I Bonds: What You Need to Know (Updated for the November 2023 Interest Reset)
US Treasury Series I Bonds allow you to take advantage of high inflation, but there are definitely some things you need to know. The latest interest reset has taken place, here are the details ..
On November 1st, 2023, the total interest rate on I Bonds was reset to 5.27%, free of state and local taxes. The guaranteed fixed component of the rate (i.e. the part not dependent on inflation data) was increased from 0.90% to 1.30%.
Here’s what you need to know about I Bonds:
I Bonds (or to give them their full name, US Treasury Series I Bonds) are US government bonds and, as such, they are considered to be credit risk-free. They are also tax-advantaged (see below).
I Bonds can be bought electronically straight from the federal government and held safely online at Treasury Direct. If you do not already have an account, you can open one here. Important: the website can be glitchy - when setting up an account, double-check that all the details you input are 100% exactly correct or you may be booted and forced to submit documentation by snail mail which can delay your account opening by many weeks.
You can easily set up single one-time purchases or schedule automated systematic recurring purchases throughout the year, subject to the annual limit (see below).
The interest rate is recalculated and reset every six months. There is a guaranteed fixed component (that is determined at the discretion of the US Treasury department and was raised in the last reset from 0.90% to 1.30%) and an inflation-indexed component. The second component is tied to the month-to-month Consumer Price Index (CPI) and it is this part that resets semi-annually (although the fixed component can also change at these times as well).
The interest rate in force on the day you buy the I Bond will be your interest rate for the first six months that you own the bond, after which time it will switch to the most-recently-adjusted rate for the next six months and so on for up to thirty years, which is how long the bond pays interest for.
New I Bonds begin earning interest on the first day of the month you purchase the bond. That means that, even if you purchase a bond at the end of the month, you’ll receive interest for that entire month.
I Bonds pay interest monthly. Interest is compounded semiannually, meaning that every six months, the bond’s interest payment is added to a new principal value (the total of the prior principal value and the interest earned in the previous six months). Thus, the bond's value grows both because it earns interest and because the principal value on which that interest is earned gets bigger.
The interest earned in any month is credited to your account on the first day of the following month. The implication: It makes sense to wait until the beginning of a month to sell an I Bond to make sure you’ve received the previous month’s interest.
The twice-a-year resets of the interest rate take place at the beginning of May and November each year. The reset takes into account the official month-to-month CPI readings over the preceding six months, annualizes the total, then adds that to the fixed component to determine the total interest rate for all I Bonds bought during the upcoming six months until the next reset. For example, if inflation had moved higher by, say, 0.35% per month each month for the six months preceding the reset, that would be a total of 2.1% for a six-month period when the month-to-month increases are all added together. Double that to annualize it (4.2%) and then add in the fixed component (1.3%) and you would get an I Bond interest rate in force for the next six months of 5.5%.
You don’t pay any state or local taxes on I Bond interest and all the federal income tax can be deferred until you redeem the bond. This is in contrast to interest on savings, Certificate of Deposit (CD) or money market accounts paid by banks, brokers, credit unions, high yield savings providers etc. that is fully taxed every year at the federal, state and local level (regular Treasury Bills are tax-advantaged in the same way as I Bonds).
If you use these bonds to pay for qualified education expenses, the interest can be federally tax-free under certain circumstances**.
** Income limitations apply to the availability of the federal tax exclusion on the interest for funds used for education purposes: total combined Modified Adjusted Gross Incomes above about $159k (2023) for joint filers and above about $101k (2023) for single filers will prevent the taxpayer(s) from getting this federal tax break, although the state and local tax exclusion will still apply.
The federal tax exclusion is also not available for any married taxpayers who choose to file separately. Nor is it available if the student was gifted the I Bonds or if the bonds were purchased in the student’s name before the student reached the age of 24 (so buying them in a minor child’s name now and having them spend it later on undergraduate education will not qualify for the federal tax deduction, although the state and local tax exclusion will still apply).
However (important!!):
You cannot cash in I Bonds for any reason for twelve months after buying them. The funds are completely locked up for a year after any purchase date.
If you cash in between one and five years from the purchase date, you forego your final three months’ interest. After five years, you receive the full interest. The value of any bonds that are less than five years old doesn’t include the latest three months of interest, reflecting the potential penalty for early withdrawal. This suggests that, for new bonds, you won’t see any interest show up in your Treasury Direct account until the beginning of month #5.
There is an annual $10k purchase limit per person (per social security number). This resets on January 1st each year.
You can use your federal tax refund to buy up to an extra $5k per year ($50 minimum) although you need to make this request in advance, at the time of filing. For some inexplicable reason, these will be issued in physical paper I Bonds, which you will then have convert to electronic I Bonds to get them into your online account.
You can buy another $10k annually in the name of each separate corporation (LLC, S-Corp etc) of which you are an owner. These bonds will be issued and held electronically in an account with the EIN number of the corporation and separate from your personal account.
You can buy another $10k annually in the name of each minor child dependent, but I strongly advise watching this video before doing so, as there are a number of considerations, complications and implications to doing this and it may not be a good idea in all cases. Children’s bonds will be issued and held electronically in a sub-account of your personal account.
You are not able to buy I Bonds in a tax-deferred account like an IRA or 401(k).
You cannot open joint accounts. Both spouses or partners would need to each create their own account. Each spouse or partner is subject to the $10k annual purchase limit, so $20k maximum purchases per calendar year per couple.
It is clear that these bonds are of significant interest during periods of high inflation but become distinctly less so as inflation moves lower. When comparing the interest earned to that of a high yield savings account, a CD, money market account or a Treasury Bill, you should take into account the your liquidity needs given the one year lockup period, the restricted purchase amount, as well as the tax benefits of I Bonds and assess how the different options stack up with each other in your own very specific financial outlook and circumstances.
For Anglia Advisors clients, I am happy to further discuss the use of I Bonds in the context of their own financial situation.
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