Amaka Chukwuma, Wealth of Geeks
It’s a given that cash is a bad asset with the current high inflation rate. Hence, suitable investments and hedge strategies for inflation become a necessity. Understanding how Series I Savings Bonds from the US treasury function can help protect your dollars from the effects of inflation.
Jeremy Keil, CFP®, is a retirement-focused financial planner with Keil Financial Partners and host of the Retirement Revealed blog and podcast. Danielle Miura, CFP®, is the founder of Spark Financial. These two experts give answers to common Series I Bond questions.
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What do I bonds mean?
According to Keil, I bonds are similar to Series E Savings Bonds, except inflation determines the interest, and the rates are now very high. I bonds annualized interest rates have reached an all-time high of 9.62 percent, and only the US Treasury issues them. I bonds are designed to beat the market and to keep money inflation-proof.
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How do I bonds address the problem of inflation?
The way I bonds fight inflation is by setting interest rates every six months based on the consumer price index. For illustration, if inflation goes up by, say, 6%, the bond rate will adjust to pay more than that. Today, The annual inflation rate in the US rose from 8.6% to 9.1% in June 2022, the highest rate since November 1981.
This meant that bond rates had to change to reflect the status quo. Unlike traditional ways of saving, I bonds don’t just yield interest but also keep your buying power.
Even with compound interest, your savings grow at a similar rate as inflation, which is something you won’t get from traditional savings. I bonds will adjust with inflation, but according to Keil, based on past inflation. Keil explains, “The 6-month inflation rates are based on two specific points in time. The six months leading up to March and again leading up to September each year.”
Keil notes that typically, by mid-April and mid-October, we should expect the Bureau of Labor Statistics (BLS) to announce the 6-month data on the first Monday of May and November.
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Update as of September 14
While we don’t yet know the exact rate that the BLS will announce come the first week of November, Jeremy Keil, CFP® did share this:
“Five of the six months needed to determine the November 2022 I Bond rate have been released. Right now, it’s looking like around a 6-7% rate, which means the highest I Bond rate in history would end in October. If someone buys before the rate reset that would equate to roughly an 8-8.5% one year rate.”
It’s a good idea to not wait for the official word in November, but if you want to take advantage of higher than usual rates, purchase Series I Bonds now to have the best chance of continuing to match or beat inflation in the next few years.
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How are interest rates calculated on these bonds?
I-bonds give two returns. Keil says that you get a fixed rate that stays the same over the bond’s life. Right now, that rate is zero percent. Then, on top of that fixed rate, you get an inflation rate of 9.62 percent, which is announced and changed every six months.
He explains that the current inflation rate covers the period from May 1, 2022, to October 31, 2022. The next rate will be from November 1, 2022, to April 30, 2023, but that rate isn’t known - it will depend on how much inflation has changed at that point.
9.62 percent per year applies as 9.62/12. And amounts to 0.802 percent per month or 4.81 percent for six months. It doesn’t mean that in six months, you’ll get a return of 9.62 percent. You also can’t get the interest payments until you cash out the bonds, which can take up to 30 years if you choose to keep them that long.
There’s also a restriction on taking the money out for the first five years. If you do, you forfeit the interest for the previous three months.
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Are they different from other bonds?
Series I Savings Bonds differ from many other bonds because they give you interest that adds up. But it adds up every six months instead of every day or month. That means the interest adds to the principal every six months. The total is then used to calculate the interest for the next six months.
Another distinction, Miura says, is that whereas most bonds have fixed rates, Series I Savings Bonds have fixed and variable rates that change in response to inflation. According to Keil, “you can only buy and sell I bonds through TreasuryDirect.gov.” He adds, “With the small exception of being able to use your Federal Income Tax Refund to buy up to $5,000 in paper I bonds.”
He claims that this is helpful because you won’t lose value in your I bonds when interest rates rise. However, he explains that it implies I bonds are less liquid because they are harder to trade.
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When and how will their interest rate update and change?
Keil remarks that you won’t receive the increased interest rate until your personal I bond’s 6-month renewal period. According to Keil’s assertion, if you haven’t reached a 6-month anniversary, you shouldn’t anticipate a rate update during the November-April interval.
Therefore, if you purchased in July, your rate won’t increase in November simply because new prices are out; rather, it will update in January when you reach your 6-month anniversary, explains Keil.
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How do they compare to the stock market?
Keil admits the fluctuating nature of the stock market makes it hard to know if you would make or lose money. He notes that the stock market is more of long-term growth investment. Miura affirms that I bonds are relatively risk-free because the US government guarantees them. Since Series I Savings Bonds are a type of bond, she says, their interest rate will fluctuate less than a typical individual stock or ETF.
