I bond interest rates are expected to drop to an annualized rate of 3.79% in May. With money markets more than 4.5% and CDs yielding more than 5%, it’s time to start planning an exit of this investment.
How I bonds work
I bonds are government issued and pay a fixed interest rate plus an inflation adjuster. The interest rate is announced in May and November each year. However, each investor’s rate resets every six months from their purchase date. For instance, someone who purchased in March of 2022 would have their interest rate reset every March and September. That means the expected 3.79% reduced rate that starts in May 2023 won’t impact this investor until September 2023.
Other rules for I bonds
- You must hold them for a minimum of 12 months.
- Redeeming them between one and five years will cost you three months of interest.
- The growth is taxed as ordinary income for federal purposes, but it is not taxable on your WI 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.
Timing the I bond sale
Assuming you have a higher paying replacement investment, here are a few considerations.
- For bonds owned more than five years, sell as soon as the rate drops.
- For bonds owned less than five years, it’s probably best to sell three months into the lower interest rate. Remember, the early redemption penalty charge is the last three months of interest. So, let’s make the penalty three months of low interest instead of three months of high interest.
- Most people pay tax on I Bond interest for the year when they sell the bonds. If your six-month renewal is close to yearend, cashing in this year or early 2024 could push the taxable income onto the 2023 or 2024 tax return respectively.
- Do you have a child in college this year or starting college in 2024? You might qualify to exclude the I Bond income from your tax return if there are qualified education expenses on that same return. Note – the exclusion is not available if your modified adjusted gross income exceeds $100,800 single or $158,650 married filing jointly (2022 limits).
What to do with the proceeds
- Pay off debt like auto loans and credit cards.
- Build your emergency fund to three to six months of living expenses.
- Maximize your tax-free backdoor Roth IRA and Health Savings Accounts.
- Start or add to your taxable investments to pay cash for a future car, home improvement or retirement. Especially with taxable investments, see the seven ways to improve performance.
Should I buy I bonds Before May 1?
No. A similar low or no risk investment like CDs currently yield more than 5%, which is more than I bonds. Here’s the math: Buying I bonds before the end of April nets 6.89% for six months, 3.79% for the next six months and 0% for the three month penalty period. That’s equivalent to 4.29% for 15 months.
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.
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