Why we like Series I Savings Bonds

April 14, 2022

You might have seen the option on your Federal tax return to purchase Series I bonds rather than receiving your tax refund in cash. What are these bonds?

I Bonds are offered via the Treasury Department and are backed by the U.S. government. They can be purchased through the government’s TreasuryDirect website, and such purchases are limited to $10,000 annually per person. In addition, savings bonds purchased with a tax refund will be issued as paper bond certificates in your name. If you are married and filed a joint return, the savings bonds will be issued in your name and your spouse's name. If you purchase savings bonds for someone else, the bonds will be issued in the name(s) that you listed on Form 8888. You can buy savings bonds in increments of $50. You buy them at face value, meaning if you pay $50 using your refund, you get a $50 savings bond. This calendar year, you can buy up to a total of $5,000 in paper series I savings bonds with your refund. Any unused amount of your refund can be sent to you in a paper check, or you can elect to have the remaining refund direct deposited into an account of your choice. [You can also later convert the paper bonds to electronic format on the Treasury Direct site.] See the Treasury Direct website for more details on taxation: https://www.treasurydirect.gov/indiv/products/prod_ibonds_glance.htm

The IRS describes these government bonds as being a low-risk, liquid savings product that earn interest and provide protection from inflation. Although savings bonds are not marketable in that they cannot be bought or sold in secondary security markets, they can be redeemed for principal and accrued earnings at any time after 12 months. For more information, check out the IRS website: https://www.irs.gov/refunds/using-your-income-tax-refund-to-save-by-buying-us-savings-bonds 

 Specifically, here are the rules for how long you should keep your bonds:

  • Minimum term of ownership: 1 year
  • Interest-earning period: 30 years or until you cash them, whichever comes first
  • Early redemption penalties:
    • Before 5 years, forfeit interest from the previous 3 months
    • After 5 years, no penalty

What makes I Bonds unique is their interest structure, which consists of a combined “Fixed Rate” and “Inflation Rate” that, together, make a “Composite Rate” – the actual rate of interest that an I Bond will earn over a six-month period. For more details, the following article gets into the nuts and bolts of things: Using I Bonds' High Interest Rate To Hedge Against Inflation (kitces.com)

 A recent article we reviewed noted that Consumer Price Index data for March laid bare the interest that new I bonds purchased by April 28 will accrue over the next 12 months: an annual rate of 7.12% for the first six months, followed by 9.62% the next six. When you crunch the numbers with I Bonds’ semi-annual compounding, clients can earn 8.54% the first year. That’s probably far more than they’re getting from bank products. This article also sheds light on the benefits of I bonds: I Bonds Offer Cash Play As Yields Top 8.5% Over Next Year (fa-mag.com)

 A note about taxes: the interest from I bonds is not taxed by state and local governments, so you are only paying Federal income taxes on the interest. Investors facing a tax liability may use the cash method and pay in a lump sum when they cash out of these bonds, or they may use the accrual method and pay regularly as interest payments create a tax liability.

 Also, while you may be able to use these bonds tax free for children’s education, many parents find their income is too high to be eligible for this tax benefit.  

 So, our bottom line is that these are good bonds to buy, particularly now with high inflation. While we are not able to purchase these for our clients in the investment accounts we manage at TD Ameritrade and Schwab, we can help you add these bonds to your self-managed portfolio. We'll then track these bonds as part of your integrated savings and investment portfolio and planning projections.