I Scream, You Scream, We all Scream for…I Bonds?
The first lesson I learned in Econ 101 was the concept “there is no such thing as a free lunch.” As a freshman college student on a prepaid meal plan, I was initially skeptical. Over time it has become a simple but useful lesson for me that “cost” has many meanings, and a monetary exchange is just one type.
The U.S. Treasury is testing this axiom with their Series I Savings Bonds (“I Bonds”). These are savings bonds that pay a nominal rate of interest plus a variable rate tied to inflation, defined by the consumer price index. Since their inception in 1998, inflation has been fairly low, and thus the interest paid on I bonds has not been all that competitive. With now the highest inflation in 40 years, these staid savings bonds have become the most popular investments of 2022. Move aside, meme stocks!
It has been a difficult few years for savers. Interest rates have been near zero for most FDIC insured deposits, although those rates will begin to increase this year as the Federal Reserve raises their benchmark rate. Considering the risk free nature of treasury issued I bonds, and their current annualized interest rate of 9.62%, many feel that these are a great place to move some excess cash savings.
There are a few considerations you need to be aware of before making a high interest loan to the U.S. government.
The first consideration is that these savings bonds can only be purchased from the U.S. Treasury through their website, TreasuryDirect.govI. Each tax payer can purchase up to $10,000 per year, plus another $5,000 from a Federal tax refund. You need to hold I bonds for at least 12 months. And if you redeem them before five years, you forfeit the previous three months of interest. The interest paid on these bonds is added to the value of the bond – not paid in cash – and is not subject to state income taxation.
The interest rate applied to I bonds can also be a little confusing. The rate resets every six months on May 1 and November 1, and is known as the “composite rate.” However, the interest rate paid on the I bond you buy will reset every six months from the date you purchased it.
For example, an I bond purchased in March will pay, for the next six months, the composite rate that was set on November 1 of the previous year. On September 1, the rate will reset for the next six months based on the May 1 composite rate update. Generally speaking, there is no advantage to buying ahead of, or prior to, a composite rate reset.
The final consideration is on-going monitoring. As inflation subsides, the composite rate will fall. While designed to never have a negative composite rate, at some point I bonds may not offer a competitive interest rate.
Until then, series I savings bonds might not be a free lunch, but it’s certainly a little dessert.
Meet Matt Cohen, CFP®, CIMA® | Relationship Manager
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