Table of Contents: Are I Bonds a good Investment
When it comes to financial education, most people are familiar with the term “inflation.” Year after year, we get used to hearing or reading about how inflation is rising and reducing the value of our money. However, not only do most people not really understand what inflation is and how it works but even fewer know what to do to protect against it. Are i bonds a good investment?
Inflation is a naturally-occurring phenomenon that is even considered to be healthy when kept below 2%. Unfortunately, events worldwide over the past years have made it quite difficult for most economies to achieve such a low level of inflation. According to the International Monetary Fund (IMF), global inflation is expected to rise from 4.7% in 2021 to 8.8%. The US, on the other hand, has experienced an inflation rate of 7.7% over the past year. What is the current rate for i bonds? 6.89%
In a world where more people are learning to gain control of their finances and generate wealth, inflation is gaining relevance by the day. As such, it is not surprising that financial tools specially designed to protect against high inflation have emerged and grown in popularity.
After all, as Ronald Reagan said right after America saw its highest inflation rate in history:
“Inflation is as violent as a mugger, as frightening as an armed robber, and as deadly as a hit man.”
Of all ways to protect against inflation, Series I savings bonds (I bonds) are one of the most popular… and with good reason. With an interest rate of 6.89%, this tool allows investors to easily protect their purchasing power. Let us tell you why every investor should consider having I bonds in their portfolios.
The Basics of I Bonds
To understand how I bonds protect your money from inflation, you first need to know how they work and who they were designed for. I bonds are a type of bond issued by the U.S. treasury that provides returns to its holder based on a composite rate resulting from an inflation rate and a fixed. I bond rates are variable and determined by the U.S. treasury every May and November, time at which both rates (inflation and fixed) are taken into account.
At the time of writing, the U.S. treasury has determined an interest rate of 6.89% for I bonds, which will be in place until April 2023. If you compare this to the previous rate of 9.26% and take the financial situation of the United States, you can see how the adjustments are based on sound financial information.
Each time a new rate is determined, the interest you earn will be added to the value of your bond. The result is that your bond gains value twice a year, which means you can take advantage of compound interest. A great pro for sure!
One important thing to consider is that I bonds can’t be cashed until 1 year has passed. Additionally, if you cash them after the year but before 5 years have passed, you will lose interest equivalent to 3 months. In short, you must hold the bond for at least 5 years to ensure you make the most out of them.
As the composite rate of I bonds varies with inflation, their ability to protect against inflation is maintained over time as they don’t lose value. In addition to this, I bonds are exempt from income taxes at the state and local level, making them even more valuable if you live in a location with high taxes.
When Do I Bonds Mature (And What Does That Mean)?
Every type of bond has a maturity date, which is the date on which the issuer (U.S. Treasury in this case) agrees to pay you interest for your investment, which is basically a loan. Once an I
bond reaches maturity, the issuer will pay you its face value. Many types of bonds give investors the option to redeem their bonds before they reach maturity, which is the case of I bonds.
The maturity of I bonds is 30 years, which means you can keep it and generate returns on it for that amount of time. A common mistake investors make is assuming that as I bonds have a maturity of 30 years, they won’t see any returns before that. This is not the case!
As we mentioned earlier, you will be able to redeem your I bonds as soon as a year passes if you choose to. However, please keep in mind that if you redeem your I bond before the 5 years mark, you will be forfeiting 3 months of interest.
What Are the Benefits of I Bonds?
There are many benefits to investing in I bonds, with the most obvious being their ability to protect your cash from inflation. As we already talked too much about this one, let’s take a look at other benefits these bonds can offer.
We already mentioned that I bonds are exempted from state and municipal income taxes. As you probably guessed already, this means that I bonds are still taxable at a federal level. However, there is an important exemption declared in the fine print.
If you choose to use your I bonds to pay for your higher education, any profit you make from your I bonds will be completely exempt from taxes. This makes I bonds a great strategy for anyone looking to save for college!
Even if you are to pay taxes on your I bonds, there is a lot of flexibility on how this is done. According to the U.S. Treasury, you can “report each year’s earnings or wait to report all the earnings when you get the money for the bond.”
This means if you choose to pay them at the time of redeeming the I bonds, you can use that money to further invest in I bonds or other assets, something that wouldn’t be possible otherwise.
As I bonds are issued by the U.S. treasury, they come with virtually no risks attached. While it is possible for a government to default on its obligations, this is not something that happens regularly. In fact, the U.S. treasury has never defaulted on the payment of its bonds and, given the potential consequences of doing so, it is unlikely to happen.
Finally, we have accessibility. Investing in I bonds is an extremely easy thing to do. This is not only because it can be done electronically starting at just $25 dollars with no set values above that. Do you have exactly $48.32 to invest? You can do so! As long as you aren’t planning to invest more than $10k per year, you are free to invest as much as you want.
Buying And Redeeming I Bonds
At this point, you might have an idea if I bonds are the right investment for you. If you have decided to go ahead and invest in them, you will be happy to know that this is a pretty easy thing to do. You can buy an I bond for yourself, your children, or even as a gift.
To buy I bonds, you will need to create an account in TreasuryDirect if you don’t have one. This is a pretty straightforward process that anyone who has ever opened an online account will be able to do. Just make sure to have your Tax ID number and bank account (or routing number) easily accessible!
Once you have a TreasuryDirect account, you will be able to choose the “BuyDirect” option, choose I bonds as the type of bond you want to acquire, and fill in the necessary information. The process is really as easy as buying an item or paying for a subscription online.
If you want to gift an I bond, you only need to know the recipient’s full name, Tax ID, and TreasuryDirect account number.
Redeeming your I bonds is just as easy as buying them: Go to your TreasuryDirect account > “Manage Direct” > Follow the link for cashing securities. From there, you just need to follow the instructions to have your I bond redeemed and your money back (plus interests).