Why would anyone want to buy I Bonds? Does a guaranteed interest rate of 7.12% do anything for you?
While you may not be a huge fan of the issuer — that would be the U.S. Treasury, a department of the U.S. government — you’re not going to find many safer sources of fixed income. After all, they have the power to create money.
How do you buy these I Bonds? It’s not as simple as buying shares of BND or VBTLX from Vanguard, but it’s not terribly complicated, either.
I recently lined up my first purchase of Series I Savings Bonds online from Treasury Direct, and I’ll walk you through the steps.
Why You’re Suddenly Hearing About I Bonds
These bonds are not new, but they’re newly enticing. You see, the interest rate is tied to one of the U.S. Governments measure of inflation, the CPI-U, and that’s been going nowhere but up in recent months.
For the same reason that Social Security benefits will receive a 5.9% boost as a cost-of-living adjustment for 2022, I Bonds are now paying more than they have in a long time.
For the formula and further details on how the interest rate is calculated, see the explanation at Treasury Direct.
In summary, it’s a combination of a fixed rate (currently 0%) and a variable rate, each of which are updated every six months in November and May. The fixed rate has been under 1% since May of 2008 and has not been above 2% since 2001.
The variable rate, on the other hand, has been as low as an annualized -5.56% during the Great Recession and has never been as high as it is now (7.12%) since I Bonds were first issued in 1998.
Note that the interest for every I Bond ever issued is updated every six months. Every I Bond purchased in the first two and a half years these were offered is now paying over 10% annualized for the next six months.
The interest rate for all I bonds will change in May of 2022 based on the inflation rate at the time. Any I Bonds you hold will be subject to a new interest rate every 6 months based on when you bought them. So, if you buy in April of 2022, you are still locked in to that 7.12% rate until October, 2022.
For a detailed look at the interest rates and how they’ve changed for I bonds issued at any time since 1998, please see this chart from Treasury Direct. Plan on zooming in on the table to actually read it; it’s a big one.
Another useful resource for looking at past performance of I Bonds purchased in the past can be found here at eyebonds.info.
Advantages of I Bonds
Interest in I Bonds is credited twice a year, but you do not pay taxes on that interest until you decide to cash out your bond. It is automatically reinvested.
This is effectively a form of tax deferral, which is different than most bonds and bond funds.
Additionally, when you do redeem your I Bonds, the interest will not be subject to state or local income taxes. A downside is that bond interest is subject to ordinary income tax rates at the federal level, which is true of most bonds, the exception being lower-interest municipal bonds.
Furthermore, if you have a modest income ($98,200 for single filers, $154,800 if married filing jointly in 2021) when your children are in college, you can redeem your I Bonds completely tax-free when you use the proceeds to cover qualified education expenses. The same is true of Series EE Bonds purchased after 1989. Funding a 529 account is a qualified education expense.
The Interest Rate!
“High Yield” savings accounts are paying about 0.5% interest in 2021. Money market funds and typical savings accounts pay even less.
Vanguard’s Total Bond Fund yields 1.5% and the value of the underlying fund is subject to change, unlike the value of an I Bond, which can never drop (or rise) in value.
A 7.12% return is awfully good for fixed income at the moment, and that rate is guaranteed for the next six months.
Low Default Risk
Sure, Congress will play games and kick the can down the road, but the odds of our government actually defaulting on debts owed to investors is exceptionally low.
There was a brief default in 1979, but Treasury bill holders got their interest after a brief delay. If the U.S. government truly defaults and is never able to pay its debts, we’ve got bigger problems than not receiving interest payments on a portion of our bond allocation that year.
Disadvantages of I Bonds
Annual Purchase Limits
You’re limited to $10,000 per person in online purchases, and you can buy an additional $5,000 in paper I Bonds via your federal tax refund if you paid more in than you owed.
If you’re married, your spouse can do the same, you can make purchases in your kids’ names, and trusts can own them, too.
I’m not going to go out of my way by forming a trust or giving the government an interest-free loan by paying more than necessary towards next year’s tax bill, so I’ll settle for $10,000 a year for me and $10,000 a year for my wife.
I can lock in this 7.12% interest rate with purchases in November for 2021 and again in January for 2022. By then, we’ll have $40,000 (plus 3 months interest on the 2021 purchases, assuming we hold for 5 years) in I Bonds between the two of us.
