I-Bonds Are Now Paying 9.6% ... but the deal won't last.

I-Bonds Are Now Paying 9.6% ... but the deal won't last.

| May 04, 2022
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In November I wrote about a government-backed savings bond paying 7.12 percent. Now, the deal has gotten even sweeter because the other day, the U.S. Treasury announced new I-bonds are paying 9.62 percent through October. You read that correctly: 9.62 percent. That means clients who purchased the 7.12% I-bonds back in November will be earning the higher rate through October, thus yielding over an 8 percent annual rate of return without risk of losing their principal.1 With the S&P 500 down over 12 percent year-to-date,2 the broad-based bond market down over 9 percent year-to-date,3 and inflation surging past 8.5 percent in March,4 I-bonds can offer an outstanding addition to your long-term investment strategy or even for emergency savings you don't need to get your hands on the within the next year. Before jumping in, be sure to read the rest of this post to understand the benefits and drawbacks of I-bonds. (Note: I wrote the following post back in November 2021 and have updated it to include current rates as of this writing.) 

"Where Can I Invest Safely?"

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 9.62 percent in something considered to be one of the safest investment vehicles. At the beginning of May, the U.S. Treasury announced that I bonds issued between now and the end of next October will earn interest at an annual rate of 9.62 percent over the first six months after purchase. That’s the highest rate ever offered on I-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 is still near 0 percent, but since inflation is at its highest level in over 40 years, the variable interest rate on I-bonds is over 9 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. If you have a trust, you may be able to set up another account and purchase another $10,000 in the name of the trust. 

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 9.62 percent is 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. As mentioned above, this 9.62 percent is the variable component that adjusts every six months. The fixed rate is currently near 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. But even if inflation went to 0% in six months, if you cash in your I-bonds after a year, you will still have netted far more than you would have in a CD or savings account. 

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.) Losing three months of interest isn't a big deal because, again, even if you only held them for a year, you'll still earn a higher rate than you could have in a savings account. 

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 at or below 1 percent, I bonds can make a lot of sense for some people, as long as they weigh the drawbacks. 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 9.62 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. 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

Back in November, 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 learn more about my online courses on "Social Security Timing," "Taxes in Retirement," and the "Intelligent Investor Course." 

 

Sources: 

  1. TreasuryDirect, ´╗┐https://treasurydirect.gov/indiv/research/indepth/ibonds/res_ibonds.htm#irat, 5/3/2022. 
  2. S&P 500 YTD ast of 5/3/2022.
  3. Bloomberg Barclays US Aggregate Bond Index YTD as of 5/3/2022.
  4. "U.S. Inflation Accelerated to 8.5% in March, Hitting Four-Decade High," Wall Street Journal, 4/12/2022. https://www.wsj.com/articles/us-inflation-consumer-price-index-march-2022-11649725215. 
  5. 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
  6. https://treasurydirect.gov/indiv/research/indepth/ibonds/res_ibonds.htm#irate , Accessed 11/29/2021
  7. Ibid. https://www.treasurydirect.gov/indiv/research/indepth/ibonds/res_ibonds_ifaq.htm#lose

 

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