What Should I be Doing with I-Bonds Now?

                                            Image: Courtesy of Micheile Henderson @ Unsplash

What should I do with I-Bonds I currently own and should I be buying more?

By Jon Aldrich

Many of us purchased I-Bonds over the last couple of years, as inflation soared, and we were able to secure interest rates over 9.6% for a period of time from these wonderful investment vehicles. Now, however, there are many competing “safe” investments such as High Yielding online FDIC insured savings accounts such as Ally, Money Market Funds at places like Schwab and Fidelity, Certificates of Deposit (CD’s) and Treasury Bonds and Treasury Inflation Protected Securities (TIPS). There are many places to earn over 5% on either FDIC insured or U.S. Government backed securities. We have not had this luxury since around 2005 or so and these rates may not be around forever.

These are all great low-risk investments at the current time, but I-Bonds still can serve a place for many of us to keep our emergency fund or just keep a chunk of our savings in an absolutely safe investment that offers inflation protection in the future and with newly issued I-Bonds growth above inflation as well.

As a reminder, I-Bonds are purchased online only at the Treasury Direct website. You can buy $10,000 of I-Bonds per year per Social Security number or Taxpayer ID#. The bonds have a 30-year maturity, and you cannot sell an I-Bond in the first year of ownership. You can sell an I-Bond in years 1-5, but you incur a 3-month interest penalty. For bonds held more than 5 years, you can sell them at any time without a penalty. Taxes are only paid upon redemption, not on the interest that is earned each year. The interest earned each year compounds on your original investment. There are 2 components to how an I-Bond earns interest each 6 months, consisting of a fixed rate (determined at the original issue of an I-Bond) and an inflation component of which the inflation component resets every 6 months in May and November based on the Consumer Price Index (CPI) at that time. The Fixed rate (currently 1.3%) stays with the I-Bond for life See the FAQ’s on the Treasury Direct website for additional details.

When I-Bonds became the real hot investment in 2021 and 2022, the inflation rate ended up being quite high which was nice (except for the rampant high inflation that accompanied it), but the fixed component of these I-Bonds was 0%. Now, with higher interest rates all around us, the fixed rate has gradually risen to 1.3% as of this November, giving a total, composite rate of 5.27% from November 2023 through April of 2024 when a new fixed rate and inflation component will be determined.

Source: I bonds interest rates — TreasuryDirect

In the future, the benefit of a fixed rate guarantees that your I-Bonds will always earn a real return, after inflation of 1.3%, which is very attractive for safe, guaranteed return of your principal money. So, now let’s take a look at what you might want to do with your existing I-Bonds purchased in the last couple of years or before, and considerations for purchasing new I-Bonds with a fixed rate component in addition to the inflation rate.

First off, why is the fixed rate so important? Here is a recent article from Money.com  

Should I Be Buying These New I-Bonds?

If you need the money in the next year or so, the one-year Treasury bills yielding about 5.3% would probably be a better deal since you would not be docked 3 months of interest if you sold in a year (like you would with an I-Bond) and Treasury Bills are also exempt from state income taxes. 1 year CDs are currently yielding 5.45%, but that will be taxable by your state. In Illinois that would be about $27 on a $10,000 CD and would reduce your annual rate to 5.18% which is lower than the one-year treasury at 5.3%.  The current yield for online savings at Ally is currently 4.25%. And don’t get me started on how low some of the savings rates I see at many of the local banks, many of them are egregiously low. Make sure you do not have too much money sitting at one of these banks earning nil.

However, for cash you are stashing away with no immediate goal in sight, new I-Bonds that will always have that 1.3% fixed rate in addition to the inflation component are a really sweet deal. These bonds are always going to guarantee that your cash grows by 1.3% more than inflation. Therefore, if you have cash that you want to preserve purchasing power (and even gain some), purchasing new I-Bonds makes a lot of sense.

As you can see in the chart below, there has not been a fixed rate this high available in I-Bonds since May of 2006, and if we are indeed closer to a top in interest rates this is a great fixed rate to lock in:

Chart: courtesy of @Charlie Biello

What to do with I-Bonds I purchased in the last couple of years?

