What are I Bonds?
July 29, 2022. By J.D. Wolfsberg:
With inflation being one of the top issues on investors minds, Series I Savings Bonds have recently garnered more attention than in the previous decade when inflation was dormant. As with any investment, there are many variables to consider prior to making an investment, so we thought it would be helpful to review the requirements and operational considerations of an investment in I Bonds.
How Does the Investment Work?
I Bonds are purchased at face value – so a $100 investment purchases exactly $100 worth of an I Bond. They have an annual interest rate that is composed of a fixed rate as well as semi-annual inflation rate. The fixed rate of the bond from the date of purchase will never change and is announced every six months as the Treasury issues new I Bonds. The semi-annual inflation rate is the rate that will adjust. This rate is tied directly to the Consumer Price Index (the most widely recognized inflation indicator). Below is an example of the interest rate decomposed directly from Treasury Direct:
(Chart Source: Treasury Direct)
The inflation rate will adjust every six months from the date of the issue of the I Bond that has been purchased. Treasury Direct notes that while the overall rate will never be negative, there can be circumstances if inflation is negative (a period of deflation) it can result in a lower overall rate than the fixed rate component on that specific I Bond (given that the fixed rate is 0% in the preceding example, it would not apply to this particular bond).
What’s interesting to note is that in the previous decade of low interest rates, the fixed rates have lagged other benchmark interest rates in the economy given that there is an inflation component to the interest rate. Fixed rates for I Bonds have not exceeded 1% since before the Financial Crisis in 2008.
How is Interest Paid?
Coupon payments are not paid to the investor but instead the interest accrues and is added to the principal. The investor will receive the payment when the bond matures in 30 years or is cashed, whichever come first.
What are the Tax Implications of Investing in Series I Bonds?
Similarly to other Treasury securities, I Bonds are subject to Federal income tax but not state income tax. As investors do not receive the accrued interest until the bond is cashed, the investor can choose to either A.) Pay taxes on the accrued interest annually or B.) Recognize the total amount of accrued interest when the bond is cashed or reaches final maturity.
What are the Limitations to Investing in I Bonds?
While the minimums are low (electronic I Bonds only require a $25 minimum purchase), an individual can only purchase up to $10k in I Bonds per calendar year. The individual must hold this bond for at least one year, and if redeemed within 5 years, will forfeit 3 months of accrued interest upon redemption of the investment. Should an individual inadvertently purchase more than $10k, a refund will be processed which could take up to 16 weeks. The other operational consideration is that these bonds can only be purchased through opening an account on Treasury Direct. Should an investor wish to move forward with a purchase of the investment, it is essential to keep track of the username and password, and keep their financial professionals in the loop.
In summary, with I Bonds receiving more attention with the highest inflation investors have seen in forty years, it’s important to consider all aspects of I Bonds, and whether or not they are a fit for your personal portfolio. The maximum purchase amount, the early withdrawal penalty, and the need to purchase through Treasury Direct are limitations that may warrant further consideration before moving forward with the investment. Should you have any questions regarding I Bonds, please do not hesitate to reach out.