28 Jul What are I Bonds, and should you own them?
You may have heard there is a US government bond yielding 9.62% and wondered can this be true. Well, it is true and there are many key details to know before making a purchase decision.
An I bond is a US savings bond issued by the US Treasury. US savings bonds pay the accumulated interest when they are sold or redeemed. They do not distribute interest payments to you before then, so they are not a desirable choice if you want regular income payments. There are two types of savings bonds, series EE and series I
Series I have an inflation component which in today’s environment makes them compelling.
The interest is a combination of a fixed rate of return and a variable semiannual rate.
The fixed rate is stated when you purchase the bond and does not change during the life of the bond. The variable semiannual rate (inflation rate) can change every 6 months. The inflation rate is announced in May and November of each year and is based on the Urban, Consumer Price Index (CPI-U) which includes food and energy. Interest accrues over the life of the bond and is paid upon redemption. The bonds last for 30 years unless you sell before then.
The current combined interest rate (through October of this year) is 9.62%.
The catch is you can only purchase $10,000 per Social Security number per calendar year. These bonds can only be held at TreasuryDirect.gov. You can however purchase an additional $5,000 of bonds per year in paper form with your federal tax refund. Your tax professional can make this selection for you.
Besides the interest rate there are several other attractive features of series I savings bonds.
- They are considered low risk because the payment is guaranteed by the US government.
- The interest is exempt from State and Local income tax.
- The interest rate will never go below zero.
- Tax reporting of interest can be deferred until redemption or can be claimed annually. You do not need to do anything to defer the interest.
· They are great gifts. You can purchase an electronic I bond as a gift for someone and hold it in your Treasury Direct account until you are ready to transfer it to the recipient. The purchase amount of a gift bond counts toward the annual limit of the recipient, not the giver.
- You can also use your federal tax refund to purchase up to $5,000 in paper bonds for each person. Again, the purchase amount of a gift bond counts toward the annual limit of each recipient, not the giver. The paper bond is sent to you so you can present it to the recipient. If the bond is lost, there is a process for replacing them on the Treasury Direct website.
- There are tax benefits for using I bonds to finance education (subject to income limits). Under the Education Savings Bond Program, you might be able to exclude savings bond interest completely or partially from Federal income tax. This can occur when you pay qualified higher education expenses at an eligible institution or state tuition plan in the same calendar year you redeem eligible, I bonds. There are restrictions and requirements so please see IRS Publication 970 – Tax benefits for education or your tax professional for details.
Besides the annual limits on the purchase of I bonds, there are a few other important restrictions to keep in mind.
- You must own them for at least one year. They cannot be sold before then. If you redeem an I bond within the first 5 years, you will lose your last 3 months of interest. For example, if you redeem an I bond after 21 months, you will receive the first 18 months of interest.
- They can only be bought, sold, or redeemed at treasurydirect.gov.
- The interest is subject to Federal income tax and estate tax at the state level.
- US citizens can buy US savings bonds as individuals and other forms of ownership are available. There are restrictions on ownership. For example, you cannot buy an I bond for your IRA. The instructions for opening an account in the name of a family trust are awkward. The details are available at the treasurydirect.gov website.
- You will have to open an account at the above website.
If you would like to learn more information or make a purchase, check out www.treasurydirect.gov
If you would like to see how we can help you, please call us at 626-795-3062.
Written by Hal Smith Senior Wealth Manager, Bridge Advisory LLC. Pasadena CA. The information in this article is based on current IRS and California tax rules as of 8/25/2021.