When To Consider I Savings Bonds (and When You May Want to Avoid Them)
Recently, there have been many headlines in the news around I savings bonds, known as I bonds or inflation bonds. These headlines have caused much confusion around the topic, and we wanted to clear up what I bonds are, how they can be utilized, and pitfalls to watch out for when considering them for your portfolio. Put briefly, I bonds are investment vehicles that track the inflation rate. As you might imagine, they are picking up a lot of steam this year for that reason.
What is an I Savings Bond?
An I bond, or an inflation bond, is a treasury bond issued directly by the US government, meaning that the earnings are taxable at the Federal level. I bonds are intended for investors who want to tie their interest payments to the inflation rate. So, when you purchase an I bond, you will get a base, fixed-rate, then an additional inflation rate is applied above and beyond the base rate. This inflation rate is adjusted every six months, so depending on where the inflation rate is running, you may have the opportunity to receive a reasonable return. Especially during a period like today with high inflation rates, I bonds can be very attractive. Still, these instruments may be less exciting when inflation is running at a lower clip. If inflation does come down in the near future, your total return will be reduced on these six-month intervals as the new inflation rate is applied to the interest you can experience.
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Here are a couple of critical things to understand regarding how I bonds function:
First, remember that the interest rate is adjusted every six months. Second is to know that these bonds are issued with a 30-year maturity date. So, these vehicles are a 30-year obligation for your investment unless sold back. This raises the question of how you can get your money back if you do not want to hold them for the full 30-year period. It is important to note that there is no secondary market for trading I Bonds. So, these bonds must be bought and sold directly through the US government.
How do the interest payments work for I bonds?
Unlike many traditional bonds, you will not be paid interest as you go; all interest recognized is accumulated, and you only receive that interest when you cash out. So, if you hold it for 30 years, you will receive the interest at the end of that period. Consider how future (and quite possibly lower) inflation rates may affect your total investment. While inflation is high now, and rates correspond to these numbers, for the long term, these investments may not be as exciting as it may seem on the surface today, when considering long-term inflation rates.
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Limitations and Restrictions on I Bonds
It is important to know that you must hold these bonds for a minimum period of one year. There is a second restriction as well if bonds are held for less than five years. If these investments are sold back before the 5-year mark, you will lose the last three months of interest. For example, if you hold the bond for two years, or 24 months, you would only receive interest for 21 months.
Additionally, you can only purchase up to $10,000 per calendar year in electronic bonds and $5,000 per year in paper bonds with your tax refund. Clearly, these limits may reduce the exposure you can experience to these vehicles, but they can be an excellent alternative to a Certificate of Deposit (CD) in the right circumstance.
Overall, while we have seen a lot of headlines about I bonds, the reality is that they may not be as practical as they seem on the surface. In certain situations there may still be great opportunities to explore with these instruments, but there are limitations to how you can buy them, where you can buy them, how you can sell them, where you can sell them, and of course, how long you may need to hold them. If you are curious about how I Bonds may fit into your financial plan or review scenarios where I bonds can be helpful, please reach out to a member of our advisory team below to discuss your particular circumstances!