This is the perfect time to discover I-Bonds.
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As inflation figures soar to 40-year highs, the ubiquitous I-Bond will reset its interest rate on May 1 to 9.62% for 6 months. So, on your $10,000 investment, you would make a guarantee (no principal risk) of 4.31%. No state tax and ultra-low risk sounds good, right? Using some quick math, that works out to about 116.5 times better than the average money market rate according to the FDIC. To put this in a different framework, you would need to invest around $120,000 to get the same return in a money market under current conditions.
what is a I-Bond? An I-Bond is a US Treasury security that is adjusted for inflation. The bond resets its interest rate to the current inflation rate every six months, specifically in early May and early November. The bond bears interest at that rate for that six-month period and then resets. The rate is a combination of a fixed rate (currently zero) and the inflation rate, which is the CPI-U. With March 2021 numbers, the next reset rate is expected to be 9.32% for new bonds. Since the rate is mixed, holders of old I-Bonds benefit from a fixed rate plus the rate of inflation. So if you bought an I-Bond in September 2000, your next reset would be 12.92% for the next six months (3.60% plus 9.32%). The I-Bond rate can never go below zero.
Is it safe? I-Bonds are secured for their principal value plus accrued interest in the full faith and credit of the US Government. They are, in effect, a form of savings bonds. They can be held for up to 30 years.
Can I cash them? You can cash out an I-Bond anytime after 12 months. However, you lose three months interest if you cash in an I-Bond during the first five years of ownership.
How much can I buy? You can buy up to $10,000 worth of I-Bonds per year per social security number. Thus, a married couple could register a bond under each spouse’s social security number, presumably with the other spouse as the beneficiary. You can also buy bonds in the name of a trust or entity. Children under 18 can also have I-Bonds. Thus, families can buy up to $10,000 per social security number in the family per year.
How to buy I-Bonds? You can buy electronic I-Bonds via Treasury Direct, which is relatively simple. You can also purchase a paper I-Bond through your tax return using your refund. Buyers file an IRS Form 8888 to use their refund to purchase the Bond. (Note: you will receive a paper deposit.)
What should I name the bond? I-Bonds can be titled individually or with a beneficiary. If there is no named beneficiary, the I-Bonds will be included in the owner’s estate. Obviously, a beneficiary is preferred.
Tax consequences? I-Bonds are subject to federal income tax when cashed, but are not subject to state income tax. I-Bonds may be tax exempt under certain circumstances if used for educational purposes. File a Form 8815 to get the tax-free benefit.
Conclusion. The boring and dumb I-Bond is a fantastic tool to get a safe and now high rate of return. For $10,000 per person per year, the I-Bond is a safe, inflation-protected addition to a portfolio. Access Treasury Direct or take an I-Bond with your tax refund. You’ll earn about 100 times more than your money market fund, at least for now, plus save taxes. As always, I will try to answer questions emailed to llabrecque@sequoia-financial.com.
