S&A Financial Services, Inc. Blog….
Welcome to the exciting world of I Bonds. FYI…. this info can also be found on my podcast Small Business Financial Podcast, episode #1.
NEVER did I think I’d be hosting a podcast episode and writing a blog on government issued I Bonds, but here we are folks. I feel compelled to talk about what the people want. And believe it or not, as of late, that is I Bonds.
These things seem to be all the rage right now. Other than when crypto caught wind in the mass media, I can’t recall a particular investment that received more attention from my clients.
I MUST EMPHASIZE that everything I write about here regarding I Bonds is NOT investment advice and before you decide to go the route of I Bonds, you need to talk to your CPA or financial advisor first. Also, everything I write about here, and other “things” I fail to mention regarding I Bonds, can be found on www.treasurydirect.com
The “I” in I bonds stands for inflation. As I’ll discuss, this is important because one of the components driving interest in the I Bond is tied to inflation.
Interest will reset every 6 months on the 1st of May and November. As I write this on May 12, we just had a rate reset back a few days ago, which I’ll discuss later.
How / where does the interest from I Bonds come from – how is it calculated…? There are 2 components to the “total” interest these I Bonds generate.
1 – You have a fixed rate that will never change for the life of the bond. Sounds great right! Unfortunately, this rate has been ZERO since May 2020. Soooo…. That won’t help you out much, right?
2 – The component that will help you out is the variable part. This is the component of I Bonds that’s tied to inflation (CPI). This rate will fluctuate each 6 months dependent upon where inflation (CPI) is. Right now, as of May 1st, that rate is at an alarming 9.62%!
I’ve been asked a time or two if these I Bonds are the same, or similar to, EE Bonds. No, they’re not the same. I’d encourage you to do your own research on this, but from my understanding, you’d need to hold the EE Bonds for 20 years and the interest on them isn’t much more than what you’re getting on your bank checking / savings account – which is close to nothing these days.
Back to I Bonds. How does one go about buying these I Bonds? 2 ways to purchase them…..
1 – Set up an account through www.treasurydirect.gov and transfer money from your bank account in order to purchase the I Bond. Everything will be electronic and you WILL NOT receive a physical certificate.
2 – Through your refund. If you were so inclined to get money back from your return, you can use those proceeds (up to $5,000) to purchase an I Bond. If you go this route you WILL receive a physical certificate, which you can turn around and convert it electronically if you choose to do so.
Please note – you can only buy I Bonds with non-qualified money. What this means is that you can’t hold these bonds in your IRA or employer retirement plan. You also can not purchase an I Bond with a brokerage account. ONLY checking or savings accounts. Now, if you happen to have a checking account at a financial institution like Schwab, you can use that.
There is a limit as to how much of an I Bond you can purchase….
$10,000 per person, per calendar year. However, if you also choose to use your refund, then you’re looking at $15,000 per person, per calendar year.
Now, if you want to get fancy, from what I’ve been told, you can use a Trust account (must have separate Tax ID number) to buy $10,000 worth of I Bonds as well. Again, this is what I’ve been told so I’d encourage you to do more research on www.treasurydirect.gov and / or talk to your CPA regarding this.
Can you gift an I Bond? Yes. Again, a little fuzzy on this one, but I do know that the $10,000 dollar limit would go towards the recipient of the I Bond, not the purchaser. Of course, this would be mostly of interest to grandparents gifting I Bonds to children / grandchildren. There will be other scenarios that would apply, but make sure you check out www.treasurydirect.gov for more details on the gifting rules.
Beneficiary – What happens to these I Bonds upon your death?
If you do nothing, then the I Bond will go through probate and the courts will decide to whom receives the I Bond (will be issued in-kind).
If you have estate planning docs in place like a Will or Trust, then the I Bond will be considered an asset that’s distributed via the language in those docs.
To make life a lot easier for everyone, you can place a POD (payable on death) on the I Bond. This is where you’ll name a beneficiary on the I Bond and that person will receive the actual I Bond (NOT the cash equivalent) upon owner’s death.
Also, you can designate joint ownership. Similar to a JTWROS account at Schwab or other brokerage house.
The last 2 options, POD and joint ownership, will help to skip the lengthy / costly process of probate and also bypass the estate docs as well.
Now, what if you inherit an I Bond? This will NOT go against your annual $10,000 limit if you wanted to purchase another I Bond in the same year.
Something I failed to mention earlier is that you can never lose principle on your I Bond investment. Not my words – this is language on www.treasurydirect.gov.
Minimum purchase on I Bonds is $25 and you’re able to dollar cost average into it with any dollar amount above that $25 minimum.
Let’s get into that fixed rate component of the I Bond. For the life of me, I can’t figure out how the fixed rate is determined. I’m sure some of you out there already know the answer to this. But after the 2min I spent trying to figure it out, I lost interest and realized that I didn’t care enough to know the answer. Fact of the matter is, fixed rate is ZERO. Good enough for me….
As for the variable rate, like I mentioned earlier, we’re looking at 9.62% as of May 1st 2022. Again, that rate will change Nov 1st depending upon where inflation (CPI) is at that time.
Take note – the interest on these I Bonds will compound for you. So, what I mean by this is that if you bought the I Bond today that rate is set at 9.62%. Whatever the new rate is in Nov., you’ll get 6 months worth of that new rate on top of your principle + interest accumulated up until Nov. 1st. Awesome feature!
I Bonds can only be held for 30 years. In fact, there’s some sort of mandatory liquidation event at the end of 30 years. Not sure what it is, but I can’t imagine most folks hold these things for that length of time. Gifts to grandkids being the main exception.
Also, interest on the I Bond can NEVER be negative. Even during deflationary times.
You’ll want to hold the I Bond for at least 12 months, but I’d advise going into this thinking that you’ll own it for 5 years. Honestly, I don’t even think you could redeem it within 12 months. If you were to redeem prior to 5 years, it’s my understanding that you’ll be penalized the prior 3 months worth of interest. After 5 years, you’re smooth sailing regarding penalties on redemptions.
Taxation….OK, I’ll give you what I know, but this is NOT my area of specialty. This is where, again, I’ll direct you towards www.treasurydirect.gov and your CPA.
Fully taxable at Fed level and tax free at State and Local level. Obviously, this would become more attractive to those living in high taxed states.
This part’s a little tricky. You will receive a 1099-INT upon selling the I Bond, but I’ve been told that there is a way to pay taxes along the way (on the interest) rather than paying upon sale. Again, I didn’t read this anywhere, but was told by tax planner that this is an option.
Now, the question all of you want to know…..do these things make sense to get into?
Well, I don’t know, what do you think?
Let’s be honest, 9.62% for 6 months (remember, that’s an annual rate) sounds great, but don’t we all think that inflation will subside somewhat over the years…?
Small dollar limitation combined with redemption restrictions (not liquid) is another knock against the I Bond.
Bottom line is that this MAY make sense for a small sleeve of your portfolio, but it’s not intended, nor will it, change your life financially. Make sure you talk to your CPA / financial advisor to see if this fits your situation.
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S&A Financial Services, Inc. is a registered investment adviser. Information presented is for educational purposes only and does not intend to make an offer or solicitation for the sale or purchase of any specific securities, investments, or investment strategies. Investments involve risk and, unless otherwise stated, are not guaranteed. Be sure to first consult with a qualified financial adviser and/or tax professional before implementing any strategy discussed herein. Past performance is not indicative of future performance.