How to Earn 7.12% on Ultra Safe Bonds

How to Earn 7.12% on Ultra Safe Bonds

| November 15, 2021
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Clients often ask me if there is something they can put their money into where they won’t lose money. The answer is, yes. We can invest in safe bonds, specifically T-bills, which are backed by the U.S. government and often considered to be the safest investment. Unfortunately, interest rates have been abysmal for quite some time, with CDs and FDIC-insured savings accounts paying practically nothing. Annuities that promise “no risk," “high returns” and "no fees," in reality often include hidden costs, surrender penalties, and complex features that clients (and many advisors) often don’t fully understand. But now, thanks to the U.S. Treasury, it may be possible to earn 7.12 percent in something considered to be one of the safest investment vehicles. On November 1 the U.S. Treasury announced that I bonds issued between now and the end of next April will earn interest at an annual rate of 7.12 percent over the first six months after purchase. That’s the second-highest initial interest rate ever for these bonds. But as with any investment decision, before jumping into it, there are some important considerations.

How Does It Work?

Series I bonds are non-marketable, interest-bearing U.S. government savings bonds that earn a fixed interest rate combined with a variable inflation rate (adjusted semi-annually). Series I bonds are intended to give investors a return plus inflation protection. Each I bond’s interest rate has two components — the inflation rate that adjusts every six months and a fixed rate designed to provide a return over inflation that is constant for the entire 30 years. The fixed rate on I bonds purchased now is … wait for it … 0 percent. Compare this 0 percent rate to the fixed rate in the first three years of the I bond program that started in 1998, which ranged from 3 percent to 3.6 percent. So if existing I bond holders get the 0 percent fixed rate PLUS the 7.12 percent inflation rate, that means those who purchased bonds 30 years ago are now earning a combined interest rate of more than 10 percent!

Do I Need an Advisor to Invest in I Bonds?

I Bonds are non-marketable securities, which means they are not sold on the secondary market, so they cannot be bought in a brokerage account or from an advisor. Instead, they are sold directly by the U.S. government. You can purchase digital series I bonds on the U.S. Treasury’s TreasuryDirect website, with a minimum investment of $25, and a maximum of $10,000 per calendar year, per Social Security number. A couple, therefore, could purchase up to $20,000 of I bonds annually. If you own a business, you may be able to do an additional $10,000 per year if the business has its own EIN. So if one spouse owns a business, a couple could do $20,000 ($10,000 for each spouse) and $10,000 for the business, for a total of $30,000, and then do the same thing after January 1, for a total of $60,000. 

Can the value of my I bonds ever be less than I paid?

According to the U.S. Treasury, “No. The interest rate can’t go below zero and the redemption value of your I bonds can’t decline.”

What are the downfalls?

While 7.12 percent sounds pretty good compared to the low CD rates, there are a few caveats to consider before investing. In addition to the $10,000 limit, I bonds have very long maturities of 30 years. While 7.12 percent may sound great today, you are not guaranteed to earn that same rate going forward.  As mentioned above, this 7.12 percent is the variable component that adjusts every six months. The fixed rate is currently 0 percent. So if inflation does come under control, as the Federal Reserve and the Biden administration are predicting, the newly issued I bonds won’t pay as much.

The other caveat is, while you can cash in your bonds after a year, you’ll lose three months worth of interest if you cash out before you’ve held them for five years. (The flip side to this of course is, if inflation persists, you can choose to hold the bonds and continue earning interest over the next 30 years, compounded semi-annually, with the rate adjusted every six months.)

Finally, with I bonds, liquidity could be an issue, as it can take much longer to cash them in than it might take to cash in other investments, in a brokerage account for example.

What are the tax considerations?

Unlike CDs and savings account interest, which is taxed annually as it accrues, I bond interest is exempt from state and local income taxes. Plus, you can elect to defer federal income taxes on your earnings until you cash in the bonds. If you cash in an I bond to pay for higher education, the interest may not be federally taxable at all. Your modified adjusted gross income must be below a certain amount to take advantage of the income exclusion (in 2021, the income exclusion begins phasing out at $83,200 for singles and at $124,800 for couples).

Should I invest in I bonds now?

With most CD rates below 1 percent, I bonds can make a lot of sense for some people, as long as they weigh the risk factors. In the case of I bonds, the primary risks are liquidity risk and re-investment risk. Remember, if you choose to redeem your bonds before five years, you lose the previous three months of interest. However, consider this: If you invested in I bonds for one year, you would earn 7.12 percent annual interest over the next six months, and then whatever new interest rate was set over the course of three more months. So in this case, you’d still come out ahead of buying a one year CD currently below 1%, especially when we consider the tax implications.

How do I invest in I Bonds?

To purchase I bonds, you can set up an account with TreasuryDirect.gov and link it to your bank or money market account. You can also buy paper bonds, but the only way to do that is to direct your tax refund be used to purchase them. If you file your 2021 tax return by early April and expect a refund, you might consider directing it into I bonds. One benefit to using your tax refund is that you can purchase up to $5,000 of I bonds with your refund plus an additional $10,000 online through TreasuryDirect.

The most important step

The other day, a prospective client asked me, “Why are you telling me about this investment if you can’t sell it to me?” Questions like this reflect a common misconception that all advisors are salespeople trying to sell products. But not all advisors are the same. Advisors who have taken the extra step to become fiduciaries do not sell investment products. Instead, they charge a fee for the advice they give. As a former teacher, I’ve always believed the primary role of an advisor is to be an educator or a coach. While I don’t think everyone needs to be an expert in financial planning, retirement planning, or investing, I believe it’s important to gain some basic knowledge in these areas, especially as it relates to your unique situation. Without some basic knowledge, it’s difficult to have confidence in your plan, and without confidence, it will be difficult to maintain the discipline required to be a successful investor. That’s why in January, I’m launching “The Intelligent Investor Course.” It’s a short series of bite-sized videos intended to simplify, and demystify, investing. Armed with this knowledge, you can build a long-term investment strategy you feel confident in. When you have confidence, it’s a bit easier to stay focused on your long-term plan rather than on short-term market swings. So whether you’re investing for retirement, or to pay for college for a child or grandchild, or for some other long-term goal, knowledge is the key to a more successful investing experience.

Click here to find out more about the “Intelligent Investor Course” that will launch in January 2022.

 

Sources: 

  1. Dore, Kate. “Sweating inflation? This risk-free bond pays 7.12% annual interest for the next six months,” CNBC 11/2/2021. https://www.cnbc.com/2021/11/02/sweating-inflation-this-risk-free-bond-pays-7point12percent-for-next-six-months.html
  2. https://treasurydirect.gov/indiv/research/indepth/ibonds/res_ibonds.htm#irate , Accessed 11/29/2021
  3. Ibid. https://www.treasurydirect.gov/indiv/research/indepth/ibonds/res_ibonds_ifaq.htm#lose

 

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