Cody on I-Bonds
May 13th, 2022
Have you asked what are I-Bonds? Should I invest?
YOU are not alone – we are fielding this question daily.
What are I Bonds?
I Bonds are a US Treasury issued bond that will earn interest in one of two ways –
A fixed interest rate that does not change for the life of the bond.
– And –
A variable interest rate tied to inflation. The rate typically changes every 6 months. Bonds purchased today through October 2022 will earn a rate of 9.62%. At the end of 6 months the rate will adjust.
What else? You’re allowed to buy $10,000 per year, per taxpayer*. A married couple can purchase $20,000 per year. *You also have the ability to purchase an additional $5,000 per year on your tax return as long as you have a refund coming your way.
It’s important to know that I Bonds cannot, under any circumstances, be redeemed within the first year of purchase. Additionally, bonds that are redeemed between years 1 and 5 will be subject to an interest rate penalty equal to 3 months of interest.
How do they earn interest?
As referenced above, bonds purchased before October 2022 have a fixed interest rate of 0% (which does not change for as long as you hold the bond) and the variable interest rate is set at 9.62%. This variable rate is quoted annually, however, interest is paid every 6 months. This means that you earn 4.81% every 6 months (9.62% / 2). Note that the variable rate is only guaranteed for 6 months though. So even though the Treasury said the annual variable interest rate was 9.62%, they don’t know with certainty what the second 6 month rate will be (said another way, you’re getting the 4.81% for your first 6 months but we don’t know what inflation will be for your next 6 month period).
● Let’s say you purchase $10,000 of I Bonds in May 2022.
● These bonds earn a fixed interest rate of 0% and a variable interest rate of 4.81% for the first 6 months (9.62% / 2).
● In November 2022 your I bond is worth $10,481. At this point your bonds will earn whatever the new 6 months rate is.
What about taxes? I Bonds are only taxable at the federal level – no state or local taxes apply. There is no tax due when the interest is earned (although you have the option to report the interest income each year); it is instead due in the year when the bonds are redeemed.
Today’s combination of inflation and lower interest rates make I Bonds disruptive. As referenced above, you can earn 4.81% for the first 6 months of owning your I Bond which crushes the rate earned on a “high yield” savings account. If you have excess cash laying around and no interest in participating in the stock market then I Bonds are worth a look. I Bonds may serve a great role in complementing the bond portion of your portfolio . It’s important to use caution though as the money is locked in for the first 12 months and you’ll be subject to a slight interest rate penalty if you redeem them within the first 5 years.