Financial Living Blog

Do I Bonds Make Sense for your Cash Reserves?

May 11, 2022 9:21:29 AM

AdobeStock_324162728With rising inflation, volatile stock and bond prices, and low interest rates on regular bank accounts, there are few places for investors to store any extra cash.

That has made a little-known investment called I bonds suddenly a hot topic. Primarily, because the Treasury Department announced that Series I savings bonds, or I bonds, will pay 9.62% interest through October.

Investors should never chase returns, but considering the current state of the economy and investment markets, this may be a good time to consider I bonds. Still, with any type of investment they have various pros and cons.

Here’s what you should know about this type of savings bond.

What are I bonds?

I bonds are a type of U.S. savings bond designed for inflation protection. They are backed by the U.S. government and offer a guarantee that you can recover your original capital plus any increases in the official cost of living along the way.

Returns on I bonds are adjusted for the inflation rate, which changes every six months and is based on the Consumer Price Index. I bond rates are announced by the Treasury Department each May and November. For I bonds issued from May 2022 through the end of October 2022, the overall rate is 9.62 percent.

With inflation hitting four-decade highs, this higher-returning, lower-risk investment may make a lot of sense for some investors.

What are some I bond rules?

I bonds have certain rules to consider before adding them to your portfolio.

The maximum purchase is $10,000 per year, per account holder. However, you can purchase another $5,000 with your tax refund, upping the annual total purchase amount of series I bonds to $15,000 per person. You may also buy more I bonds through businesses, trusts or estates.

Additionally, you must own the bond for at least five years to receive all of the interest that is due. You cannot cash out an I bond before holding it for a year. If you do so after a year but before five years, you forfeit three months of interest.

How are I bonds taxed?

Series I savings bonds are subject to federal taxes. You will owe the federal government taxes on the interest income you earn during the time you hold them. However, I bonds are exempt from state and local income taxes, which makes them an even better low-risk investment for investors who live in high-tax states and cities.

Where can you buy I bonds?

I bonds can be purchased annually through the government’s TreasuryDirect website at Treasurydirect.gov.

But here’s the thing: investors must purchase and manage the I bonds they purchase on their own. That means an investor’s financial adviser could not purchase them on their behalf and those bonds would essentially exist outside of their portfolio that is professionally managed.

What are the drawbacks of I bonds?

Again, you can’t redeem I bonds for at least one year, and if you cash them in within five years, you’ll lose the previous three months of interest.

Plus, there is the possibility of lower future returns. The inflation-adjusted rate may adjust downward every six months, making other higher-paying investment assets a better option for your portfolio.

Another drawback to reiterate is that this is an investment you would have to buy and manage on your own. They could not be seamlessly added to an investment portfolio managed by your financial adviser.

So, do I bonds make sense in your portfolio?

Depending on your situation, I bonds could be a good place to store cash you don’t need right away. Therefore, they should be considered for funds outside of your emergency fund and not as a replacement for long-term funds.

As with any investment opportunity, make sure you do your homework and carefully weigh the pros and cons. To eliminate any of the guesswork, you can make sure I bonds make sense for you with the help of a financial adviser.

Just as important as getting the most out of your savings is choosing the right strategy for claiming Social Security. Learn more about Social Security by downloading this free guide:

SocSecGuide-imageDownload the Social Security Guide Here

    
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