Have you heard the recent buzz of I-Bonds, but are left wondering what they are and if they’re right for you?
We’ve got you covered.
The rise in popularity of I-Bonds raises a lot of questions:
How much/many can I purchase?
Individuals are limited to purchasing $10,000 of I-bonds annually, couples can each purchase $10,000 for a total of $20,000 annually. Though individuals can only purchase $10,000 in bonds there are ample opportunities to increase the total value of bonds purchased. Business’s, living trusts and children can purchase up to $10,000 each of I-bonds. Additionally, taxpayers that expect to receive a refund can opt for up to $5,000 of their return to be refunded in paper I-bonds, increasing their total annual purchase of bonds; with additional paperwork. With these allowances couples with children or living trusts may be able to purchase several times the standard limit of I-Bonds.
When and how are I-bond rates set?
I-bond rates are set in May and November of each year and are guaranteed for the first six months following the purchase of the bonds. After this initial six months the bonds will continue to pay each subsequent rate as set for the following six months, though it is important to note that there are no rate guarantees. Given the timing of the rate reset, and that the I-Bonds pay the purchase rate for 6 months, strategic timing of the bond purchase can maximize the amount you earn over a 7 month period. The total composite rate is based on the variable current inflation rate and a fixed component that will stay the same for the life of the bond. The variable current inflation rate is based upon the consumer price index for urban consumers or CPI-U, which and is calculated monthly, and is currently at 9.62% annualized. Currently, the fixed component that will be paid for the life of the bond is 0% meaning that bonds bought today should closely mirror the inflation rate but will have no additional fixed component. In the past this fixed component has been as high as 3.60% (May to November 2000).
What is the current rate of I-bonds and why is it significant?
The growing popularity of these I-bonds is due in large part to their extremely high current yield. Presently issued I-bonds are paying a record 4.81% over the first six months (9.62% annualized). Several of the older bonds with a large, fixed rate component are earning over 13% and I-bonds sold as recently as 2019 are earning over 10% this year. While earning 10% in the equity market is certainly not uncommon, earning close to 10% in the fixed income market is noteworthy. Current I-bond yields are at record highs but this is an outlier, in the past three years these I-bonds have earned: 7.12%, 3.54%, 1.68%, 1.06% and 2.22% semiannually, far less than the current favorable rate. Due to several notable restrictions and penalties upon early disposal investors should be cautious before purchasing large quantities of these bonds.
How long must I hold I-bonds and there any penalties associated with I-bonds that I should be aware of before purchasing them?
Holding requirements are an important factor to consider when purchasing I-bonds. These bonds must be held for at least 12 months before they can be redeemed or cashed out. This prevents purchasers from buying and selling bonds as part of a short-term strategy and preventing exploitation of the presently high rates. If liquidity is a concern within one year, then these bonds are a poor tool for investors. Additionally, if bonds are redeemed within five years of purchase date, then the last three months of interest are deducted as a penalty imposed upon the earnings of the bond interest. Bonds are routinely utilized to provide fixed income and stability in portfolios, trading the potential for higher returns for more stability than stocks. I-bonds are a useful tool to help anchor portfolios with higher potential returns than more traditional fixed income tools such as CD’s or Series EE Treasury bonds. Current Series EE savings bonds are earning .10% annually and are guaranteed to be worth twice their purchase price at maturity (20 years) though they can be held for up to 30 years. Compared to these traditional savings bonds I-bonds offer the same stability in a portfolio with significantly more earning potential.
How are I bonds taxed?
Interest earned on the bonds is taxed at the Federal level and are not taxed by the state The interest earned on I-bonds can be taxed in two ways. The taxes can be paid annually, or they can be paid upon redemption or sale of the bond. If bond interest is reported annually once, then all bond income must continue to be reported annually. The other more common approach is to report the earnings at the redemption or maturity of the bond. Either way the interest will be shown on the form 1099-INT. If the bonds are used for education funding, then there may be opportunities to promote greater tax efficiency. Subject to several requirements the I-bonds and their earnings can be a tax advantaged way to fund higher education.
How can I-bonds be a useful asset in my portfolio?
I-bonds like many fixed income assets are utilized to provide stability to a blended portfolio consisting of equity, commodities, fixed income and other assets. During times of market volatility fixed income is routinely used to maintain stability in such portfolios though this stability is afforded at the expense of earning potential. I-bonds currently offer greater earning potential than traditional fixed income instruments and may augment the returns in a portfolio typically provided by equity or other higher risk assets. Finally, with some careful planning, I-Bonds can make up a portion of your emergency cash reserves, eliminating the #1 complaint of emergency savings, which is “the money is losing value.”
Curious about how I-bonds can fit into your financial picture? Contact us to learn how I-bonds may become a valuable asset to your financial plan.
Written by Devin McCombs
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