Incorporating Series I Bonds - Emergency Fund & Cash Positions

I Bonds

If you are currently holding cash that is above the comfort of your emergency fund, you may be stuck in what is called “analysis paralysis”. That is, with extra money to invest, you are holding back as an investor due to uncertainties in markets. A volatile equities market and a low yielding bond market due to low interest rates can do that to you. So, you are keeping money in cash for the time being, all while we are dealing with the highest inflation numbers in 40 years. If this is you, and you are concerned about keeping up with inflation, the Federal Series I Saving Bond (I Bond) can be very attractive.

What is the Federal Series I Saving Bond?

The Series I Bond is offered by the Treasury Department and are backed by the U.S Government. They can be purchased directly through the TreasuryDirect website. I Bonds are a fixed income investment and the interest rate it earns is what is known as the “Composite Rate”, which is a combination of a fixed (currently 0%), and an inflation rate (currently 7.12%). The current composite rate for these bonds is 7.12%! The I Bond has a 30-year maturity, but can be redeemed after holding the bond for 12 months. The composite rate of these bonds (7.12%) is good for the first six months the bond is held, thereafter, a new rate is applied that is correlated with the current inflation level.

How Much Can One Individual Buy?

One Individual is limited to purchasing $10,000 in I Bonds for the calendar year. So, for 2022, a married couple may purchase up to $20,000 in I Bonds, $10,000 for each individual. Although, there is a bonus, you may purchase up to $5,000 extra in a calendar year with your tax return refund money. The refund money is per return, so a married filing joint couple could only add an additional $5,000 combined into I Bonds from their tax return refund. These buying limits reset every calendar year, so they could purchase another $20,000 in 2023.

What’s the Catch?

Timing

As mentioned, the current 7.12% composite rate will be evaluated and updated, investors have until May 1st, 2022 to lock in the 7.12% rate for their first six months.

Penalties

The I Bond has a 30-year maturity but can be redeemed after 12 months. If it is redeemed between 12 months and 5 years, you will lose the last 3 months of interest earned. This results in limited liquidity as the I Bond does not provide liquidity within the first 12 months (Not redeemable in the first 12 months unless a federally declared disaster).

Example

Susie purchases the I Bond for the maximum amount of $10,000. Susie is safe to assume that the value of her bonds at the time of the 6-month redemption rate will be $10,361. The next 6 months, the composite rate will be adjusted, for the sake of the example, lets assume inflation zeroes out and the composite rate drops to 0%. For the same 12-month period, Susie would still have earned a return of 3.56%! A U.S Government backed return of 3.56% is much more attractive than the current interest rates on high-yield savings instruments, such as 1% CD.

Pros and The Cons of I Bonds

Pros

  • Extremely low risk and protection of principle
  • Keeps up with inflation in a high inflationary environment (7.12%) **as of 3/5/2022**
  • No state or local tax when the bond is redeemed
  • Growth is tax deferred until redemption

Cons

  • Lack of liquidity (no redemption within 12 months)
  • Purchasing limits of $10,000 per person
  • Forfeit the last 3 months of interest earned if redeemed between 1-5 years

Overall, I bonds may be a great investment if the alternative is low yielding savings account and fixed income. The investor must be aware of the liquidity timeline (greater than 12 months), as well as the change of the composite rate every 6 months. If inflation continues to roar, I bonds will be a good place to protect principle and keep up with that roaring inflation.

To Purchase an I Bond – please follow these instructions here.

Please consult with your financial advisor today if I Bonds may be the right thing for you. This article is for educational purposes only and not personal financial advice.

Author: Dustin Burkhart