Inflation is a silent killer. It erodes the value of your money, and it makes you feel poorer and less secure in your retirement savings. While the Fed continued to harp that “inflation is transitory,” all of you are experiencing inflation in one form or another.
The rise in inflation should not surprise long-time readers, as anticipated in our article on Modern Monetary Theory (MMT) published last year.
In the past, we talked about assets to protect against a hyperinflationary scenario like bitcoin when the price was only $8,800. Given the high volatility of cryptocurrency and the increased risk, it is not meant for everyone.
We also covered more mainstream options lower in the risk curve backed by hard assets such as farmland investing, including farmland’s inflation protection benefits. And investment in real estate crowdfunding.
Stocks also work in an inflationary environment as long as you can withstand the volatility and do not keep questioning should I sell my stocks now. Remember that growth stocks with no profits will get hit in a rising rate environment, as discussed in our article on stocks vs. real estate.
Moving further down the risk curve of income-producing assets, we have fixed-income investments. While most fixed income assets do not offer inflation protection, there are a few risk-free ways to protect ourselves from inflation, such as I Bonds.
I bonds are a low-risk investment, but it can be hard to understand what I bonds are and why they’re worth investing in.
This article will cover everything you need to know about I bonds, including benefits, risks, the timeline for purchase, maturity, redemption rates, tax implications, and how to buy I bonds. Let’s dive in.
What Is An I Bond And Why Invest In Them?
I Bonds, also known as Series I Bonds, are non-marketable savings bonds issued by the U.S. Department of Treasury primarily for individuals to purchase and invest in. I Bonds earn a fixed interest rate for 30 years while having an inflation component that varies with inflation expectations each May and November.
I bonds are safe investments issued by the U.S. Treasury to protect your money from losing value due to inflation.
One drawback of I-Bonds is that the interest and principal are paid when you cash the bond. For individuals looking for investments that pay monthly income they would need to figure out how to allocate the interest to their budget template.
How I Bonds Work?
I Bonds work as variable interest rate Certificates of Deposit (CD) with a maturity of more than a year issued by the U.S. Treasury.
I Bonds are sold at face value. For example, if someone were to purchase a $100 I Bond, they would pay only $100 and receive the stated interest rate over the next 30 years. Interest rates on I bonds are adjusted regularly to keep pace with rising prices.
How Much Will I Earn If I Invest In I Bonds?
You earn money from two interest rates when you buy an I bond
- A fixed-rate that will never change for as long as you hold the Bond.
- A separate inflation rate that varies every six months.
The fixed-rate and the inflation rate are added together to give you the composite rate. The current fixed rate is 0% which will remain constant over the life of the I bond.
The variable inflation component adjusts every May and November. The I Bond’s variable interest rate for May to October 2021 is 3.54%. The rate is expected to change in November 2021 to 7.12%
Treasury Direct has a chart that shows the composite rates for all Series I savings bonds issued.
Why Invest In I Bonds
I Bonds have relatively low default risk, and I Bonds are also backed by the U.S. government that is considered highly unlikely to default on I Bond holders.
I Bonds can be bought with an initial investment of as little as $25. I Bonds come in various denominations up to $10,000.
You don’t have to redeem the whole amount. It’s okay to cash out a portion of the total purchase. For example, you can redeem $5,000 while the remaining amount continues to earn interest.
I Bonds are low-risk, liquid savings vehicles that you can redeem anytime after 1 year. You lose the last 3 months’ interest if redeemed before 5 years, but it is much more flexible than a bank certificate of deposit (CD).
I Bonds give investors a return plus inflation protection on their purchasing power. I Bonds are known for offering interest rates that provide higher returns than many other safe investments, such as bank savings accounts.
While we should not let the tax strategies wag the returns dog, it is excellent to know that I Bonds are not subject to state or local taxes. You pay federal taxes, although you can defer federal income taxes until you redeem them, so you pay zero in taxes until they are sold.
The interest portion of your I Bond balance is compounded semiannually and rolled into the principal balance, meaning you earn interest on the interest already earned. I am a massive fan of compounding.
How To Buy I Bonds?
You can buy I Bonds by opening an account with Treasury Direct.
After logging in to your Treasury Direct account, go to the Buy Direct tab at the top of the page, then choose the Bonds ‘Series I’ option.
At the Treasury Direct website, you may purchase I bonds electronically up to a maximum of $10,000 per year per SSN.
