I bonds used to be a very popular investment years ago, when interest rates were higher and inflation was higher. The last several years, I bonds grew out of favor due to lower interest rates and low inflation. Now, with an expectation that interest rates are going to go up and inflation roaring its ugly head with the Consumer Price Index (CPI) going north of 6 percent, the I bond is now looking very attractive. As of Nov. 30, 2021, an I bond is paying 7.12 percent APY. Not bad for a government-protected savings vehicle with no risk of principal.
So, What Is the I Bond?
It is a government-backed savings bond similar to the EE bonds you used to purchase at the bank in paper for birthday gifts or other special occasions. As of 2012, you can no longer buy savings bonds in paper form at banking institutions. So, the EE bonds and I bonds became less and less visible. Unlike an EE that you buy that is going to double in 20 years, which comes out to an effective rate of roughly 3.5 percent per year, the I bond is tied to inflation and is adjusted semiannually. This allows your buying power to not get compromised like a savings account or fixed rate bond, such as the treasury bond if inflation goes up. The bond is not only guaranteed, but also pays a really great interest rate when inflation rises. Since these are issued by the federal government, they are exempt from state and some local taxes. You will have to pay federal income tax on your gains unless you qualify for some exemption like a qualified education deduction.
So, Why Not Go All in on I Bonds?
Not so fast! While I think this is now a viable option for some savings, there happens to be a lot of limitations. Here are some things to be aware of:
- You’re limited to $10,000 per social security number per year. You can purchase for each of your children, and there is an additional add for family trust when applicable, which could add up.
- Your money is tied up for at least one year. You can take it out after five years without any penalty and a partial penalty from one to five years.
- It will be taxed federally. Please make sure you are aware of what your tax implications will be on your interest gained. However, there are some exclusions around education for children, so please speak with your tax professional.
- You cannot buy them in a brokerage or savings account. You will own them direct from the Treasury in paper or through a treasury direct account. So, for asset management, your financial planner will not be able to process this for you, and you will need to keep track of your purchases.
For many, this is an option I would highly consider. You can actually use your tax refund when you do your tax return to purchase them for yourself or as a gift for others. There are also the tax savings if you qualify for a qualified education expense. If you have a family with multiple kids, then you will be able to add $10,000 a year for each member, which can add up to a nice amount earning a high interest rate safely. However, for some more affluent clients or people with higher risk tolerances, the time to open these accounts for the amount you can add might not be worth the time or energy. Since money managers are not able to buy for clients in brokerage accounts or savings accounts, some people might not want to go through the process of setting up one of these accounts. However, I do think this is a way of taking some of your “conservative” savings and getting a higher yield than you might get in fixed income with rates bound to rise eventually.