Many people purchased I-Bonds in the last couple of years to take advantage of those 9.6% interest rates offered when inflation was roaring, but most of the bonds purchased in 2021-22 had a Fixed Rate component of 0%, so those bonds are only yielding a composite rate of 3.97% currently. This is not horrible, but there are better, safer yields available as mentioned before. So, what should you do now if you own these bonds purchased with the 0% fixed rate?

If you have I-Bonds that were purchased greater than 5 years ago, the decision is easy, sell these and purchase new I-Bonds that contain the 1.3% Fixed Rate. Yes, you will pay Federal income tax on the gain in your bonds, but locking in that above inflation fixed rate will be beneficial in the future.

For I-Bonds purchased in the last couple of years, the choice is a little more nuanced. If you sell before the 5 years is up, you lose the last 3 months of interest and you will still pay Federal income tax on the gain in the bonds.  However, over the next year or two, you will more than make up for this with the higher 1.3% fixed rate that is added to the inflation rate. I plan on doing this with my 2021 and 2022 I-Bond purchases as time permits. Remember, you can only purchase $10,000 of I-Bonds per year, per Social Security or Taxpayer ID #, so if you already purchased in 2023, you would need to wait until 2024, to buy more, even if you sell some of these 2021-22 vintage bonds.

Optimal Times to Buy and Sell I-Bonds:

Ok, if you have decided that you want to sell and re-purchase new I-Bonds, you should be aware of the best times for you to do so. Remember that although the inflation adjustment for I-Bonds resets each May and November, you still receive 6 months of the current declared rate no matter when you purchase. For example, say that you purchased I-Bonds last September (2022) that contained the 9.62% rate effective in the May 2022 reset, even though the new declared rate resets in November of 2022 to a lower 6.48%, since you purchased in September of 2022, the 9.62% rate applies to your bonds through February of 2023 (You always get 6 months of the current rate from the month of purchase even though the rates reset in May and November). Then in March of 2023 the 6.48% rate applies to your bonds through September of 2023. You can see the current table of official I-Bond Fixed and inflation rates here. You can also enter the date and amount you purchased at eyebonds.info and see exactly what the interest rate and amount your I-Bonds are worth.

It is best to buy I-Bonds near the end of the month, because even if you buy on the last day of the month, you get credit for a full month of interest on the first day of the month following. Conversely, it is best to sell I-Bonds near the beginning of the month (probably the 2nd of the month to be safe) because interest is credited on the first day, and it is probably better not to sell on that day in case something gets screwed up with the interest credit.

For the example above, for I-bonds purchased in September 2022, the optimal sell date to have the smallest amount of interest penalty would be early in the month of December 2023 (next month). This is because the May inflation rate reset was 3.38%, but this rate does not apply to your bonds until September 2023 (your month of purchase). Thus, this 3.38% applies to September, October, and November and the 3-month penalty you would incur would not include any of the 6.48% rate that ended for you in August of 2023, but rather just the 3.38% current rate. Whew!

If this is too confusing or sounds like too much work, keeping your I-Bonds purchased in the last couple of years with a 0% Fixed rate is not the worst thing in the world. So, if it is easier and less confusing for you, just hold those bonds until 5 years are up and then sell, but you may want to consider the buy and sell dates mentioned above.

Why is the Fixed Rate so Important?

By providing a real return above inflation. If inflation comes down and all safe investment interest rates come down to 2%, that is what you would likely earn in one of these investments no matter what inflation is.  Now, let’s assume inflation is also running at 2%, the above-mentioned money market or savings probably earns you about 2%, but the I-Bond you have with the 1.3% Fixed rate gives you a total rate of 2% inflation plus 1.3% Fixed which equals roughly 3.3%. And if the inflation rate was higher, the I-Bond performs even better. The only time the I-Bond does not perform better than regular savings accounts is when inflation is less than 0.7%. And you rarely see inflation this low.

Conclusion

I-Bonds are still a very good investment due to the rise in the Fixed interest rate assigned to new I-Bond purchases. This fixed rate ensures a 1.3% real return above inflation, as measured by CPI). This is an opportunity we have not had in over a decade and a half. In addition, I-Bonds allow for deferral of taxes, inflation protection, are easy to purchase, and are exempt from state income tax.

If you hold I-Bonds with a 0% Fixed rate, now is a good time to evaluate if you should trade these in for the new 1.3% Fixed rate bonds or hold on to those and just purchase additional I-Bonds.