Series I Savings Bonds (aka “I Bonds”) are a unique investment sold directly to individuals by the US Treasury that pay out a variable interest rate linked to inflation. This post collects general reasons to own these savings bonds without going into the internal details of how they work. Please also see my related post .
Backed by the US government and will never decrease in nominal value. If you buy an I Bond for $1,000, you’ll never get less than $1,000 back. Sometimes it’s nice to know that something will only go up in numerical value.
Pays interest that is the sum of a fixed rate and an inflation-linked rate. The fixed rate is set at purchase. The inflation-linked rate is reset every 6 months based on a preset formula tracking the CPI-U (Consumer Price Index for All Urban Consumers). This is unique and would come in helpful in times of unexpectedly higher inflation. I write about the every 6 months as well.
Sold directly by US Treasury with no fees. You must either buy them directly online at TreasuryDirect.gov or via paper bonds via tax return. There are no purchase fees or annual maintenance fees.
Interest from I-Bonds are exempt from state and/or local income taxes. Same as with US Treasury bonds and TIPS.
Federal income tax on interest is not due until redemption. This means that you can defer paying taxes on accrued interest for up to 30 years. You don’t owe taxes until you cash out. This also means that you can time your eventual withdrawal during a year where you have the lowest tax rate (i.e. when your income drops after retirement).
Possible tax-free interest when used for qualified educational expenses. If you meet all the requirements, you can even avoid federal income taxes completely when paying qualified higher education expenses at an eligible institution. These include income phase-out limits.More information at this . You can even contribute your proceeds to a 529 plan or Coverdell Educational Savings Account. Here are some tips from Finaid.org.
Series EE and I US Savings Bonds issued after December 31, 1989 may be redeemed tax-free in order to contribute the proceeds to a section 529 plan or Coverdell Education Savings Account. (To take advantage of this, file IRS Form 8815 to claim an exclusion for the interest after rolling the proceeds of these US Savings Bonds into a section 529 college savings plan or Coverdell Education Savings account. Write “529 College Savings Plan” or “Coverdell Education Savings Account” in the answer to 1(b), where it asks for the name of the educational institution. The specific citation in the tax code for this guidance is IRC Section 135(c)((2)(C).)
Reasons for NOT owning I Bonds.
- There are purchase limits for I Bonds of $10,000 per person per year in electronic format. You can also buy an additional $5,000 in paper bonds per year using your tax refund with . If you have children, you may be able to buy additional savings bonds by using a .
- The fixed rate has been low in recent years. Here, the inflation-linking may help you get an interest rate slightly above inflation, but after taxes, your net return may still lag inflation. For example if the fixed rate was zero and inflation was 2%, you would probably get less than a 2% return after taxes.
- As with interest earned from bank accounts and taxable bonds, interest is eventually taxed at ordinary income rates. Long-term capital gains and dividends from stocks are usually taxed at lower rate.
- You can’t redeem your savings bonds at all during the first 12 months. I believe there is a small exception if you can show yourself to be affected by an official natural disaster.
- If you redeem within the first 5 years, you will be subject to an early redemption penalty of your last 3 months of interest.
- TIPS are analyzed more deeply by financial professionals, and have not been found to lie on the “efficient frontier” curve. Thus, it is also unlikely that I bonds will optimal in that way.
- You may not want to open and track a separate Treasury Direct account just to hold your I Bonds.
- If you lose your online login and password to TreasuryDirect.gov and someone jumps through to steal your electronic I bonds, then the US Treasury will not reimburse you. If you lose paper bonds, there is a replacement policy.
TIPS vs. I Bonds.
Both have interest that both linked to inflation and is exempt from state/local taxes. You should compare the fixed rate from I Bonds with the current real rate in the TIPS market. Things that might make I Bonds more attractive than TIPS include the tax-deferral ability and the ability to avoid taxes when spent on qualified educational expenses. Things that might makes TIPS more attractive are the intra-day liquidity at all times and the ability to buy unlimited amounts via your choice of broker.
I own both TIPS and I Bonds in my . Inflation-protected bonds are part of my chosen asset allocation, and I prefer to use a lot of my tax-deferred account space for REITs. Series I Bonds allow me to own inflation-linked bonds in effectively a tax-deferred manner. I may also be able to use the interest tax-free for educational expenses as I have three young kids with 12-16 years to go before college.
from .
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