One of the best deals for savers now are Treasury Series I savings bonds now paying a 7.12% interest rate.
Individuals are limited to a purchase of $10,000 annually. The bonds need to be held for 12 months and have a 30-year maturity. If they are redeemed before five years of ownership, holders lose three months of interest. They are available for as little as $25. Individuals can buy an additional $5,000 annually in paper form using proceeds from income-tax refunds.
The series I bonds pay interest, which is added to the price of the bond, every six months based on the all-urban CPI index. The most recent 12-month increase in the CPI index was 6.8% for November.
The bonds have a fixed rate, which is now zero, plus the inflation component that is reset every six months. The rate is set on the first business day of May and November. Buyers will now earn the 7.12% rate for the first six months that they hold the bonds.
With inflation likely to run high at least for 2022 and potentially longer, the series I bonds offer a good alternative to bank saving accounts now paying close to zero and to most bond investments. They offer protection against the event that bondholders should fear most: high inflation.
The problem with Treasury notes and bonds is that they don’t provide that inflation protection. Their real, or inflation-adjusted, rates are deeply negative now with most Treasuries yielding in the 1% to 2% range. And Treasuries may have negative real rates for years, heightening the appeal of I bonds.
The savings bonds are well suited to small savers and as a complement to a 401(k) or IRA retirement plan, which have limited annual contributions. They also can be paired with 529 college savings plans.
And interest on savings bonds can be tax free when used for educational purposes for the holder, spouse or children within income limits. Bonds bought by parents in the name of their children under age 24 don’t qualify for this tax benefit.
The standard advice from experts is that younger people should invest their retirement accounts heavily in stocks. In real life, however, younger workers often redeem their 401(k) accounts early because of job loss, divorce, or other adverse events—sometimes at the worst possible time. Having a stable base to draw upon, like savings bonds, permits investors to leave their equity portfolios intact to grow over the long term.
Like other Treasury obligations, I bonds aren’t subject to state and local taxes on interest income and offer an appealing tax deferral feature allowing holders to put off paying taxes until they redeem the bonds.
Given current I bond yields, they offer a good alternative even after taxes to municipal bonds, which now yield about 1% for top-grade intermediate-term debt.
Interest accrues over the life of the bonds, eliminating the reinvestment risk involving interest payments on standard bonds. And if inflation is negative (deflation) the rate on the I bonds can’t be set at less than zero.
The Series I bonds offer a higher rate than Treasury inflation-protected securities (TIPS), which now pay a rate below the CPI index. Ten-year TIPS, for instance, now effectively pay a rate that is less than one percentage point below the CPI index. The advantage of TIPs is that there is no $10,000 annual investment ceiling.
Many individuals prefer TIPs exchange-traded funds like the $39 billion iShares TIPS Bond ETF (ticker: TIP) to holding TIPs, given the better liquidity and relatively low fees. The TIP ETF has an annual fee of 0.19 percentage point.
The ETF invests mainly in intermediate-term TIPS and has an average maturity of eight years. Like the bonds it holds, the ETF has a negative real rate that recently stood about one percentage point less than the inflation rate.
I bonds may not do a lot for the portfolios of the wealthy, but for those of lesser means, they can be an excellent bond alternative.
Randall W. Forsyth contributed reporting.
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