Some Thoughts on I Bonds

Originally when planning to write this week’s post it was going to be a longer piece about all the minutia of I Bonds, those investments made popular by excess inflation. But then I figured there’s so much out there online about these bonds already that I’d instead offer some thoughts on the purchase decision. Hopefully this will address your questions but I’m happy to discuss these and other details as needed.

Should you buy an I Bond?

The short answer is yes, but that’s mostly because I can’t think of a reason not to. Let me explain.

I Bonds are bought direct from the government via www.TreasuryDirect.gov. You’d hold them in electronic form and access all relevant information on that site. Yes, you can buy paper bonds but just with your tax refund. I don’t know why you’d opt for paper bonds these days anyway.

So, the first consideration is the hassle factor of yet another account on yet another website, and this time the site is pretty antiquated. Still, the process for setting up an online account, linking to your bank for funding, and actually buying an I Bond (or other types of savings bonds – you can do it all through this website) is clunky and prone to time-consuming mistakes. For example, my wife got locked out of her account and was told the only fix was to call Treasury Direct. We called and we’re told that too many people were calling and to call back some other time. We did so another day and had the same result. Frustrating.

That said, once you get the hang of the website’s quirks (and don’t get locked out) it’s pretty smooth. You can buy now, the money comes out of your bank account the next day and presto, you own an I Bond.

If we can get beyond the hassle factor, the reason to buy is that I Bonds pay an interest rate based on inflation measured by the Consumer Price Index. More on that below. And when CPI is high, as it is now, I Bonds aim to keep pace with it. Last year when inflation was ripping I Bonds were paying 9.62%. This sounded awesome since typical core bonds in your investment accounts may have been down by that much or more. The CPI has moderated in recent months so new I Bonds pay 6.89%.

Even at the reduced rate I Bond interest is still higher than the yield on the 10yr Treasury note, a key market benchmark, at about 3.5%, so what gives? Wouldn’t you just put all of your money into I Bonds at 6.89% and sail off happy into the future?

The answer is unfortunately no. The fundamental problem, if we can call it that, is that each person can only buy $10,000 worth of I Bonds per year. Maybe up to $5,000 more if you do so via your tax refund, but hopefully you’re managing your taxes better than letting the government hold thousands of your hard-earned dollars for a year at no interest, but I digress… You also can’t buy I Bonds in retirement accounts. I Bonds can only be held in your name, jointly with another person, your trust’s name, or with a beneficiary listed. “Entity” accounts are also possible but are beyond the scope of this post.

Is it worth the hassle factor to invest a relatively small amount of your nest egg? After thinking about this at length last year and again this year I think the short answer is yes. Why yes if I’ve been complaining about the hassle of dealing with an antiquated website? Mostly because I can’t think of a good other reason not to.

Some additional I Bond details –

There’s no secondary market for these bonds, so you won’t see their value fluctuate every day. The value of your I Bond sits there unchanged until interest gets applied every six months. That’s a psychological difference but may help a little at maintaining your sanity in volatile markets.

The money has to sit for at least 12 months but can be accessed prior to five years with a penalty of three months interest. Maybe I Bonds are good for extra medium-term savings that you’d prefer not to commit to the stock and bond markets? Otherwise, you could let the money accrue interest for up to 30 years.

The interest accrues tax-deferred until withdrawn unless you choose to report it each year. Then it gets taxed by the Feds and not the state.

And maybe no tax if you use the proceeds for higher education expenses and your modified adjusted gross income is lower than about $159,000 on your joint tax return. Those are current numbers, so this benefit may not materialize at the time if your income is too high, but at least in theory the interest could be tax free. If you know you’ll have higher income than this, I wouldn’t bother putting any money into I Bonds that would otherwise go into your kid’s 529 plan, for example.

The other issue for I Bonds is your average return over a longer period of time is likely to be less, perhaps substantially less, than current rates. The reason is that I Bond interest is a blend of a tiny, fixed rate and a rate that adjusts every six months based on the CPI. Assuming inflation gets back to the Fed’s goal of around 2%, I Bonds could end up averaging something much closer to that, perhaps less than the 10yr Treasury.

But again, worse case is you put some of your excess cash savings into something that ends up looking like a medium-term Treasury bond. What financial planner could find fault with that?

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