Is rising inflation souring your mood? Protecting the bulk of your wealth is mostly about building and maintaining a well-structured investment portfolio with a few anti-inflation elements. Outside of your core portfolio, there is also a potentially sweet deal for turning some of today's inflations lemons into lemonade. So let's talk about U.S. Series I Saving Bonds (“I Bonds”).
First, I Bonds are not a cure-all for inflation. And there are things you should know before you decide whether to proceed. But as one of few holdings whose payouts are indexed to inflation, they may offer a haven for a portion of your emergency or similar cash reserves.
What Are I Bonds?
I Bonds are inflation-indexed savings bonds issued by the U.S. Treasury. The interest you earn on your I Bond is the sum of two rates:
Fixed Rate + Inflation Rate = I Bond Composite Rate
The fixed rate is based roughly on current economic conditions. The inflation rate is based on inflation, as measured by the Consumer Price Index for all Urban Consumers, or the CPI-U. The U.S. Treasury guarantees your I Bond will never be worth less than what you paid for it, so your composite rate will never drop below 0%.
The Treasury adjusts I Bond rates every six months, on the first business day of each May and November. Current rates for I Bonds purchased from May–October 2022 have a 0% fixed annualized rate for the life of the bond. The inflation rate is an annualized 9.62% for at least the first six months. After that, your bond’s inflation rate may rise or fall over time, based on the Treasury’s semi-annual November/May rate changes.
If you purchase an I Bond today, you are essentially guaranteed to earn a 9.62% annualized interest rate for the next six months. If inflation remains high after that, so too will your I Bond’s interest payments.
No wonder I Bonds are receiving increased attention—and investor dollars—even though they’ve been around since 1998. Where else can you earn nearly 10% annually, essentially risk-free, on relatively accessible cash?
The Rules of I Bond Engagement
So far, so good. But before you prepare to pile your life’s savings into I Bonds, let’s review their “operating instructions.”
Maximum Investments: You can only purchase up to $10,000 in I Bonds per person, per year, although you also can direct up to $5,000 of a tax refund into paper I Bonds on top of that. (Paper bonds can be converted to electronic ones with extra effort. You also can gift I Bonds to others, and invest in them through a business entity.)
Liquidity: Once you purchase an I Bond, you must hold it for at least a year (with a few hardship exceptions). You may hold it for up to 30 years before it comes due. If you cash out after 1 year but before 5 years, you are penalized three months of interest.
Tax Ramifications: At the Federal level, I Bond interest is tax-deferred. As described in this TIPSwatch “I Bond Manifesto” article, “You can elect to report [I Bond] interest annually if you prefer, but most investors choose the default tax deferral option and thus only pay tax on the accumulated interest when they eventually redeem the I Bonds.” (Hint: This permits you to deliberately redeem the bonds in tax-favorable years.)
I Bonds are exempt from state and local income taxes, offering extra incentives if you live in a high-tax region. There’s also a Federal tax exclusion if your income level qualifies you, and you spend the proceeds on qualified educational expenses. To be eligible in 2021, your Modified Adjusted Gross Income (MAGI) had to be under $98,200 for single, or $154,800 for married filing jointly filers.
Logistics: I Bonds are only sold directly to you, the public, through an account you establish at TreasuryDirect.gov. This means we, as your advisor, cannot open or manage your I Bond account for you. We can coach you as you access the TreasuryDirect system, and advise you on the financial, investment, and tax-planning logistics. But unfortunately, you must hold your I Bonds outside of your primary portfolio. This is a direct deal between you and the Federal government, there are no ($0) investment fees. If you purchase a $1,000 I Bond and hold it for at least 5 years, you will receive $1,000 back, plus all interest earned.
Timing: Interest is earned on the last day of each month and is posted to your account on the first day of the following month. So, if you own your I Bonds on the last day of any month, you’ll earn that full month’s interest. Reverse that logic by selling I Bonds toward the beginning of the month, and still accruing that month’s interest in your TreasuryDirect account. Your one-year holding period starts at the beginning, not the end of the month in which you purchase the bond.
Are I Bonds Right for You?
I Bonds are an attractive opportunity at this time. But are they the right opportunity for your greater financial needs? Before you buy, here are a few caveats to consider.
Considerations: Having a TreasuryDirect.gov account filled with I Bonds purchased over the years represents one more set of financial details to track. The inconvenience multiplies if you also purchase any paper I Bonds, directly or through tax refunds. There are due dates to remember, rates to monitor, taxable interest to report, and account security to manage. Is the hassle factor worth it to you? Maybe yes; maybe no.
It’s always satisfying to score strong returns on any given holding. But if you do decide to purchase I Bonds, where will the money come from, and how else could you have used it? Let's be sure to incorporate your decision into your structured investment plan and make sure the one-year I Bond holding requirement won’t create a cash-flow problem if unexpected expenses arises.
In summary, even if we’re unable to directly manage your I Bond accounts for you, we can still help you decide how much money can you comfortably allocate to I Bonds, How to best use of their tax-planning possibilities, and answer other questions you might have. Before you buy, let’s talk.
 The actual calculation is a little more complicated, but essentially ends up being the sum of these two rates.