I Bonds currently have a stated interest rate of 7.12% through the end of April and are expected to earn 9.62% after May 1.
How they work
I Bonds are government issued and pay a fixed interest rate plus an inflation adjuster. The interest rate is announced every 6 months in May and November each year. However, each investor’s rate resets every 6 months from their purchase date. That means an investor today could earn 7.12% April to October then an anticipated rate of 9.62% October through April of next year. They are only available through treasurydirect.gov.
Sounds good, so what’s the catch?
- You must hold them a minimum of 12 months.
- Redeeming them between 1 and 5 years will cost you 3 months of interest.
- The growth is taxed as ordinary income for federal purposes, but they are not taxable on your Wisconsin tax return.
- Each person is limited to $10,000 per year with an additional $5,000 purchase available via tax refund.
- I Bonds cannot be purchased in retirement accounts.
When are they worth it?
For a guaranteed fixed investment, you really can’t beat an annualized blended return of 8.54%.
When are they not worth it?
Let’s take the math a step further to see what we really earn.
- After subtracting the 3-month interest penalty for cashing in at 12 months, the return is reduced to 6.05%. Now subtract federal income taxes on the 6.05%. At the 24% tax bracket, the net return is 4.6%. Still pretty darn good for a fixed investment.
- The interest rate is higher if you wait until month 15 to redeem so you don’t lose 3 months of the high 9.62% interest rate. That’s equivalent to an annualized return of 6.78%.1 After 24% federal taxes, the net return is 5.15%, a great return for a guaranteed investment.
- What about just holding the bond for the full 5 years to avoid the 3-month interest penalty? Well, inflation for the next 5 years is projected to be 3.25%.2 So, that’s the 5-year before tax return expectation for I Bonds.
However, before buying I Bonds, look into the following.
- Get your full employer matching contribution on your 401(k) or 403(b). A dollar-for-dollar match is equivalent to a 100% rate of return immediately.
- Maximize your tax-free Roth and Health Savings Accounts. Long term investments can net more than 4.6% or 5.15% on an annualized basis and there’s no tax drag in these accounts.3
- Have a proper emergency fund because you cannot redeem I Bonds for at least 12 months.
- Pay off all high interest debt.
- Those with Medicare should understand I Bond income is included in AGI and can therefore impact Medicare premiums at higher income levels.
- I Bonds income can also increase the taxation on Social Security income in some circumstances.
What other investments can traditionally do well if inflation is expected to rise or is high?
- Real estate
- Floating rate bonds
If you have the cash, met the other criteria and can make the purchase before the end of April, now may be a great time to purchase I Bonds.
For personalized help eliminating debt, investing smart and securing retirement, please contact Mark Ziety, CFP®, AIF® 608.442.3750.
Mark Ziety, CFP®, AIF®
WisMed Financial, Inc. part of the Wisconsin Medical Society.
1 8.54% blended return for 12 months + 0% for 3 months = 8.54% for 15 months = 6.78% for 12 months
2 5-Year breakeven inflation rate, FRED Economic Data.
3 Roth accounts are tax free after 5 years and age 59 ½. HSA has tax free withdrawals for qualifying medical expenses only.
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