I Bonds, Offering a Safe Space for Cash, Get a Big Rate Bump

The rise in prices has affected not only consumer goods but some government savings bonds, and it could benefit some investors looking for safe spaces for their money.

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As the country recovers from the pandemic, rising prices have become a worry for many Americans. But inflation has also driven up rates on some government savings bonds, creating an opportunity for people seeking a safe haven for their cash.

New series I savings bonds, known as inflation bonds or I bonds, issued in the next six months will earn a rate of 7.12 percent, the Treasury Department announced this week. That represents the second-highest initial rate ever offered on the bonds, the department said. The new inflation-based rate applies to I bonds issued from November of this year through next April, as well as to older I bonds that are still earning interest.

By comparison, the average rate for a one-year, online certificate of deposit is less than 0.5 percent, according to the financial website DepositAccounts.com.

“It’s a pretty good deal,” said Stephen Biggs, chief investment officer at HC Financial Advisors in Lafayette, Calif., of the current rate on I bonds.

Savings bonds generally are low-risk investments, but I bonds’ rate structure is complicated and there are drawbacks, like limits on how much you can buy and penalties if you cash them in early.

“While Series I bonds may sound really attractive at first glance, investors should carefully consider the complexities coupled with the cap on the purchase amounts before making an investment,” said Kevin Shea, senior portfolio manager at Creative Planning, a wealth management firm in Overland Park, Kan.

The rate earned by inflation bonds, which were first issued in 1998, is made up of two parts: a base rate, fixed for the life of the bond; and a rate that varies based on inflation, as measured by the Consumer Price Index, which can reset every six months, in May and November. The Treasury Department applies a formula to combine those two rates into a “composite” rate.

For more than a year, the fixed rate on I bonds has been a disheartening zero. Yes, zilch. That means all of the interest earned on those I bonds comes from their variable inflation rate. No one knows for sure if the current bout of brisk inflation will be temporary or persist into next year. But if the bonds’ inflation rate were to fall, while the fixed rate stayed at zero, the rate paid on the bonds could be less attractive.

The composite rate for new bonds could even reach zero — although it’s guaranteed to never go below that. So you’ll at least get back your original investment when you redeem the bond, according to Treasury.

You won’t owe state or local income taxes on the interest earned, but you will owe federal income tax — although you can wait until you redeem the bonds to pay it. (If you use the money for higher education, you may be able to avoid part or all of the federal taxes.)

Inflation bonds pay interest for 30 years unless you redeem them earlier. You can redeem digital I bonds online and have the money deposited in your bank account. If you still hold paper bonds, you can redeem them at local banks, according to Treasury Direct.

Savers who bought I bonds years ago, when the fixed-rate component was higher, may be earning double-digit composite rates now. Holders of bonds issued from May to October 2000, for instance, will earn 10.85 percent because the latest variable inflation rate is added to the bonds’ fixed rate of 3.6 percent, said Ken Tumin, founder of DepositAccounts.com.

To see what rate your bond is currently paying, check on TreasuryDirect, the website operated by the Bureau of the Fiscal Service, part of the Treasury Department.

So how do you buy I bonds? There are two ways. The first is to purchase them at TreasuryDirect.com. To do this, you’ll first need to establish an online account with a minimum deposit of $25 and link it to your bank account. You won’t receive a paper bond; most new savings bonds are electronic and remain in your digital account.

You can buy up to $10,000 in digital I bonds per person, per year.

The second way is to buy I bonds at tax time with your federal income tax refund. You can buy up to $5,000 in bonds this way — the only way left to get paper savings bonds.

A couple filing a joint tax return can buy up to $25,000 a year — $10,000 each, plus an extra $5,000 at tax time. It’s possible to buy more, by purchasing I bonds as gifts.

There are other caveats. You must hold the bond for at least 12 months before redeeming it. So if you are using the bonds for emergency funds, Mr. Tumin said, you should have extra cash set aside elsewhere, in case you need it sooner. “It’s not an ideal emergency fund,” he said.

And keep in mind that if you redeem an I bond before five years, you’ll owe a penalty worth the interest of the previous three months.

The latest bout of inflation may be transient, so I bonds should be considered along with other options for beating inflation longer-term, said Jacob Kuebler, senior financial adviser with Bluestem Financial Advisors in Champaign, Ill. “Over a long period,” he said, “the stock market is a good inflation hedge.”

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