It costs what?!!
By Jennifer Edwards, CFP®, CSLP®
To say that inflation has been hitting us all pretty hard recently, would be an understatement. Prices of everything from haircuts to lunchmeat went up an average of 8.5% in March, the highest in decades. And heaven help you if you need to rent a car!
You may be trying to find a way to combat the deterioration of the purchasing power in your cash savings. And while some do better than others, savings account rates typically don’t keep up with inflation. There is, however, a safe way to earn a decent return on at least a chunk of your spare cash. Let’s take a look at “I bonds”.
I bonds are a type of security issued by the federal government that allow US persons to make a whopping 9.62% until November. That’s 192 times what your typical high-yield savings account is paying right now! I bonds are only available for purchase through Treasury Direct and opening an account takes about 15 minutes. But before you jump on the I bond train, there are some important things to keep in mind.
How bonds are bought and redeemed
A bond is basically a loan. When you buy a bond from the federal government, you are loaning them some of your money and they will pay you interest on that loan. Different types of bonds have different “maturities”. The maturity of a bond just refers to how long that bond will pay interest. You buy a bond today, the government pays you interest and when you “redeem” your bond, you get your initial bond purchase price back. Bonds are a way for entities like the government or companies to raise capital, or sometimes, for the government to induce people to save instead of spend.
Penalty if you redeem within 5 years
I bonds have a maturity of 30 years, meaning they only pay interest for a maximum of 30 years. The minimum holding period is 12 months, so you cannot redeem them within a year. If you redeem them before holding them for at least 5 years, you will be assessed a penalty of your last 3 months’ interest payments. So they are kind of like a 5-year CD with a minimum holding period of 1 year.
Interest rates are variable
Unlike a CD where the interest rate is stable for the entire time you have the CD, I bonds have a variable interest rate. The rate is based on the CPI (Urban) rate for the previous 6-month period. The 9.62% interest rate runs through October, but after that, the rate could change depending on inflation. But think of this – even if the rate were to go to zero in November (not likely) you’d still be making substantially more over the year than your average savings account.
You can only buy up to $15,000 of I Bonds
Denominations are in $25 increments and each person or legal entity can only buy up to $10,000 per calendar year of bonds in electronic form. You can use your tax return to buy another $5000 of paper bonds, for a max of $15,000 per year. So, you can’t stick a large amount of your portfolio in these.
One of the great things about I bonds is that you are not taxed on the interest until you redeem the bonds. This is very different from bond funds where you pay income tax on interest payments when they are issued whether or not you liquidate your shares in the bond fund. You can avoid taxes altogether by using the bond to pay for college expenses. Interest on I bonds is not subject to state or local income taxes.
In Summary – I Bonds may be right for you!
If you have some extra cash lying around that you are sure you are not going to need for at least a year (this would not be a good place for your emergency fund), you may want to consider I bonds – one way to make lemonade out of overpriced lemons.