Don’t Forget About I-bonds

Investing
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By Lyman Howard

Learn more about Lyman on NerdWallet’s Ask an Advisor

  • I-bonds sound like an Apple Product, but are actually just old-fashioned US Savings Bonds with a few modern twists
  • They have unique benefits that reduce taxes and preserve buying power
  • You can only buy $10,000 per person per year, and only electronically (exception is when purchased with IRS tax refund)
  • They can only be purchased/redeemed directly through the US Treasury, but on very flexible terms
  • You should visit Treasury Direct.gov for complete details

Here is a  link to a good story from PBS.org about I-bonds, offered by the United States Treasury to encourage individuals to buy bonds (lend to the US Government) for long term savings. I-bonds are just one type of savings bond available, and happen to be indexed to inflation. This means money you have “invested” will be paid back to you with money whose purchasing power has been maintained, adjusted upward along with changes in the Consumer Price Index over the period of ownership.

Key Advantage: What makes I-bonds unique is that inflation adjustment solves one of the great flaws of bond investing, namely vulnerability to inflation over time. Inflation results in the money which you are lending out being paid back to you in a currency that is less valuable, purchasing fewer goods due to inflation’s upward push on the prices of goods. If you could get your money back corrected for that shortfall, wouldn’t that remove a major downside associated with buying bonds? Yes, and that is what I-bonds do, in fact. Think of it as getting a cost of living adjustment on the face value of your bonds.

Key Disadvantage: The expected returns might be much lower than your other investment alternatives. You currently receive inflation adjustment plus an additional 1.18% on newly issued I-bonds.

Who should buy I-bonds?

College savers: I-bonds are tax deferred, so you neither receive nor pay taxes on accruing interest until you redeem the bond (you can elect annual taxation if you prefer). If cashed in during the year wherein you or a family member incurs eligible education expenses, none of the interest will be taxable (this advantage is phased out for high income households).

Retirement savers: I-bonds will at a minimum maintain the purchasing power of your money, which is a guarantee not found in a savings account or even a traditional savings bond. If you have fixed lifestyle expenses in retirement, you could stagger the maturities of a number of I-bonds to produce the income you need over many years and be assured that your purchasing power will remain intact. You will also have the safety of a security backed by the US Government.

*I-bonds continue to earn interest for up to 30 years, but can be redeemed early after five years without penalty, and after just one year by surrendering the prior three months of interest earned

*Interest is exempt from state income taxes

*Savers who have maxed out other tax deferred savings accounts such as 401k and IRA accounts can still purchase up to $10,000 of I-bonds per year in nearly any dollar amount as another tax deferral opportunity

*Should newer bonds be issued later at more attractive rates than yours, redeem yours at full face value and purchase the new bonds instead (a great option!). The dollar value of your bonds can never go down, only up

Because I-bonds are for individuals, they are different from Treasury Inflation Protected Securities (TIPS). Here is a handy table  that compares I-bonds to TIPS. Keep in mind most people who purchase TIPS do so via a mutual fund or ETF.

If you wish to learn more, go to TreasuryDirect.gov for additional details.

 

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