I’ve been getting daily questions lately about I-Bonds. The current economic environment has obviously thrown these financial products into the forefront.
First, while it seems like consulting with a banker or financial adviser to learn about these investments is a good place to start, it's important to know that I-Bonds cannot be purchased through banks, brokerage firms or investment adviser firms. They also cannot be purchased from online brokerage firms.
I-Bonds, or more accurately U.S. Treasury securities Series I, are a type of savings bond purchased only directly from the government. If you immediately felt sleepy when I said the words “savings bond,” try to stay with me, there’s more to the story. But, yes, U.S. Savings Bonds are still a thing, and not just something grandmas give on First Communion day.
I-Bonds in particular are presenting an interesting value proposition right now, which is why they are getting all the attention. This is because an important component of the interest rate paid by I-Bonds is determined using the Consumer Price Index, or CPI, which is the highest profile measure of inflation quoted in the United States.
This means based on the recent CPI numbers released this week, I-Bonds may soon offer interest payments approaching the 10% range. The interest rate paid on I-Bonds has two components. Like traditional savings bonds, the “core” rate on I-Bonds is set by the US Treasury, and not surprisingly this core rate is very low, like zero percent low. The second component of the interest rate, however, is a six-month rate set by the change in the CPI. This component of the bond’s interest rate is variable, which means it will not lock in for the duration of the bond, but it’s reasonable to assume the variable rate component could be quite attractive for the immediate future as inflation continues to rage in the U.S.
I-Bonds, like all savings bonds and U.S. Treasury securities, are backed by the full faith and credit of the U.S. government, which is of course the highest standard of financial guarantee. Like all savings bonds, I-Bonds also offer some potential tax benefits. The interest on I-Bonds can be deferred until the bonds mature (30 years), and for families in certain income brackets, if the I-Bond proceeds are used for college costs the interest may be received tax free.
As far as disadvantages to I-Bonds, there are a few subtle things to be aware of. These bonds are issued with 30-year maturities, and must be held for at least one year. While they don’t price actively in the financial markets, it is highly likely at some point the CPI based interest rate component will drop off and for investors not paying attention, they might find these bonds paying lower than market rates over time.
They also are difficult to integrate into a complete portfolio strategy. Being only available through TreasuryDirect.gov, investing in I-Bonds will require a new account be opened, and being candid, I don’t find TreasuryDirect.gov to be the most intuitive platform to navigate. Also, the government no longer issues physical savings bonds, so I-Bonds will be held in electronic form on the Treasurydirect.gov platform, which should make them easier to monitor, but yet harder to integrate with other holdings.
If an I-Bond is cashed-in prior to maturity, the proceeds will be penalized by a charge-back on the last three months of interest. Considering the CPI component of the current interest rate offered, I can envision a scenario where an I-Bond could be held for a year and still generate a net 6% interest even after the interest penalty, which of course is much higher than other federally insured financial products.
Finally, the current purchase limit for an I-Bond is $10,000 per individual, per year. So in my opinion, they aren’t really a complete solution for investment income needs, but as a way to increase the yield on a family’s cash reserves, these “old fashioned” investments are getting a well deserved fresh look from many savers.
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. Government bonds and Treasury bills are guaranteed by the U.S. government as to the timely payment of principal and interest and, if held to maturity, offer a fixed rate of return and fixed principal value. Marc Ruiz is a wealth advisor and partner with Oak Partners and registered representative of LPL Financial. Contact Marc at firstname.lastname@example.org. Securities offered through LPL Financial, member FINRA/SIPC.