I-Bonds: An Appealing Alternative to Excess Cash Reserves

Written By: Nick Ziarek, CFP®, CFA

A lot of attention has been given of late to the old Series I-bonds offered by the US government. And rightfully so; they are a savings bond that offers a combination of a fixed coupon and a variable rate based on inflation. Today the combined rate is 9.62%, far out pacing anything offered by your local bank.  If you have excess cash on hand or regularly carry a high checking and savings balance, an investment could make sense to earn some extra interest.

Although there are a few caveats you should be aware of before investing:

• Purchases are limited to $10,000 per calendar year per person. A couple would be eligible to purchase $20,000 in a calendar year. (There is a way to purchase an additional $5,000 when filing your federal income tax return, but that can only be done with your refund).
• The bonds must be purchased electronically through the government’s TreasuryDirect website (treasurydirect.gov).
• Bonds can be purchased throughout the year, although the variable inflation rate is set in May and November of each year based off the official Consumer Price Index (CPI-U). Bonds purchased any time before the reset dates will receive the current rate for a full 6 months before adjusting.
• You must hold the bond for at least 12 months. This means there will be one rate reset during your holding period which could be higher or lower than the current rate. The rate is reported as an annualized rate (9.62%) although you only earn that interest for 6 months (4.81% semi-annually) before it is reset to the then current CPI-U level.
• If you hold the bonds for less than 5 years, you will forfeit the prior three months of interest.
• Interest is added to the bond monthly and paid when you cash the bond.
• The interest can be reported on your taxes every year or deferred until you cash the bond in. It is only taxable at your marginal Federal income tax rate. No state or local taxes are owed.

Let’s look at a hypothetical scenario where you purchase an I-bond today earning 9.62%. Remember that rate is credited semi-annually before adjusting to the then current CPI-U. Let’s say inflation rate comes down a bit and you earn 5% (2.5% semi-annually) for the second six months at which time you cash in your bond.

You would have earned 7.56% for the full one-year holding period. But, there is the three month interest penalty for holding the bond less than five years, reducing the interest earned to 6.22%. After adjusting for Federal taxes owed on the interest, the net after-tax yield could be as high as 5.6% for those in the lowest tax bracket and as low as 3.9% for those in the highest brackets.

If you are willing to do a little legwork, are comfortable with opening and funding accounts online knowing the investment and return are limited, I-bonds can offer an attractive return compared to 0.1% on your bank savings, but maybe not as rich as the 9.62% headline rate you may have read about as these bonds are advertised. Your Shakespeare advisor is always happy to answer your questions to see if I-bonds make sense for your overall financial plan.