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The Fuss about I Bonds: Pros and Cons

The Series I Treasury Savings Bond has made quite a ruckus in the news recently. With a current 9.62% interest rate being earned, the I Bond has suddenly become a hot commodity. Rising inflation and a downturn in the stock market have caused people to look for investment vehicles with higher returns.

Let’s look at these bonds, plus the pros and cons of owning them.


What are I Bonds?

Series I Savings Bonds are a type of savings bond issued by the U.S. Treasury. They are considered a low-risk investment, earning interest while protecting your money from inflation. Backed by the federal government, there is nearly zero risk of default.


I Bonds earn interest from a combination of two different interest rates: fixed rate and inflation rate. What does this mean?

Fixed Rate. This rate remains consistent throughout the life of the bond.

Inflation Rate. A rate that changes every six months and is announced in May and November of each year.


So, the combination of the fixed and inflation rates makes for a composite rate that the bond earns interest upon for that six-month period. The interest earned is then credited each month and compounded twice a year. It is paid when the bond is cashed. Currently, the composite rate is the highest it has been in several years.


Other important things to know about I bonds include:

Paper vs Electronic. Bonds can be purchased electronically for any amount over $25, but paper bonds are only available in denominations of 50, 100, 200, 500, and 1000 dollars. All bonds are sold at face value (meaning, you pay $25 for a $25 bond).

Term of Ownership. Minimum time you can hold this bond is 1 year. Maximum is 30 years.

Tax Paid. Interest earned is subject to federal income tax, but not state tax.

Amount Limits. Up to $10,000 in electronic bonds can be purchased annually by any one individual. An additional $5,000 in paper bonds can be bought in lieu of a federal tax refund.


Should you purchase I bonds? Maybe.


Pros and Cons

Depending on your current financial situation and goals, you might purchase I bonds. While they do not replace a three to six-month emergency fund, they are a way to set aside money and have it earn interest in order to use it for future short-term to midterm goals.


As with anything in life, there are pros and cons.


Pros

There are many pros to owning I Bonds, the chief one being that it protects the money invested from inflation. Other advantages include:

● No risk to the principal amount. The fixed interest rate never falls below zero. Unlike stocks, you won’t lose money on it.

● The interest earned is tax-exempt if used for college tuition. However, there are several conditions that need to be met in order to qualify for this tax exclusion, including income level, age when purchased, and the year in which the bond is cashed in.

● No penalty for cashing in the bond as long as you have held it for five years or longer.


Cons

● Must be held for one year. Once purchased, the bonds are not liquid for one year, and you have no access to that money in the meantime.

● Penalty if cashed in before five years. In years two to five, you can cash in the bond, but you will pay the previous three months in interest as a penalty fee.

● Can only be purchased through the U.S. Treasury website. While buying online is convenient, many consumers have complained that the site is not user-friendly. Also, because the bonds are not sold by brokerages, you will need to keep track of the investment and corresponding documentation yourself.


Over all, these bonds can be a safe short-term to long-term way to protect your money against inflation, if you have the cash to do so.


Investing FAQs

As you investigate the option of purchasing bonds, it’s helpful to consult with your financial advisor about whether it is beneficial to add them to your portfolio. Some other information that is good to know includes:

  1. Kids Can Own Them. As a parent, you can establish a Treasury Direct account for your child that is linked to your account. You can purchase up to $10,000 in I bonds a year for them. The caveat: once they turn 18, the bonds belong to them to use as they wish.

  2. Bonds as Gifts. Your favorite nephew may not appreciate a bond as much as he would a new skateboard, but he may come to value it once he becomes of legal age. Bonds can be purchased as birthday, Christmas, or wedding presents.

  3. Businesses Can Own Them. You can purchase up to $10,000 in bonds for your sole proprietorship, partnership, LLC, C-Corp and S-Corp. Because your business is a separate entity from you as an individual, you will need to set up an entity account for your business when purchasing bonds on the Treasury website. If you have multiple businesses, you can purchase up to $10,000 for each of them.

  4. Trusts Can Own Them. If you have a trust set up, you can purchase $10,000 annually in the name of your trust. For married couples with separate trusts, each trust can buy another $10,000.

Final Thoughts

The Series I Bonds have garnered a lot of attention and are worth considering. We’ve looked at the pros and cons of owning them, but it’s important for you to do some research as well to see if they are right for your circumstances and financial situation.


Written by Matthew Delaney