Like many of my clients you may have a dusty pile of savings bonds lying around somewhere.** Maybe they belong to you or your children. Odds are they were gifts from an older relative. Most likely they are EE bonds, which have their charms.
But, the savings bond I’m most excited about today is the I bond.
I bonds were introduced in 1998. The interest rate you earn on I bonds is adjusted every 6 months based on inflation as measured by the Consumer Price Index.
There are several great features of I bonds:
- They are inflation protected = you don’t lose purchasing power
- The current composite rate (which consists of a fixed rate + the inflation rate) is 1.48%, handsome compared to other cash vehicles such as money markets or savings accounts. This relatively low rate reflects our current low inflation environment. If inflation climbs, so will the interest rate.
- I bonds are principal protected = you cannot lose money
- Even in periods of deflation, the composite interest rate cannot be less than 0%.
- I bonds are federal income tax deferred = you don’t pay any federal tax on the interest income until you cash the bond
- I bonds are state and local income tax free = the interest is never taxed by any state or locality
- I bonds have an education tax exclusion = qualified taxpayers can use the bonds to pay for qualified education expenses tax free
- There are a number of additional requirements to qualify for this, including an income limitation.
To my knowledge there is not anything else available today with this unique combination of features. For example, cash is principal protected but lags inflation. TIPS are inflation protected, but can lose principal.
So what’s the downside you ask? Always a good question.
- You cannot cash the I-bond for at least one year after purchase, and if you cash them before 5 years you forfeit the last 3 months of interest
- These are meant to be long-term investments, so this is not the place for your emergency fund money.
- You can only buy them in electronic format via the Treasury’s website and they must be held there
- The federal government is not known for great websites—it is “cludgy” and doesn’t have the easiest user interface.
- There is a purchase limit of $10,000 per calendar year per social security number (so a couple can buy $20,000/year)
Note: It is possible to purchase a paper I bond up to $5000 using your federal income tax refund, and this allows you to go above the $10,000/year limit.
Like any vehicle I bonds are not right for all people. But for many investors, building a position in I bonds over time as part of a well diversified portfolio is a great opportunity to add inflation protection to the portfolio.
**If you are wondering what your dusty pile of savings bonds is worth you can find out by plugging in the serial number, denomination and issue date here.