You can also buy up to an additional $5,000 in the paper I Bonds if you have a tax refund due when you file your federal income tax return. You’d need to complete IRS Form 8888 and include it when you file your tax return. Some individuals make extra estimated tax payments during the year so they can claim a refund when filing taxes and get an additional allocation of $5,000 I Bonds.
You can establish a second Treasury Direct account for your firm with a different business name and EIN. It enables you to buy another $10,000 in I Bonds each calendar year using the same EIN.
You can purchase another $10,000 per year under the trust’s name if you have one. Residents of states like California usually create a revocable living trust to avoid probate. Your revocable living trust qualifies you to buy another $10,000 in I bonds.
When Do I Bonds Mature?
Series I Savings Bonds mature – meaning they stop earning interest – at 30 years. They carry a 20-year original maturity period immediately followed by a 10-year extended maturity period. After the first 20 years, I Bonds continue to earn interest for an additional 10 years unless cashed before that time.
When Can I Cash In I Bonds?
- I bonds can’t be cashed for a year after purchase. If a bond is redeemed anytime after one year and before 5 years, the prior three months of interest are lost (penalty).
- After 5 years you can cash the bonds without any interest penalty.
How to Cash in I Bonds?
The TreasuryDirect website allows you to exchange your electronic I bonds for cash. You can encash your paper bonds at any bank.
I bonds do not have a secondary market; you must redeem them only through the government.
How Are I Bonds Taxed?
The interest on I bonds is not subject to state or local income taxes. Only estate or inheritance taxes might be applicable. However, it is unlikely for you to have I bonds as part of your building generational wealth plan.
I bonds are subject to federal income taxes except when used to pay for qualified higher education expenses. Owners can choose to pay federal taxes on the interest earned each year, at maturity, or when the Bond is redeemed.
Differences between EE Bond and I Bond
Although the post is focused on I Bonds, I want to highlight the differences between another Treasury Direct product aimed at retail investors, known as the EE Bond.
Treasury Direct has a page comparing Series EE and Series I Savings Bonds
I would avoid EE Bond for the following reasons
1) Unlike I Bonds, the interest rate of EE bonds is fixed and not indexed to inflation.
2) EE Bonds double in value after 20 years. Although this might seem like a great deal, it is not. Because if you encash your EE bonds before 20 years, you do not get the doubling in value. You only receive the fixed rate of interest, which is currently 0.1%
Differences between TIPS and I Bond
A more complicated investment is the Treasury Inflation-Protected Securities (TIPS) program. Every month of the year, the Department of Treasury auctions TIPS, either new issues or reopenings. Investors can join in these auctions by putting noncompetitive bids (at $100) at TreasuryDirect, with no costs or commissions to pay.
Treasury Direct has a page comparing TIPS and Series I Savings Bonds
The Treasury establishes the coupon rate, which determines the interest paid twice yearly on the TIPS’ principal balance after the beginning auction. However, investors at the auction pay a premium above or below par value, resulting in an actual yield to maturity for the TIPS.
TIPS are complicated because once they are auctioned, they can also be traded on a secondary market. The market value of a TIPS shifts continuously, which implies the actual yield for new investors is also fluctuating.
You can also buy TIPS on the secondary market via brokerage firms. Many brokerage firms charge commissions when purchasing TIPS. You may also invest in TIPS via ETFs such as the TIP (iShares), SCHP(Schwab), or VTIP (Vanguard).
I would avoid TIPS since they have a lower fixed rate and come with taxes on phantom income with no tax deferral option. Instead, I would focus on I bonds and bank bonuses to get a higher yield on my risk-free portfolio.
Are I Bonds A Good Investment?
Buying an I bond is NOT investing. It is a method of saving money to keep pace with inflation.
I bonds are a great place to store your emergency funds. Usually, the interest rate is not high, but due to the rampant inflation, the I Bonds are offering a great rate.
I bonds are low-risk, and the best time to buy I bonds is when interest rates in the economy start rising. Investors should keep an eye on inflation and adjust their bond purchases accordingly.
I Bonds won’t help you get rich. But after you are rich, it can be a part of your portfolio you want to keep pace with inflation in a risk-free manner.
Readers, have you purchased I bonds before? Would you consider I Bonds as part of your asset allocation?
What steps are you taking to protect your portfolio from inflation?
John Dealbreuin came from a third world country to the US with only $1,000 not knowing anyone; guided by an immigrant dream. In 12 years, he achieved his retirement number.
He started Financial Freedom Countdown to help everyone think differently about their financial challenges and live their best lives. John resides in the San Francisco Bay Area enjoying nature trails and weight training.
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