Time For I Bonds – Week In Review

The title of this weekly review probably caught some investors by surprise. However, savers and investors who have owned US Government I Bonds in the past are not surprised. The I bond interest rates are 7.12% for the next four months through April 2022. This rate is the best interest rate in many years. For savers and investors looking for a highly safe place to put cash, I Bonds are an option. In addition, I Bonds can help a saver beat inflation—more on that topic below. Inflation has surged in 2021, and if inflation remains elevated or goes even higher, the composite interest rate on I Bonds may stay the same or possibly even reset higher. The rate is a good one and makes it time for I Bonds, in my opinion.

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Basics of I Bonds?

Series I Savings Bonds known as I Bonds are inflation-protected savings bonds issued by the US Government. They were first issued in 1998. Electronic I Bonds can be purchased directly from the US Treasury.  In addition, a saver can purchase paper I Bonds with his or her federal tax refund.

The minimum purchase is $25 for electronic I Bonds and $50 for the paper I Bonds. The maximum investment is $10,000 for electronic I Bonds and $5,000 for paper I Bonds.

I Bonds have two components for interest rate added together to make a composite rate. The two rates are the fixed-rate and the inflation rate. 

The fixed-rate is set when an investor buys the I Bonds and does not change during the life of the bond. The fixed-rate is announced every six months (1^st business day of May and November) by the US Treasury.

The inflation rate changes every six months (1^st business day of May and November) by the US Treasury. It is based on the non-seasonally adjusted Consumer Price Index for all Urban Consumers (CPI-U) for all items. This index includes volatile food and energy prices.

The composite interest rate is never less than zero. However, the fixed rate can be zero as it has been often since late 2010. The fixed-rate has ranged from 0% to 3.6% since 1998. The inflation rate can be negative, offsetting a positive fixed rate. The semi-annual inflation rate has ranged from (-2.78%) during the sub-prime mortgage crisis to a high of 3.56% today.

Currently, the annual composite rate is between 7.12% for bonds bought when the fixed rate was 0% and 10.85% for bonds bought when the fixed rate was 3.6%. Imagine getting more than 10% on an investment vehicle, essentially a savings account.

Example of I Bond Composite Rate

The most recent rate announcement was on November 1, 2021.

Source: US Treasury

Advantages of I Bonds

The nice part about I Bonds is that they are guaranteed by the US Government savings and are thus generally low-risk investments. Of course, no investment is entirely risk-free, but the US Government has always paid interest in its savings bonds.

As mentioned above, I Bonds are inflation-protected. If inflation rises further, the inflation rate will reset higher. Hence, if inflation reaches double-digits, as some people fear, the interest rate earned on I Bonds will be double-digit too. In addition, due to the inflation rate, I Bonds will usually have a greater interest rate than savings accounts, money market deposit accounts, or certificates of deposit (CDs). Since inflation is high in 2021 and into 2022, many savers think it is a good time for I Bonds.

Another primary advantage is the interest earned on I Bonds is tax-deferred at the federal level. If a saver uses I Bonds for education, the federal tax on interest is waived. This benefit is subject to income limitations.

The sweetener is that interest from I Bonds is not taxable at the state or municipality level. Hence, considering the interest rate and the tax benefit, it may be time to buy I Bonds. However, there are some challenges for owning I Bonds.

The combination of inflation protection and tax advantages makes it an excellent time to own I Bonds.

Disadvantages of I Bonds

The maturity for an I Bond is 30-years, meaning it will pay interest for 30-years. However, the minimum holding period is one year before redeeming. If an investor owns I Bonds for more than none year but less than five years, there is a 3-month interest penalty. This fact means a loss of three months’ interest when the I Bonds are redeemed. If I Bonds are held for more than five years, there is no penalty. This fact makes I Bonds appropriate for longer-term holdings and not for an emergency fund.

The interest rate on I Bonds is more complex than regular savings accounts or CDs. IN the case of a CD, a saver can buy a CD, and the interest is fixed until renewal. However, I Bond interest rates are variable depending on inflation adding complexity,

It is possible that I Bonds may not earn interest if the sum of the fixed-rate and inflation rate is 0%. It does not seem likely, but if inflation is negative and the fixed rate is low, your I Bonds may not earn interest until the following rate announcement.

Another consideration is the US Treasury does not mail a 1099-INT, unlike a bank. Hence, a saver must keep track of their electronic I Bonds or safely store their paper I Bonds. Since I Bonds are tax-advantaged for many years, they do not show up on tax returns, making it difficult for heirs and executors to track them. 

Final Thoughts on Time for I Bonds

I Bonds are often forgotten by savers and investors. However, they are currently a decent deal, and it may be time for buying I Bonds with cash beyond your immediate needs or emergency fund. Where else will savers get a low-risk investment earning a 7.12% annualized interest rate? In a high inflation environment, I Bonds protect cash. However, the risk is inflation is transitory, and the I Bonds you buy today may earn a low composite interest rate in the future.