How to buy I-bonds, the surprise hot investment of 2022
Stocks and bonds alike have plummeted this year, taking the wind out of retirement savings and brokerage accounts. Meanwhile, the interest rates on the highest-paying savings accounts barely reach 3% — less than half the rate of inflation.
But there is one financial vehicle that offers a hefty return to savers who don't need to spend their money immediately. Series I savings bonds — commonly known as I-bonds — currently offer an interest rate of 6.89%. While that's lower than the 9.62% they offered during the six months that ended November 1, it's still an attractive rate for savers who would otherwise be putting money into a savings account or CD.
Typically a niche investment vehicle, I-bonds have exploded in popularity in the last two years as inflation has reached a 40-year high. The Treasury issued nearly a billion dollars' worth of I-bonds last Friday during a surge of interest from buyers that temporarily crashed a government website.
"For clients who have some extra cash who want to ride out the market, it's a great investment, especially in the current climate," Jay Lee, founder of Ballaster Financial, told CBS MoneyWatch. "It's a bit of a no-brainer."
Read on to learn how I-bonds work, why they're nearly inflation-proof and why interested investors have piled into this once-obscure vehicle.
Inflation-busting rate
The interest rate on I-bonds changes twice a year — on November 1 and May 1 — and is calculated based on the rate of inflation over the previous six months. (In addition to the variable rate, there's a fixed rate, which has been below 1% since 2007.)
Between May 1 and November 1 of this year, the yield on I-bonds was 9.62%, reflecting the painful jump in consumer prices this year and rivaling stocks' performance, all while avoiding the heartburn that comes with being invested in today's seesawing markets.
For bonds issued starting November 1, the fixed rate is 0.4% and the variable rate is 6.48%—for a total rate of 6.89%.
When the new interest rate is announced, it applies to every I-bond issued prior to the announcement date and is good for six months, until the next rate is set. The fixed rate stays the same for the lifetime of the bond.
Setting up an account
The first step in purchasing I-bonds is setting up an account with TreasuryDirect.gov, if you don't already have one, and linking it to a bank account. The process, while straightforward, does take some time and requires the applicant to have ID and banking information on hand; it also isn't mobile-friendly.
Buyers should also triple-check account information and banking information before entering it, since making a mistake could take months to correct.
Jarrod Sandra, the owner of Crowley, Texas-based Chisholm Wealth Management, relayed the story of a client who tried to buy $10,000 of I-bonds earlier this year and mistyped his bank account number on the TreasuryDirect site.
"You cannot correct this online. The Treasury Department requested a certified letter from the bank with a medallion signature. Then it had to be mailed in and wait six to eight weeks for processing," Sandra said. "It was such a pain that my client decided not to pursue it."
Also, when you're buying bonds, make sure not to enter more than $10,000. While you can't buy more than that amount, the website will not limit your purchase, noted Katherine Fox, founder of Sunnybranch Wealth in Portland, Oregon. Instead, you'll have to wait six to eight weeks, or longer, for a refund.
Tax-deferred interest
I-bonds earn interest every month, and compound it every six months. However, the interest isn't actually paid out until the bondholder cashes out the bond, or at the end of its 30-year lifetime.
"Once the bond is redeemed (sold) or it matures, the investor receives the full principal amount plus all the accrued interest – and is taxed on the interest at ordinary tax rates at that time," Craig Toberman of Toberman Wealth told CBS MoneyWatch.
He noted, "This tax deferral can be beneficial from a tax perspective if an investor is in a high tax bracket (e.g., still working) when they purchase the bond and later is in a lower tax bracket (e.g., in retirement) when they finally redeem the bond and pay the deferred tax."
Limits on investment
There are limits on how much you can invest. One person can buy up to $10,000 worth of bonds a year, with an additional $5,000 allowed if they use a tax refund for the purchase. For married couples, that limit doubles. Parents can also buy I-bonds for their children (under age 18), although they need to set up separate accounts for each kid.
While those limits are plenty for most regular folks, wealthy investors with more resources will usually want to look elsewhere. "This isn't a sky-is-the-limit income opportunity," said Sefa Mawuli, a CFP at Pavlov Financial Planning.
And unlike many other financial instruments, investors can't deputize a broker or money manager to buy I-bonds, but rather need to do it directly through TreasuryDirect.gov.
"You have to buy them yourself, so for people who have financial advisers buy their investments, it's different," said Alex Rezzo, founder of Andante Financial. Because advisers don't get a commission for steering customers to I-bonds, he added, "there's not a lot of marketing for this, so people may not have heard of them."
Still, the safety of these government-backed accounts means they're one of the few financial products Rezzo widely recommends.
"These are the closest thing to a free lunch I've seen in the markets, particularly in the current environment," he said.
Buy and hold
I-bond buyers aren't allowed to redeem them for the first year. After that, you can sell the bond, but that will forfeit the last three months of interest. After five years, investors can sell with no restrictions.
Investors collect all the interest on the bond at the time they redeem it or when it matures (30 years after issuance.) They also pay tax on the interest at that time, and not before. I-bonds are exempt from local and state income taxes, making them another good choice for people in high-tax states.
However, the minimum one-year wait makes I-bonds a poor choice for a true emergency fund — money that a person needs to access at a moment's notice to cope with a job loss, illness or other unexpected financial problem.
"You shouldn't replace your emergency fund with I-bonds, but may consider them if for some reason you need to have some extra cash lying around for about a year or more," Mawuli said.