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Understanding I-Bonds & How They May Fit Your Plan

Understanding I-Bonds

I-bonds are the hot topic these days and rightfully so given the high rate of interest they currently pay.

If you aren’t already familiar with this investment then it is certainly something worth learning about to determine if it has a place in your financial strategy.

Here I will break down:

  1. What an I-bond is and how it works
  2. Rules around purchasing I-bonds
  3. How it might fit within your financial strategy

What is an I-bond?

An I-bond is a government issued bond that is tied to inflation - hence why they are so popular right now given the continued high rate of inflation.They consist of two parts: a fixed rate, current set at 0% and an inflation rate, currently set at 9.62%.

That's right...I-bonds currently yield 9.62%!!

You may want to go put all of your money into this investment, but unfortunately there are rules and limits which we will get to shortly. And besides that, I don't advise ever putting all of your money in any one investment.

The interest rate on I-bonds is reset every 6 months in May and November. The way that it works is if you buy an I-bond anytime within that window, then you will lock in that rate for the next 6 months. Once you have held the bond for 6 months, your interest rate will reset to whatever the new rate is that was announced in either May or November, depending on the time frame of your purchase. 

For example: If you are to buy an I-bond at 9.62% on July 1, 2022 then you will receive that interest rate for the next 6 months - meaning through December of 2022. On January 1 of 2023, the interest rate would reset to whatever rate was announced in November of 2022. But remember, the interest rate could adjust up OR down every 6 months. There is no guarantee that you will continue to receive such high interest rates going forward if inflation cools down. 

Taxation

Not only do I-bonds currently have very high interest rates, but the interest can also be tax deferred until you cash in your bond. That means you will not be taxed on the interest annually. Even better is that your interest will earn interest going forward, a term called compounding. In addition to the interest being tax deferred, once you do pay tax it is only at the federal level, not state. 

Sounds to good to be true, right?!? Now to the downside. Iin truth, there isn't much downside, you just need to understand all aspects of the investment.

Holding Period

I-bonds can be held for up to 30 years, but they must be held for a minimum of 12 months, meaning you cannot access the money during that time should you need it for any reason. Additionally, if you cash in your bond within the first 5 years, then you will lose the last 3 months of interest. 

There are also limits on how much you can purchase each year. 

How Much Can You Purchase? 

Because I-bonds are such a great deal, the government limits how much you are able to purchase. 

Each person is limited to $10,000 in purchases per year in electronic form and an additional $5,000 in paper form by using your tax refund. However, trusts and business entities can also purchase up to $10,000 per year. Plus, I-bonds can be gifted to others, such as children. 

Let's run through an example of a family of 4 - 2 parents and 2 children - who also own a business. In this case, the family could purchase $55,000 in I-bonds per year. $10,000 in electronic form per parent, $10,000 through the business, $10,000 in the name of each child (be careful - this is an irrevocable gift) and $5,000 in paper form through the couples tax refund. 

That is a lot of money that could be put into this high interest bearing investment! 

So how do you buy an I-bond? Not like most other investments that are purchased through your IRA or brokerage account at a custodian. I-bonds must be purchased directly through the treasury at www.treasurydirect.com You must first establish an account for yourself, or for anyone else who you are buying a bond for. If you are purchasing an I-bond through a trust or business entity, then you must establish an account through those as well. 

How Can I-bonds Fit Within Your Financial Strategy?

So now that you have learned about the benefits of I-bonds, the holding period requirement, how much you can buy and so on, you may be wondering how this may fit within your financial strategy. Good question. 

  1. I-bonds can be a good place to park extra cash above and beyond your emergency fund that you want to hedge against inflation, but which you don't necessarily want to invest. These are not a good substitute for emergency savings given the lockup period for 12 months. You will still want to keep your emergency fund easily accessible in the bank. They can be good for any excess cash though. 
  2. Within your broader bond allocation. Because the value of the investment is secure and it earns interest, it can be viewed in the context of your bond holdings. For example, if you have $500,000 in investments, 20% of which you have in bonds ($100,000) then any amount of I-bonds you accumulate over the years could be part of that allocation. 
  3. As a gift. As I discussed earlier, you can gift I-bonds to your children - or to any other individuals for that matter as long as you have their personal information. If you would like to set aside money for your children then I-bonds could be a good option. Don't forget though, that these are irrevocable gifts and count toward your annual gift exclusion, which is $16,000 per person in 2022. These gifts can be earmarked for college purposes or or in any other way that you wish your kids to use them. 

Final Thoughts

Whether I-bonds are appropriate for you depends on your financial situation. As with any other financial decision, the inclusion of these investments should be intentional and with specific purpose. They are certainly something that you need to be aware of and consider. Any tool to fight inflation should be looked at. 

If you are unsure about whether I-bonds are a good fit for you then contact Crest Wealth Advisors today to discuss your financial strategy and how this may fit within your plan. 

Disclaimer: This article is provided for general information and illustration purposes only. Nothing contained in the material constitutes tax advice, a recommendation for purchase or sale of any security, or investment advisory services. I encourage you to consult a financial planner, accountant, and/or legal counsel for advice specific to your situation. Reproduction of this material is prohibited without written permission from Jason Dall’Acqua, and all rights are reserved.