How do they mature?
According to Keil, Series I Savings Bonds mature in 30 years but can’t cash out in the first year no matter how hard you try. You’ll also lose the prior three months’ interest if you cash out in the first five years of owning it. This isn’t a reason to think you have to hold the bonds for five years. It’s just a consideration to remember when looking for other interest-rate investments,” Keil clarifies.
What Should Be Considered Before Buying?
Miura advises before investing money into I bonds, double-check your emergency fund. Since the maximum allowed to invest in I bonds is $15,000, those with a high net worth will not feel the effects of having a 9% return. She further notes that one should consider that it’s impossible to purchase I bonds from retirement accounts. You will have to use other savings.
Consider how you would fare without the money you intend to invest in order to avoid being stranded in the immediate future. You should also consider your future financial goals and see if investing in I bonds can help you reach them. According to Keil, “If you need money 1+ years from now and you want it guaranteed, it’s hard to beat an I bond.”
How Are They Taxed?
Keil explains that you could choose to pay taxes each year on the interest. But you’re likely to wait until you cash out the I bond and pay taxes on all the interest you’ve earned over the life of the bond in that one year. He notes that the interest is state and local tax-free and only needs to be reported on your Federal Income Tax return.
In addition, Miura notes that savings bonds are not taxable when used for qualified educational expenses. Therefore, she suggests that this investment may be suitable for those who are paying for their child’s education or their own education in the future.
Are They Good for Low-risk Investing?
I bonds are a great choice, as Miura says, for conservative investors who want a secure investment to protect their money from inflation. It gives you a steady return with low risk, and Kiel says it’s great for people who can wait at least a year to use it. For example, if you want to buy a property in two years, you can store cash by buying I bonds in two installments of $10,000 each.
What Are Some Alternatives to I Bonds?
Some alternatives to I bonds, Kiel says, include certificates of deposit, CDs, Multi-Year Guaranty Annuities, money markets, and Treasury Bills. Treasury inflation-protected securities (TIPs) and Series EE bonds, Muira says, are also great alternatives.
What’s the Minimum Purchase?
$25 is the minimum purchase for electronic I bonds and $50 for paper bonds.
What Happens if One Loses I Bonds?
Miura advises that if you lose your paper I bond, investors can substitute the lost physical documentation with an electronic savings bond. However, since many people purchase I bonds electronically, it’s unlikely that you would lose them.
How Are I Bonds Different From EE Bonds?
The distinction between the two lies in determining your investments’ long-term value. For example, Keil asserts that the value of EE Bonds is guaranteed to double in 20 years. In fact, the whole purpose of the EE Series Savings Bonds is that you pay half up front and they fully vest in 20 years (i.e., $25 initial buy becomes $50 in 20 years).
With I Bonds, you have no knowledge or guarantee of their value in 20 years. They may increase dramatically, or simply hold their accumulated value, as the interest rate is guaranteed never to fall below 0%.
The US Treasury establishes the rate for EE bonds without adjusting for inflation, while I bonds include that inflation adjustment.
Adding to that, Miura states that the decision to invest in either is strongly influenced by the existing interest rates and the projected inflation trajectory. You can decide by weighing your options. Keil opines that EE bonds are appropriate if you want a guarantee that your money will double in 20 years, but may have accrued less value than that if drawn out within the first 20 years. If you’re more concerned with an interest rate focused on inflation, an I bond is the best option.
How Much Can One Invest in Series I Bonds?
You can invest up to $10,000 per calendar year per tax entity, responds Keil. He further explains that this means you and your spouse could each buy $10,000. So can your kids, your business, and especially your revocable living trust.
Do I Bonds Have Long-term Growth Potential as Other Asset Classes Like Stocks?
Keil thinks they are suitable to replace regular, traceable bonds, especially over the next 2-3 years, but they are not a stock replacement. According to him, historically, stocks have returned 4-6 percent over inflation in the long run, but with big swings in return (including big negatives). On the flip side, I bonds have returned 0-3 percent over inflation but with no negative returns.
Miura further suggests that investing two to five years in I bonds long-term might help you reach your saving goal. But keeping them for over 30 years makes you unsure what your returns will be, even though you will not lose any interest in penalties. Also, according to her, Series I bonds are unlikely to significantly impact diversifying your portfolio because of their yearly purchase limit. She concludes that investments like stocks might be more suitable for long-time horizons.
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Updated 9/13/2022.
