Inflation, the Ukraine War, and ongoing recession fears have made it tough for investors this year. With the outlook for the economy keeping stock investors on edge, and rising interest rates driving selloffs in the bond market, it’s hard for investors seeking any kind of decent return to find an option that doesn’t require a huge risk-return tradeoff.
On the plus side, there is one relatively safe investment option that currently offers a return that may serve as a hedge against inflation: Series I Savings Bonds (I-Bonds).
An option for inflationary times
Issued by the U.S. government, I-Bonds are savings bonds you buy directly from the U.S. Treasury. What makes them different than traditional savings bonds is that part of their interest rate adjusts with inflation.
How they work
Each I-Bond has a compound annual interest rate comprised of two components:
- A fixed (coupon) rate that never changes; and
- An additional “inflation rate premium,” calculated semi-annually.
The fixed rate is usually low—for example, it’s currently 0%. It’s the inflation premium that gives I-Bonds their real value.
The inflation premium is calculated based on changes in the non-seasonally adjusted Consumer Price Index for all Urban Consumers (CPI-U). According to the U.S. Bureau of Labor Statistics, CPI-U is a monthly measure of the average change over time in the prices paid by consumers in urban areas for a market basket of consumer goods and services, including food and energy.
The inflation premium is calculated twice a year and goes into effect on the first business day of May and November. When inflation rises, the premium goes up. Likewise, when inflation falls, the premium falls.
How long you’ll earn that particular interest rate depends on when you buy the bond. For example, if you bought an I-Bond in September 2022, you’d earn the May 2022 interest rate (9.62%) through the end of February 2023. On March 1, 2023, your bond’s interest rate will change to the new rate established on November 1, 2022. Then, on September 1, 2023, the rate will change to the new rate in effect starting on May 1, 2023.
I-Bonds earn this interest monthly. The accrued interest is paid to your account every six months. However, unlike other bonds, the interest isn’t paid out to you until you actually redeem the bond.
Unlike other bonds, you can’t purchase I-Bonds through a brokerage account or IRA. You must purchase them directly from the U.S. Treasury.
You pay face value for the bond. If you buy online through the U.S. Treasury’s TreasuryDirect website, you can specify any denomination over $25. For example, you can decide to buy several different bonds with face values of $50, $500.75, $5,005.25 or any other amount. However, your total combined purchases cannot exceed $10,000 per year. If you’re married, both you and your spouse can each purchase up to $10,000 in I-Bonds every year.
If you’re getting a federal tax refund, you can use it to purchase up to an additional $5,000 in paper I-Bonds every year. Paper bonds are available in $50, $100, $200, $500 and $1,000 denominations.
You must hold an I-Bond at least one year before redeeming it.
When you redeem an I-Bond, you’ll receive the amount you paid for it (the principal) along with any accrued interest you’ve earned.
If you redeem your bond before you’ve held it for at least five years, you’ll lose the last three months of interest. On the other hand, you can hold your I-Bond for up to 30 years before redeeming it.
Unique tax advantages
Interest earned by I-Bonds is subject to federal income taxes, as well as any applicable federal gift and excise taxes and any state estate or inheritance taxes. However, interest is not subject to state and local income taxes. Interest may also be exempt from federal income taxes if used to pay for qualified higher education expenses.
And, unlike other kinds of taxable bonds, there’s greater flexibility over when you’ll have to pay those taxes. That’s because you’ll only pay taxes on your accrued earnings when you redeem the bond.
This may make I-Bonds particularly useful for long-term tax planning. For example, if you’re in your 50s and you anticipate that your income during retirement will be a lot lower than it is now, redeeming some of your I-Bonds after you retire but before you start taking Social Security benefits or Required Minimum Distributions from retirement accounts could reduce the tax impact.
Also available as gifts
You can also buy I-Bonds as gifts. Each recipient can receive up to $10,000 in electronic I-Bonds and $5,000 in paper I-Bonds. (Note: A recipient must open a TreasuryDirect account to receive an electronic I-Bond gift). Keep in mind that recipients can choose to redeem their I-Bonds at any time once a year has passed.
Where do I-Bonds fit into your financial plan?
As potentially attractive as I-Bonds might be right now, it’s important to consider why you’re investing in them. Are you trying to earn a better interest rate than savings accounts and certificates of deposit currently offer? Do you want them to serve as supplemental long-term investments for your retirement or your children's higher education? Or would you like to use them instead of traditional U.S. savings bonds as birthday and graduation gifts for your children and grandchildren? Speaking with a financial advisor can help you figure out where I-Bonds fit into your overall financial plan.
Disclosure: All investments, even those backed by the U.S. government, are subject to risk, including the loss of principal. Some investments are not suitable for all investors, and there is no guarantee that any investing goal will be met. Past returns are not indicative of future returns. This material is intended for informational/educational purposes only and should not be construed as investment advice, a solicitation, or a recommendation to buy or sell any security or investment product, nor does it constitute either tax or legal advice. Although we go to great lengths to make sure our information is accurate and useful, we recommend you consult an accountant or professional tax preparer to discuss tax issues or a financial advisor before making any investing decisions.
This article was authored by Joelle Spear and Jeffrey Briskin. Joelle is a financial advisor and Partner located at Canby Financial Advisors, 161 Worcester Road, Framingham, MA 01701. She offers securities and advisory services as an Investment Adviser Representative of Commonwealth Financial Network®, Member FINRA/SIPC, a Registered Investment Adviser. She can be reached at 508.598.1082 or firstname.lastname@example.org. Jeffrey Briskin is Director of Marketing at Canby Financial Advisors.
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