US Treasury (Series I Savings Bonds)
What Are I Bonds?
The Treasury Department introduced the Series I Savings Bond in 1998 to protect consumers’ savings from losing value due to inflation. The I Savings Bond interest (sometimes referred to as the composite or earnings rate) is calculated using a complex formula that accounts for a fixed rate and an inflation rate that changes every six months. At the time of this writing, the composite rate for the most recent I Savings Bond issued in May 2021 guarantees investors a rate of return of 3.54%. This rate of 3.54% is set to change again in a few days on November 1, 2021, and every six months after that, with the following rate change on May 1, 2022.
Investors can buy up to $10,000 worth of I Bonds every calendar year directly at TreasuryDirect.gov. You can purchase another $5,000 with your tax refund/per return, upping the annual total purchase amount of series I bonds to $15,000 per Social Security Number. If you are married filing jointly, there’s a maximum of $25,000 for couples per calendar year. $10,000 per spouse purchased electronically via the website and another $5,000 as a paper I Bond, which can be converted to electronic shares with your online account.
Why Are They Beneficial Right Now?
I Bond yields far surpass that of any other government-guaranteed interest rate available from any bank, brokerage, or other insured sources at the moment. Because of this, these bonds are an attractive part of a conservative portfolio for you and your family. The composite rate is set to change in November to 7.12%, which hasn’t happened in decades. For this reason, given the current climate of low-interest rates and the upcoming high-interest rate of I Bonds, we are highly recommending this solution for many of our clients.
How Do I Bonds Earn Interest?
These bonds accrue interest monthly, though you don’t get access to the interest payments until you cash out or redeem the bond. The interest you earn is added to the value of the bond semiannually. Let’s assume you purchase $10,000 with today’s current rate of 3.54% on October 2021. You will now earn 3.54% for six months until March 2022. At that time, your rate will be locked according to the rate for November 2021-May 2022 term, which is set to be at 7.12%. In other words, as you finish the first 6-month term, you will then lock in your interest rate at the future rate of 7.12% with your funds between April 2022 to September 2022. We don't know what the composite rate will be in May 2022, so after September 2022, we will have an undisclosed amount for the following six months.
What’s the Catch?
You must lock the funds in for 15 months, well technically, one year from the purchase of the I bond. However, if you redeem the bond before five years, you will be penalized and lose 3-months’ worth of interest. If you leave the money in for five years, there is no penalty.
With the example above of purchasing $10,000 Series I Bond in October 2021, you can withdraw at the 15-month mark (January 2023) and receive 12 months’ worth of interest. Even if you don’t want to leave the funds there for five years, you can pull the funds out in January 2023, and you’ll lose the interest from October, November, December 2022. To be clear, you’ll earn a total cumulative yield of 5.39%, which ends up being about 4.10-4.50% APY on the 15 months you hold these bonds. Now, let's further analyze a Bond purchase and take a look at the chart below to see how the interest is earned and how penalties affect the total interest earned:
Parting Words?
Series I Savings Bonds offer tax advantages, decent rates of return for guaranteed investments, and some protection against inflation. They’re also flexible and easy to purchase or sell via the TreasuryDirect account. Remember that you can redeem after the 12-month mark; however, there’s a penalty (3 months’ worth of interest) if cashed out before five years. These savings bonds come with frustrating restrictions that may alienate more experienced investors as they have annual purchase limits and lower returns compared to the next meme stock or that "big shot" alt-crypto position. However, these bonds do have an important role to play in a balanced, fundamentally conservative portfolio, especially with the recently announced upcoming rate of 7.12% APY between November 2021 – May 2022.
Pro-Tips & Other Important Facts About I Bonds:
The total maturity of I Bonds is 30 years. I Bonds initially mature 20 years after their issue date, but the Treasury Department offers investors the option to renew their bonds for an additional 10 years.
Accounts can be registered in the names of individuals and some entities (trusts, estates, and corporations). Please make sure to add a beneficiary/POD (payable on death) to your account before you transfer funds into the I bond.
If you don’t buy until after November 1, you can still invest $10,000 in 2021. However, we don’t know what the second 6 months will be – it’s all tied to inflation rates. Some investors might prefer to wait until after November 1, thinking that the May 2022 rate will be higher than 3.54%, but you run the risk of the composite rate going down as low as 0%.
You only pay federal tax on the interest. There are no state or local taxes. Even the federal taxes can be deferred until the bond matures in 30 years. You might be exempt from federal taxes if the funds are used for certain higher education expenses.
The best approach is to buy I Bonds is at the end of the month since interest is paid as if you purchased from the 1st of the month, regardless of when you buy. Again, from the example above, if you buy on Thursday, October 28, 2021, you’ll earn interest as if you purchased on October 1, 2021.
Some clients may be interested in purposefully overpaying their taxes to get a refund and then use those funds to purchase the $5,000 paper I Bonds at the 7.12% rate as well before the rate changes on April 30, 2022.
Spouses can each do this separately: a married filing jointly couple can lock in $45,000 at the 7.12% rate as each can get $20,000, plus $5,000 paper I Bonds on their shared tax return. (Assuming that the couple purchases $20k in 2021 and another $20k in early 2022 with the additional $5k with the tax return refund).
To maximize this benefit, investors can also open a second TreasuryDirect account for their business with its separate business name and EIN. (Allowing you to purchase an additional $10,000 in I Bonds each calendar year).