Only One Seller
You can’t buy these from your favorite brokerage, and there’s no I Bond mutual fund or ETF. That also means that there are no fees, so in some ways, this is an advantage.
It does mean that you have to create an account at Treasury Direct, so that’s a bit more to keep track of.
Illiquidity for One Year
You cannot redeem I bonds until you’ve owned them for a full year. If you choose to cash them in before a full five years has passed, you’ll forfeit 3 months of interest payments.
This 3-month interest forfeiture is actually assumed and baked in to the balance shown on your I Bonds, and they’ll credit you the missing interest in your account once you hit the 5-year mark.
Compare this to a more typical 6-12 month penalty for early withdrawals from certificates of deposit, and it doesn’t look so bad.
How to Buy I Bonds from Treasury Direct
Step 1: Go to the TreasuryDirect website
Navigate to Individual / My Accounts. Here is the direct link: https://www.treasurydirect.gov/indiv/myaccount/myaccount.htm
Click on “Open an account” in the middle of the page.
Step 2: Choose to “Apply Now”
You’re taken to overview screen explaining the process. They’ve also got links to tutorials, but I’m hoping this one is the only one you’ll need.
You’ll find the blue “Apply Now” button at the bottom of the screen. Click it!
Step 3: Choose an Account Type
If you’re purchasing as an individual, which will be the most common scenario, click the first circle to indicate that you’re purchasing as a person rather than as a business or a trust.
If you’re not purchasing as an individual, click the appropriate circle. The Finance Buff has a tutorial for buying I Bonds in a trust, which is one way to get more than $10,000 or $15,000 per person per year.
Click the “Submit” button at the bottom once you’ve made your selection above.
Step 4: Enter Your Details
TreasuryDirect calls it Step 2, and it’s the most time-consuming step.
This is straightforward as long as you have the necessary information handy, including a Social Security number (or EIN for a business), your state-issued ID, and bank account info.
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Step 5: Don’t Perjure Yourself
Make sure you entered the correct Social Security number or EIN, that you’re not subject to backup withholding (you’d know if you are), and that you are not only a person, but a U.S. person as defined by the IRS.
Click the “Submit” button if all of this is true.
Step 6: You’ve Got an Account!
The Treasury Department welcomes you to your brand-spanking-new account, and it’s ready to use instantly. Let’s keep this party going!
Step 7: Select “BuyDirect” & “Series I”
We’re here to buy some I Bonds. Once you’ve clicked on “BuyDirect” in the menu bar at the top, turning it orange, select the circle next to “Series I” under Savings Bonds.
For the curious, they’ve got a breakdown of the similarities and differences between Series I and Series EE Bonds. EE Bonds are not adjusted for inflation and are currently paying 0.10% as of November, 2021.
Click “Submit” at the bottom once you’ve made your selection, and be sure to select Series I unless you want to give up 7.02% in interest.
Step 8: How Much Would You Like?
Remember, you’re limited to $10,000 per calendar year in online I Bond purchases. The simplest method is to invest $10,000 at once, but if that’s too rich for your blood, you can set up scheduled purchases at regular or irregular intervals.
Enter the purchase amount and date(s). Your bank information was entered earlier, and you’ll want to make sure that your account is selected in the dropdown box as the source of funds.
Regarding timing, as long as your money is in before the end of the month, you’ll earn interest for that month. You don’t earn any more interest by investing on the 1st of the month as opposed to the 31st. That said, there can be a delay of several business days, so I timed my purchase for a week before the end of the month.
When redeeming your I Bonds, it’s best to withdraw early in the month. You don’t accrue any additional interest by remaining invested beyond the 1st of the month.
Step 9: Review and Submit
Look everything over to ensure you didn’t goof anything up. If you goofed, select “Edit” at the bottom and get it right. If all looks good, click “Submit.”
Congratulations! You’ve scheduled your first I Bond purchase(s) in a few short minutes.
The next screen should be a confirmation of what you’ve set up.
You’ll also receive an email from [email protected] confirming the activity.
If you’ve got questions, ask them! I’m almost as new to this as you are. You can reach TreasuryDirect at 844.284.2676 if you can’t find the answer to your questions on the website.