We have received many questions regarding I bonds this year, and for good reason. They are likely a good option for cash you have set aside and don’t need for at least a year.
What are I Bonds?
I Bonds are a series of bond issued by the United States Treasury, with an interest rate that is linked to the inflation rate (as measured by the Consumer Price Index, aka CPI-U). The interest rate on these bonds is comprised of two components: a fixed rate that does not change for the life of the bond and a variable rate that is tied to recent inflation rates. The Treasury Department updates the rates on I Bonds semi-annually in May and November. Rates are guaranteed and the bonds are backed by the full faith of the US Government.
Why are we talking about I Bonds?
Historically, bond returns have outperformed the rate of inflation, albeit minimally, but consistently. Over the last year however, inflation has risen significantly and is currently outpacing bond yields. As of May 2022, the current I bond rate is 9.62%. Yes, over 9% as compared to the current 30-year and 10-year US treasury bonds yielding ~3%. These are the highest rates we have seen in recent history. Typically the yields on I bonds were below corporate and other bond rates. To review the historical interest rates on I bonds, check this chart from Treasury Direct. With rates this high, I Bonds are an ideal substitute for a small portion of your bond portfolio and/or as a high yielding saving account.
So, what’s the catch? Shouldn’t I be buying a lot of these bonds?
If this sounds too good to be true, you are partially correct. The government has limited one’s ability to directly purchase these bonds to $10,000 per person (or per trust) per calendar year. A taxpayer is also able to purchase up to an additional $5,000 in I bonds with their tax refund.
Other important things to know
From the date of purchase, the interest rate is fixed for 6 months, and resets every 6 months. For example, if you purchase the bonds in July, the interest rate on your bond is unchanged until December.
In December, the rate will update to the most recent Treasury reset rate, which in this case is from November.
I bonds have a 30-year maturity. However, you do not need to hold the bonds to maturity. You are required to own the bonds for at least one year, which means that this investment is not for those looking for higher liquidity. If you chose to sell the bonds after one year and before holding them for five years, you will forfeit 3-months’ interest at the time of sale. If you hold the bonds beyond their maturity date, you will no longer receive any interest.
It is recommended that you name a beneficiary on your I bond purchases. You can only name one beneficiary per I Bond purchase. Keep in mind, that if you want to name more than one beneficiary, you can break your $10,000 investment up into increments. If you want to name 2 beneficiaries, you will make two purchases in the amount of $5,000.
Taxation on I Bonds
Interest from I bonds is only taxed federally, not on the state or local levels. As a taxpayer, you have the choice to declare the interest income from the bonds annually or defer until the bond is redeemed or fully matures.
How do I buy I Bonds?
I bonds are purchased online via Treasury Direct or in paper format via a form you include with your federal tax return. Unfortunately, DWA cannot create this online account for you nor purchase the bonds in your investment accounts. For some instructions to help you with the online purchase, click here. For assistance with purchasing the bonds with your tax refund, please ask your accountant.
Please don’t hesitate to call us or email team@daviswealthadvisors.net with an questions!
