Following a decade of unprecedented growth across multiple asset classes, investors can be forgiven for overlooking bonds. While bonds can bring stability to a portfolio, historically modest returns have recently relegated them to be an afterthought among risker asset classes in a market that spent years rewarding everybody. Times have changed, uncertainty has hit all markets, and we find the humble I Bond paying a 9.62 percent return. In a world where the stock market is off to its worst start since 1939 and inflation dwarfs even the best high yields savings accounts, are I bonds a good investment?
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What are I Bonds?
Introduced in 1998 to insulate Americans’ savings from inflation, the Series I Savings Bond (I bond) can protect your purchasing power in times of high inflation. A secure investment, I bonds are backed by the US Government, currently an AAA-rated issuer of debt worldwide.
Bonds are often considered a safe investment, but one with limited upside relative to vehicles such as stocks or real estate. I bonds are meant to mirror the movement of the consumer price index, keeping pace with changes in the cost of living rather than growing your savings.
In a time where inflation nears ten percent, and other investments are struggling to keep pace, I bonds can provide a viable store of value.
Who Can Purchase I Bonds?
Individuals who are citizens or residents of the US and are eighteen years of age or older can purchase and hold I bonds. Company owners can additionally purchase up to $10k annually in the name of each registered business.
How Much Do You Earn with I Bonds?
I bonds pay a flexible rate tied to the consumer price index on top of a fixed interest rate. The fixed portion is typically very low and will hold steady throughout the life of the bond. The Treasury adjusts the variable portion of the interest in May and Nov of each year. This collective interest compounds on a semi-annual basis from the bond’s purchase date. However, bondholders will not collect these proceeds until the bond’s redemption.
The US government provides a downside guarantee – in times of zero or negative inflation, I bonds will never fall below the face value of the bond.
How Long Do You Have to Hold an I Bond?
The purchase of an I bond is a commitment, as the owner must hold for a minimum of 1 year. After this lockup period, but prior to 5 years from purchase, you can cash out, but you will lose the most recent quarter of interest. After five years, you can redeem your I bond freely, or can hold and continue to earn interest for up to thirty years.
What are the Tax Implications of I Bonds?
The IRS considers interest earned by holding Series I Savings Bonds as standard income, and taxes it at your nominal tax rate during the year of redemption. You will only pay tax at the federal level as the proceeds are exempt from your state and locality.
If you use the proceeds of the bond to pay qualified higher-education expenses, including tuition, you may be able to exclude the income from your federal taxes. In recent years, the price of education has grown much faster than inflation, reducing this benefit. Still, in years where inflation growth approaches or exceeds any growth in tuition and related expenses, it merits consideration.
Top earners will see fewer benefits from the Education Savings Bond Program. Tax benefits start to reduce around the 85k income level for individuals and around 128k for joint filers. These income thresholds are adjusted annually and current levels can always be found on the IRS’s website.
To qualify for this tax credit, the taxpayer must have been at least 24 years of age when they purchased the bond. If you wish to use this program for your child’s education, purchase the Bonds in your name instead of gifting them to your child.
How Much Can You Invest in I Bonds?
Household can purchase up to $10k across government bond offerings per unique tax id or SSN. A two parent HH with 1 child could purchase up to 30k annually. Individuals who receive a federal tax return can direct up to $5000 dollars of that return to purchase I bonds. This amount does not count against your 10k annual limitation.
I Bonds are sold at face value. Electronic bonds require a minimum investment of $25 and can be purchased in any amount. Paper Bonds have a minimum investment of $50 and can be issued in multiples of $50.
Gifting I Bonds
You can purchase I bonds for other parties (including children) and give them as gifts. The value of the bond will count against the annual contribution of the recipient and will have no impact on your ability to purchase bonds in your name. If you transfer your bonds or inherent bonds upon the death of another, the value of those bonds does not count against the annual limit.
Are I Bonds a Good Investment
Bonds almost universally offer a safe, if modest return, throughout most markets. Following growth in the CPI, I bonds protect your purchasing power, including in times of high inflation and uncertainty where other asset class may not. In our current environment, the 9.62 percent return offered by the I bond has a role to play in many portfolios.
Pros
Secure
Backed by the US Government, a world in which your return gets defaulted on is one where there are much larger concerns.
Insulation from Inflation
The purchasing power of cash moves inversely with inflation. By earning a similar value in interest, the I Bond ensures your purchasing power is maintained.
Tax Benefits
Earned interest is tax exempt on both the state and local levels.
If proceeds are used to pay qualified Higher Education expenses, they may additionally qualify for a federal tax credit.
Diversification
Bonds provide stability to a portfolio and historically have shown reasonable diversification from stocks.
Cons
Your money will be tied up for at least one year
This tie-up period expands to 5 years if you don’t want to lose out on three months of interest.
Limited Upside and Opportunity Cost
While bonds provide downside protection within a portfolio, their overall return tend to lag other asset classes. In times of stability, money could be allocated other places in pursuit of larger returns.
How To Purchase I Bonds
1.) Open a web browser and navigate to TreasuryDirect.gov
2.) navigate to open an account.
3.) Click on the blue “Apply Now” button at the bottom of the screen.
4.) Select your entity type. In most cases, this will be the pre-selected option of “Individual”.
5.) Click the blue “Submit button” at the bottom of the screen.
6.) Provide the required personal information for the account, including:
Tax payer id number
Funding bank account.
7.) Check the check box stating that the information you have provided is accurate and hit the blue “submit” button.
8.) Wait for a verification email. Once it arrives, follow it to log into your new Treasury Direct account.
9.) Select the “Buy Direct” option.
10.) Select the type of bond and amount you wish to purchase.
11.) Select your funding source (the bank account you chose when creating your account) and click “continue”.
12.) Review and agree to the purchase information and the Terms and Conditions.
How to Purchase I Bonds as a Gift
1.) The process begins just as if you were purchasing an I Bond for yourself. Start by repeating steps 1-9 above.
If you already have a Treasury Direct account, you will only have to log into your account and hit the “buy direct” button.
2.) You should now be on the “purchase” page.
If you have gifted a bond to this individual in the past, select their name from the dropdown.
If this is the first time you have bought a bond for them, click the “add new registration” button
Enter the required information for the individual you are purchasing the gift for, including SSN.
3.) select the “This is a Gift” box.
3. )Select the type of bond and amount you wish to purchase
4.) Select your funding source (the bank account you chose when creating your account) and click “continue”
5.) Review and agree to the purchase information and the Terms and Conditions.
How To Leverage Your Tax Refund to Purchase I Bonds
If you are owned a Federal tax refund you can elect to redirect up to $5000 to purchase I bonds. This allowance is independent from your $10k annual limit. In this way, it is possible for one individual to purchase a total of $15k in bonds within one tax year.
You will use tax form 8888 to request to allocate your return towards the new bonds. If you file your taxes via TurboTax (or any other tax preparation software), it should ask you towards the end of the process after your federal return has been calculated.
What Happens to Your Bonds When You Die?
If your bonds were jointly owned, they will pass to that individual upon your death. If your bonds are independent in your name, you can name a beneficiary, whom the bonds will pass to bypassing probate. The inheriting party will be responsible for all taxes upon redemption of the bond(s).
Because I bonds do not generate any income until redemption, they trigger no statements or tax forms during the life of the bond. As the bondholder, consider including the account/holdings in your will or make sure someone is aware of the account so they do not vanish into the ether.