency exchange rates, political risks, market risks, different methods of accounting and financial reporting, and foreign taxes. Your use of these materials, including the tullfinancial.com website, is your acknowledgment that you have read and understood the full disclaimer below.
The discussion is general in nature, and therefore not intended to recommend or endorse any asset class, security, or technical aspect of any security for the purpose of allowing a reader to use the approach on their own.
Risk of Loss
All investments have certain risks that are borne by the investor. TFG’s investment approach keeps the risk of loss in mind. However, as with all investments, clients face investment risks with particular instruments discussed in this article which including the following:
- Default Risk. This risk pertains to the ability of a company to service its debt. Ratings provided by several rating services help to identify those companies with more risk. Obligations of the U.S. government are said to be free of default risk.
- Interest Rate Risk is the exposure of a bank’s current or future earnings and capital to adverse changes in market rates. This risk is a normal part of banking and can be an important source of profitability and shareholder value; however, excessive interest rate risk can threaten banks’ earnings, capital, liquidity, and solvency. Therefore, it is important to effectively identify, measure, monitor, and control interest rate risk exposure through effective policies and risk management processes. Interest rate risk is also the probability of a decline in the value of an asset resulting from unexpected fluctuations in interest rates. Interest rate risk is mostly associated with fixed-income assets (e.g., bonds) rather than with equity investments. The interest rate is one of the primary drivers of a bond’s price.
- Purchasing Power Risk. Purchasing power risk is the risk that a client’s investment’s value will decline as the price of goods rises (inflation). The investment’s value itself does not decline, but its relative value does, which is the same thing. Inflation can happen for a variety of complex reasons, including a growing economy and a rising money supply.