In most cases, there is an obvious trade-off to investing. If you want the possibility of higher returns, you must accept higher risks. There is one investment, however, that should soon offer returns that annualize at a rate of return of 9.62%, while carrying a US government-backed payment guarantee. This investment? I-Bonds.
I-Bonds are 30-year US government bonds that offer a fixed rate of return plus an inflation-adjusted rate of return. The fixed rate is currently at 0%, and on May 1, the inflation-adjusted rate of return is expected to increase to that annualized level of 9.62%. This makes I-Bonds a way to earn a virtually risk-free annualized return of nearly 10%, but of course there are conditions attached to this investment.
What’s the catch?
The catch is that each individual can only purchase $10,000 worth of I-Bonds per year electronically through TreasuryDirect, plus an additional $5,000 worth of paper I-Bonds if purchased through cashback. tax. This makes I-Bonds useful but limits their scope in the fixed income portion of an investor’s portfolio.
Another – and potentially much bigger – problem is that once you’ve purchased an I-Bond, you must keep it for at least a year. You are not allowed to sell earlier than this period, which means your money is locked in for at least that long. It is therefore difficult to recommend I-Bonds as a source of emergency funds, because the purpose of an emergency fund is to have money available when you need it.
As if that weren’t enough, you only really get the advertised returns on your I-Bonds if you hold them for at least five years. If you sell before then, you lose the last three months of accrued interest on the bonds.
On top of that, the US Treasury adjusts the yields offered by I-Bonds every six months, based on recent inflation rates. This means that while I-Bonds purchased between May and October 2022 will likely earn this high rate of return for six months, their future returns will depend on inflation.
And of course, the interest you earn on the I-Bonds is considered ordinary income – and federally taxed accordingly, unless you use the I-Bonds to pay college fees in some way. qualified. On a more positive note, you can defer these taxes until you pay off your I-Bonds or they reach their final maturity.
So, for whom do I-Bonds make sense?
These catches make the reality of owning I-Bonds a little less appealing than the potential returns would indicate. That doesn’t mean they’re worthless, though. This means you need to consider how they can play a reasonable role in your portfolio given the pitfalls and restrictions associated with owning them.
One way they may play a role is if you expect inflation to stay high for years while you also expect the stock market to stay rocky over the same period. In this world, I-Bonds can be a reasonable parking spot instead of cash, since that cash should at least approximate inflation (after taxes and potential prepayment penalty).
Also, a key financial guideline to remember is that the money you plan to spend over the next five years does not belong in stocks. If you know of a major expense coming up in about five years – like your child’s education, paying off ballooning debt, or buying a new car – then I-Bonds can be a great place to keep that money. Even with the terms attached, I-Bond rates are currently higher than most investment-grade bonds of similar duration, making them an attractive alternative.
I-Bonds can also play a role in your children’s education planning, as you may be able to exclude interest from I-Bonds from your income if you use them to pay school fees. That said, there are key restrictions to this benefit, including these:
- Your income must be less than $98,200 if you are single or $154,800 if you are married and filing jointly.
- You must be at least 24 years old when you buy the I-Bonds,
- You collect the I-Bonds the same year that you pay the tuition fees.
Given these restrictions, it makes sense to consider I-Bonds as a potential source of college savings only after maximizing the tax advantages of a 529 plan. maximum incomes of their parents, and a sufficiently high income will eliminate this tax advantage related to the use of I-Bonds for education expenses.
Get your plan in place today
If you’re considering investing in I-Bonds as part of your inflation-fighting plan, it’s important that you have a decent end-to-end strategy in place before doing so. Indeed, the purchase limit per year, the minimum holding period of one year and the potential loss of interest for early withdrawals make them more suitable for surgical-style use. So get your plan in place today and give yourself a decent chance of seeing at least some of your money have a chance of staying close to inflation.