Including I Bonds in Your Financial Strategy
I love I Bonds and have had them since 1999. If you can wait a year to get your money back a bit like a CD, they are an incredible choice for your ‘safe’ money. However, they are not as easy to use as one would hope and I think they fit best in a long-term strategy. Here are some tips (pardon the pun) I give clients for purchasing and using them.
You can only buy I Bonds directly from the US government at the Treasury. They pay a regular (tiny) interest rate, like your savings account. On top of that, they pay an amount equal to CPI every year: the inflation adjustment. The I Bond you buy ($25 minimum) compounds like a savings account. When you cash it in you get the interest, plus the inflation adjustment, plus your original value all back at once.
One nice feature of I Bonds is that they grow tax-deferred, like your 401(k) or IRA. You don’t pay the interest until you cash out.
So why aren't we all loading up on I Bonds? The biggest issue is that one can only buy $10,000 a year per social security number. (Perhaps ironically, that $10,000 limit established in 1998 was not inflation-indexed.)
If you are very determined, the $10,000 limit has a few workarounds:
If you are married, both of you can put $10,000 in every calendar year.
Deliberately overpay your taxes, and request a $5,000 per tax return I Bond with form 8888.
Open a Treasury Direct account for your private business and buy $10,000 (LLC, S-Corp, partnership).
File for a revocable trust, and open one for each trust.
Open accounts for your kids “Establish a Minor Linked Account” - but know that they own it when they turn 18.
Another potential pitfall is that your money is tied up for a year. That's important to remember. Don't put money in there that you know you will need within 12 months. After that 12-month period, you lose a quarter of a year's interest if withdrawn before five years, a small penalty.
An I Bond can't be split up or partially cashed. It's all or nothing. And when you cash it, it's gone permanently. Treasury Direct is not like a checking or savings account.
I Bond returns have not always been better than a savings account. They have done better about half the time since they were introduced in the late 1990s. However, I Bonds have done better than savings accounts for most of the last two decades.
There is an education benefit for I Bonds that work like 529s but there are income limits. You can take the money out and pay no taxes on the interest if it's for a qualified education expense (not for room and board), but your income has to be modest. I find clients are usually in high-earning years when kids start college.
The Treasury Direct website is terrible. This is talked about on consumer investing forums a lot, but don't let it scare you, it's navigable. (However when setting up your account, if you fail their identification questions, you may need a difficult-to-obtain signature guarantee and that's a pain in the ass.)
How should you use them? If you are saving for retirement, they are excellent tax-deferred investments and should be part of your bond allocation. The only downside is you can’t rebalance them into stocks as markets shift, at least not without selling them.
What I really like them for is an emergency fund. Put $10,000 (or $20,000 if a couple) away every year until you have a fully-funded emergency reserve. It will always (nearly) match inflation, never lose value, and be there when you need it.
I think this is an especially good use of I Bonds if you are the type of person who dips into emergency funds for less-than-full emergencies. The I Bond 'all or nothing' cash out and Treasury Direct website difficulty become ‘features not bugs’ in this respect. You'll still need a month or two in a regular savings account for quick access, but you can get the I Bonds later if you need it.