Series I Savings Bonds
As the old curse goes: May you live in interesting times. For investors, the times are — to put it mildly — interesting. With volatile market fluctuations joining the highest inflation in decades, lower-risk investment vehicles are surging in popularity. One such vehicle is Series I bonds, but many people are not yet familiar with them. Many ask, what are I bonds, and why are they such a popular choice in today’s landscape?
What are I bonds?
Series I bonds are a US savings bond that earns interest based on combining a fixed rate and a variable inflation rate. They are non-marketable, meaning they cannot be bought or sold in secondary markets. I bonds are designed to offer a low-risk investment to help protect savings from inflation, since their redemption value cannot decline. If the variable inflation rate becomes negative enough to cancel out the fixed rate, the composite rate will be set to zero. In contrast, corporate or municipal bonds can lose value, though they also generally provide higher returns. The return rates on I bonds are more comparable to high-interest savings accounts.
How do I bonds work?
As mentioned, I bonds earn interest by combining a fixed rate and an inflation rate. The fixed rate is set by the Secretary of the Treasury and is announced semi-annually in May and November. That rate then applies to all I bonds sold over the next six months. The inflation rate is also adjusted each May and November and is based on the consumer price index for all urban consumers (CPI-U). They have a 20-year initial maturity with a 10-year extended period for a maximum of 30 years. I bonds can be sold after as little as one year, but if sold within 5 years of purchase the holder sacrifices the last 3 months of interest. I bonds are zero-coupon bonds, which means no interest is paid out during the life of the bond. Instead, the interest is added back to the value of the bond, earning compound interest
How are I bonds taxed?
Interest income from Series I bonds are taxable at the federal level but are exempt from state and local taxes. There are two methods of taxation for I bonds: cash and accrual. The cash method taxes interest accrued from the bonds at the time of sale. The accrual method taxes interest earned on the bonds each year. I bonds also have a unique tax advantage if used to pay for education. Proceeds from I bond sales which are used to pay for qualified higher education expenses within the same calendar year are exempt from federal income tax.
How are I bonds purchased?
There are two possible ways to purchase I bonds. Electronic bonds can be bought online from the US Treasury using the TreasuryDirect website, or paper bonds can be purchased with federal income tax refunds. The minimum purchase amount for electronic bonds is $25, while the maximum purchase amount is $10,000 per social security number per year. This means married couples can purchase $20,000 annually, and children can also have I bonds purchased on their behalf (though a custodial account through TreasuryDirect must first be made). Paper bonds come with a $50 minimum and $5,000 maximum. These totals can be combined for individuals (and in some cases trusts and estates). For example, an individual who purchases $10,000 of electronic bonds can still use their federal tax refund to purchase an additional $5,000 of paper bonds (though this requires IRS Form 8888 to be filed with their federal tax return). LLCs, corporations, sole proprietorships, living trusts, and estates can also purchase electronic I bonds. Hypothetically, a married couple who each own a business and have two children can purchase a combined $70,000 in I bonds annually (even more if you add living trusts!), but each person or entity will need their own TreasuryDirect account.
The information provided is for informational purposes only. It is not intended to be used, and should not be used, as the sole basis for legal and/or tax advice. Individuals should seek and rely upon the guidance and advice of their own legal and tax counsel before making any decisions regarding any planning, investment, tax concepts or strategies discussed herein. Individual circumstances may vary and results discussed are no guarantees of applicability or future performance.
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