What are I Bonds?

With inflation increasing at alarming rates, investors are looking for ways to counteract the slaughter of their dollar. With most bank accounts yielding 1% or less, more traditional savings options are not very compelling in light of an 8.5% inflation rate.

One option that has made headlines recently is I Bonds.

I Bonds are inflation bonds issued by the United States Treasury. As of May 31, $17.5 billion in Series I savings bonds have been sold in the last 6 months, compared to just $364 million sales in all of 2020. That’s nearly a 50-fold increase in demand from two years ago!

In this week’s discussion, we will address what I Bonds are, what makes them worth considering as a savings tool, as well as some of the pitfalls to know prior to investing in them.

What are I Bonds?

I Bonds are bonds issued by the US Treasury that provide inflation protection during periods of elevated inflation. To do this, the coupon rate on the bond is adjusted every 6 months to factor in the current inflation rate.

The interest of an I Bond is calculated in 2 ways:

• First, there is a fixed interest rate associated with the bond. This interest rate lasts for the life of the bond (30 years). Currently the fixed interest rate on I Bonds is 0%. When low inflation environments exist as we saw in the previous decade, the incentive to purchase I Bonds greatly diminishes.

• Second, there is a variable inflation rate that is adjusted every 6 months. The last adjustment occurred on May 1, 2022, and the next adjustment is scheduled for November 1, 2022. For the next four months, the inflation rate is set at 9.62%.

This means that if you purchase $10,000 of I Bonds and the coupon rate remain the same, you could earn $962 in interest over the next year, versus the $100 you would earn on a bank account paying 1%.

Before you scroll to the bottom of the article to learn how to buy these bonds, make sure that you are aware the following:

• I Bonds cannot be cashed out within the first year of purchase. You must hold on to them for at least 12 months from the date of purchase.

• After waiting the full 12 months, you must wait 5 years from your date of purchase to cash the bond out without a penalty. If you cash out the bond before the five-year mark (but after the one-year mark), you will forfeit the last 3 months of interest you earned.

• I Bonds are exempt from state and local taxes, but they are taxed at the federal level. I Bonds used for higher education expenses are tax-exempt at the federal level too.

• I Bond purchases are limited to $10,000 per person or entity, per year. This cap means that investors looking to store all their money into a safe vehicle will need other options.

  • You can purchase an additional $5,000 in I Bonds per person if you overpay your taxes, then elect to receive I Bonds instead of a refund into your bank account.

How to Buy Them

If you are comfortable with the reduced liquidity of I Bonds and want to own them, you cannot buy I Bonds on the open market. You must use the Treasury website to purchase the bonds directly, and the system in place to purchase I Bonds is antiquated, to say the least!

1. Head to http://treasurydirect.gov/

2. Under the “Account Login” box, select the “Open an Account” option.

3. Select the “Treasury Direct” option to create your account

4. Fill out your personal information, along with the bank information that you want to link to purchase the bonds. Be sure to review everything entered, as changing this information is a time-intensive project that often involves going to a bank, signing paperwork, and then mailing that documentation into the IRS.

5. Once your information is submitted, you will receive an email with the next steps. Follow the next steps in that email and you should be able to see your account with the option to purchase I Bonds via the BuyDirect® option at the top of the page.

Series I Bonds are a reasonable investment option given the current state of the market. Investors looking to take advantage of the elevated yield can do so in the near term. When rates adjust in November, the high rate currently offered may decline. However, even if the rates are reduced in November, inflation is not expected to suddenly disappear. And that provides investors with a relatively attractive, low-risk alternative to their 1% yielding savings account.

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