Are I Bonds Worth the Trouble?
Many have seen the pictures of the enduring traffic jams at shipping ports and noticed the closed signs in the windows of restaurants in the afternoon. Supply constraints and labor shortages coupled with what seems to be insatiable consumer demand appear to have brought back inflation after a long hiatus, at least temporarily. But as inflation rises, so too do the interest rates on newly issued Series I Savings Bonds, creating an opportunity for investors seeking low-risk alternatives for cash.
Series I Savings Bonds, also known as I Bonds, were first introduced in 1998 by the U.S. Treasury to give Americans a way to save for the future while providing a hedge against inflation. The bonds can only be purchased electronically through TreasuryDirect.gov or with a tax refund – the only remaining way to receive a paper certificate.
Unlike a traditional savings bond, the yield on I Bonds is derived from a fixed rate set for the entirety of the bond and a semiannual inflation adjustment that is reset on May 1 and November 1 each year based on the consumer price index (CPI). Newly issued I Bonds released in November now accruing a whopping 7.12% through April 2022, the second-highest initial rate ever offered for I Bonds.
I Bonds are comparable to Treasury Inflation-Protected Securities (TIPS), which are also issued by the US Treasury. Both instruments offer inflation-adjusted investment returns. Unlike TIPS, I Bonds are only sold at face value, which is better than the current price of TIPS.
Just how good of a deal I Bonds are depends on several limitations and special considerations.
Each calendar year, an individual is limited to purchasing up to $10,000. An additional $5,000 can be purchased with a tax refund. Hypothetically, a couple married filing jointly could purchase $25,000 per annum.
I Bonds earn interest for 30 years and must be held for at least one year. Interest from the previous three months is forfeited if the I Bond is redeemed before five years.
The current 7.12% rate consists entirely of the variable inflation component. The fixed rate is a disheartening zero. If the current bout of inflation is short-lived, the income earned could be lower. Until November, the yield on I Bonds was 3.54% - not bad but half the new rate. Fortunately, the coupon cannot fall below zero.
Much like U.S. Treasury bonds, interest is federally taxable but exempt from state taxes. However, taxes are not owed until redemption or maturity. In certain instances, taxes on earnings can even be avoided if used for certain education expenses.
WHAT IT ALL MEANS
I Bonds could be an appropriate alternative to certificates of deposit or money earning the measly interest in a savings account at the bank. In addition to the constraints and limitations of I Bonds, it’s also important to consider your circumstances, objectives, and risk tolerance.
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