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What Are I Bonds, And Are They Worth The Hype for Retirees?

Over the last several months, inflation has dominated financial conversations and concerns. As of June 2022, inflation ballooned to 9.1%, leaving people wondering how to keep up.

With stocks down, falling bond yields, and low interest rates, retirees might be asking,

Is there a way to invest that keeps pace with inflation?

The answer might just be “yes.”

Record inflation has also made way for a diamond in the rough investment, the I bond. 

I bonds are unique because they offer two interest rates, and one is adjusted for inflation. Let’s take a closer look at I bonds and how retirees could benefit from its inflation protection. 

What’s An I Bond?

Bonds play an important role in your retirement income plan. 

You’re likely investing in several types of bonds for their guaranteed income. But bonds haven’t been offering the best yields and interest rates of late, causing many retirees to worry about the solvency of their fixed income strategy.

In comes the I bond. 

A Series I bond is an inflation-protected savings bond backed by the U.S government. With the government behind them, these bonds are considered some of the safest investments on the market. And people are clambering to get their hands on them. 

As of last November, sales have netted $14.9 billion, which is $6 billion more than during the previous 20 years! 

While most bonds only have one interest rate, I bonds have two:

  • A fixed interest rate that lasts until the bond’s maturity date (30 years)
  • A variable interest rate adjusted for inflation every 6 months (and compounds semi-annually). This number is tied to the Consumer Price Index (CPI), which measures the change in the price of goods and services. 

It’s the latter that’s getting all the press attention. I bonds enable investors to get a return and protect themselves against inflation. And the return is pretty good. While the current fixed interest rate is 0%, the inflation-adjusted interest rate for I bonds purchased through October 2022 is 9.62%

If you buy an I bond within that window, you lock in the 9.62% interest rate for six months. So, if you went to Treasury Direct and bought $1,000 worth of I bonds today, you’d retain the same interest rate until January 2023. Once the six months expire, you’ll receive the new inflation-adjusted interest rate for the next period. 

I bonds can be excellent options for retirees to build up the conservative bucket of their retirement income plan. As low-risk investments, they are a way for risk-averse investors to beat inflation without putting more resources into the stock market. 

How I Bonds Work

As with any investment, I bonds come with several rules and regulations. Let’s take a closer look at how these investments work. 

First, you can only purchase I bonds via the Treasury Direct website. The minimum investment you can make is $25, and you’re limited to purchasing up to $10,000 worth of electronic bonds per individual per year. You can also use your tax refund to buy up to $5,000 of paper bonds each year. But if you want more, you may be able to exceed the limit by buying I bonds within a trust. 

If you want to buy I bonds, you have to make an account via Treasury Direct. Married couples must each create separate accounts, as there is no “joint” option. 

I bonds have a 30-year maturity unless you cash them out first. Similar to a certificate of deposit (CD), there is a minimum 12-month holding period for I bonds, so don’t lock-up money you may need in the next year. This means that I bonds may be a suitable supplement for your emergency savings, but they might not be a complete replacement since you can’t access the funds right away. 

After a year, you have more flexibility to cash out your I bond, but there are additional rules to consider. Should you redeem I bonds before five years, you will lose the previous three month’s worth of interest. So, if you cash your I bond at 20 months, you’ll only get 17 months of interest payments. If you stick with your I bonds for at least 5 years, you can redeem them for their full present value, giving you a lot of flexibility until the bond’s maturity date. 

I Bonds and Taxes 

How does the government tax I bonds?

Interest from I bonds isn’t taxable at the state level, but it is at the federal level. You’ll be on the hook for income tax on the interest accrued. 

You can either report the interest every year or, the more popular approach, defer reporting the interest until you cash out the I bond, it reaches maturity, or you transfer ownership to another person, like a spouse or dependent. 

You may be able to avoid paying income tax if you use the I bond to pay for qualifying education expenses. This strategy can be effective for grandparents looking to help their grandchildren pay for higher education. 

I Bond Strategies And Considerations For Retirees

I bonds can be an excellent addition to a retiree’s fixed income allocation. With built-in inflation protection and low-risk levels, they’re a beneficial way for retirees to beat inflation without risking short-term losses like investing in the stock market.

So how can retirees best utilize this popular security? 

Perhaps one of the best use-cases for I bonds in your retirement portfolio is to supplement your emergency savings, cash reserve, and other low-risk guaranteed income avenues. Think of I bonds as existing in your first retirement income bucket. Since I bonds are designed to keep pace with inflation, your savings aren’t losing money the way they would in a savings account. 

But while I bonds are strong alternatives for more risk-conscious investors, there are other considerations. 

Remember, the inflation-adjusted interest rate makes I bonds so appealing presently. It’s important to note that this interest rate is variable and changes every 6 months. The good news is that it will help you keep pace with inflation safely, unlike a traditional or even a high-yield savings account. 

Our historic inflation levels drastically increase the allure of the I bond. 

But while I bonds may be helpful in times of high inflation, they might not be as lucrative when inflation slows. With the fixed interest rate set at 0%, if inflation slows, the variable interest rate will come down with it, making them less attractive over time.

So, I bonds shouldn’t replace your entire retirement portfolio, but they do serve a unique purpose in this irregular market cycle. 

I bonds can support your effort to null the effects of inflation and earn some interest along the way. Book some time on our calendar to see how I bonds could impact your retirement portfolio.