It was painful enough earning next to nothing in my checking and savings accounts over the last decade, but at least inflation wasn't running red hot like it is today (November's CPI was 6.8%, a 39-year high). So where does one go to preserve the purchasing power of the safest, most stable portion of their portfolio today? Series I Savings Bonds from the US Treasury, of course. Never heard of an I Bond before? Well, neither had I until this past summer. Evidently they've been around since 1998, but because financial advisors and brokers can't make money recommending them, they haven't received much press.
So what's the big deal about I Bonds? 7.12% annualized interest for the first six months on I Bonds purchased before the end of April 2022. After six months, the interest rate of your I Bonds will reset based on the going rate of inflation, just like it was set for the current period. While you're just keeping ahead of inflation (i.e. your purchasing power is growing, but not by much), the alternative safe investment vehicles are grossly inferior. A quick check of Bankrate.com shows that the best 1-year CDs and money market funds are paying out around 0.6%. The best 3-year and 5-year CDs are only paying 1.1% and 1.3%, respectively.
Like other Treasuries, interest on I Bonds is exempt from state and local income taxes (but are still subject to Federal income taxes, and state estate and inheritance taxes), a nice perk for you if you happen to live in a high tax state like California or Oregon. And you won't be required to pay the Federal income tax until you cash out your I Bonds, so your interest will compound tax-free over the year(s) that you hold it. However, you can avoid Federal income taxes on your I Bonds interest if you use the I Bonds to pay for qualified higher education expenses at an eligible institution.
What's the catch, you're probably thinking? As with most good things, there are a few:
- You lose all liquidity for the first year (i.e. you can't sell them for the first year).
- You are only allowed to buy $10,000 in I Bonds an any calendar year.* But if you can act quickly, you can put $20,000 to work over the next two weeks — $10,000 now for your 2021 allowance, and then another $10,000 after the new year for your 2022 allowance. This is per person and/or trust, so a couple with a trust could conceivably put $60,000 to work at 7.12% over the next two weeks.
- You surrender the last three months of interest if you cash out your I Bonds during their first five years. But given the extremely high interest rate paid by I Bonds, they are still much more attractive than the 'safe' alternatives, even if held for only a year or two.
As mentioned earlier, you can't get I Bonds through your financial advisor or broker. Instead, you need to buy them directly at TreasuryDirect, the US Treasury's website for retail investors to buy Treasuries. But be forewarned, the TreasuryDirect website is straight out of 1994, and the customer service is horrible. During the setup process, you'll link up your checking account that will allow for your I Bond purchases to be paid out of your checking account.
So in summary, I Bonds are the best thing going right now for the ultra-safe portion of your investment portfolio. Their interest rate resets every six months based on the inflation rate, guaranteeing that you will maintain the purchasing power of your investment. I Bonds also have some attractive tax treatment, such as exemptions from state and local taxes, deferral of Federal tax on interest to the time of the sale of the investment, and no Federal tax on interest if you use the I Bonds to pay for higher education expenses. However, they must be held for at least one year, so they are not appropriate for funds that may be needed at a moment's notice over the next 12 months. I Bonds are so attractive, you may want to back up the truck (i.e. stuff your portfolio) with them, but unfortunately you are capped at $10,000 per person, per calendar year. If your savings allow, now is the time to buy your 2021 allowance, and soon after New Years for your 2022 allowance.
*You are also allowed to direct up to $5,000 of your Federal income tax refund towards the purchase of paper I Bonds. You can do this by filing a Form 8888. Note that this $5,000 allowance is per tax filing, not per individual, so a married couple filing jointly can only purchase $5,000 in paper I Bonds if they have a refund at least that large. Paper Bonds can be easy to keep track of, so I would recommend converting it to an electronic I Bond using TreasuryDirect's SmartExchange.