I Bond Pros and Cons: Why They’re Such a Sweet Treat Right Now
I scream. You scream. We all scream for… I Bonds.
Yep. There is currently a lot of excitement about I Bonds because, according to the Wall Street Journal, they will offer annual interest payments of 9.6%. This is an extraordinarily good return for an investment with so little risk. And, they are proving very popular. Over the last 6 months, almost $11 billion in I Bonds have been issued, many more than the $1.2 billion issued during the same period in 2020 and 2021.
Making healthy returns on “safe” investments has been incredibly challenging for the last few decades. Interest rates have been low and many people have needed to risk money in the stock market in order to keep pace with inflation and their retirement income needs.
With the shifts in the economy, the tides are turning. And, currently many financial experts are excited about I Bonds as a high return almost risk-less investment.
What is a Bond?
Before learning about I Bonds, you may first want to understand bonds.
Bonds are fixed-income investments. You are loaning money – often to a government entity – with specified terms for interest, payments and time horizon. When you purchase a bond, you know exactly what you are going to get in return.
What is an I Bond?
An I Bond is a specific type of bond issued by the U.S. Treasury. I Bonds are designed to protect your money from losing value due to inflation.
The bonds pay both:
- A fixed rate that is set by the Treasury
- An inflation-adjusted rate that is determined by the rise and fall of inflation – specifically the CPI
How Returns on I Bonds Work
When you purchase an I Bond, you are loaning the government money at a specified rate of return for the first six months.
The Treasury sets rates for I Bonds returns twice a year (on the first business day in May and on the first business day in November). The rate of return is a composite rate (a combination of the fixed and inflation-adjusted rates).
For the first six months after your I Bond purchase, you will earn the rate offered on the date of purchase. And, that rate will adjust every six months thereafter. So, bonds issued in January would be reset January 1 and July 1. Bonds issued in February would be reset February 1 and August 1.
I Bonds Pros and Cons
There are quite a few cons listed below, mostly about convenience. However, the pros are significant. Joshua Rauh, a senior fellow at Stanford’s Hoover Institution, told the Wall Street Journal, “[there is] nothing nearly as good as the I Bond.”
Pro: High Returns
Currently, holders of I Bonds are earning higher returns than most high performing stocks and certainly higher than the average – without the risks. And, I Bond returns are massively higher than other low risk savings vehicles like high-yield savings accounts and CDs.
Pro: No Risk to Principal
With an I Bonds you currently carry virtually no risk of principal loss.
Pro: Tax Benefits
I Bonds have some flexible tax benefits. For example:
- I Bond holders can opt to defer I Bond interest until maturity or redemption.
- Income from an I Bond may be tax exempt for lower- and middle-income families if you use the bond to pay for college tuition.
Con: Limits on I Bond Purchases
You can not dump all of your money into I Bonds.
Each person can only purchase up to $10,000 worth of I Bonds annually. Plus, another $5,000 with your tax refund, if applicable.
Rob Berger discusses buying strategies for I Bonds on his engaging YouTube video.
Pro: Returns May Go Higher
The Wall Street Journal reports that bonds could pay more if Treasury Secretary Janet Yellen chooses to raise the fixed interest rate, an increasingly possible scenario.
Con: Must Be Purchased through the Treasury
Con: The Buying Process Can Be Problematic
Many people report that the purchasing process can be problematic.
On the NewRetirement Facebook group, Mike commented: “I’ve been a software developer for 30+ years and am used to dealing with all kinds of UI’s but I think the Treasury Direct site is one of the most un-user friendly I’ve ever seen.”
Sue agreed, “Just have to chime in that the web site is horrible. If you don’t recall the exact same challenge questions you selected when signing up, you get locked out and will have to wait on hold for over an hour to unlock account. Maddening.”
However, many others report no real problems and that it could be quick.
Con: You Need to Document and Track Your Purchase
I Bonds are not sold by banks or brokerages. So, you are not going to get great reporting tools. You need to carefully print your paperwork and keep track of the investment yourself.
Mike advises, “They do have a good return, but they are well hidden assets. You get no paper trail so make sure you document the account well.”
Con: Need to Document I Bond Carefully for Estate Purposes
It is up to you to document your I Bond as part of your overall portfolio. And, for estate planning purposes, be sure that:
- Your heirs know how to access the funds.
- You have designated a beneficiary.
Shannon warns, “Please be careful to think about beneficiaries before you decide to plunk the whole 10k down. I am single, but have two kids. I usually set at 50% each for my beneficiary accounts. You can only name one Pay on Death beneficiary if you’ve already created the deposit, so this year I had to name one and next year will do it again and name the other. In hindsight, break up your deposits to match with each beneficiary. So ideally it should have been a 5k deposit and another 5k deposit.”
Con: Limited Liquidity
I Bonds must be held for at least one year. And, I Bonds redeemed after less than 5 years are penalized for the last 3 months of earned interest. (Unless you are a victim of some type of disaster.)
The term of I Bonds is 30 years. They are generally considered to be a longer term investment.
Con: Can Not Be Purchased with Assets in a Retirement Account
You are not allowed to purchase I bonds with funds in an IRA or employer-sponsored savings plan, such as a 401(k) plan. You’ll need to buy I bonds with money that you have saved outside of these programs.
Con: Hassle May Not Be Worth It
Because you are limited to how much money can go into I Bonds each year, the high returns and low risk may not actually be worth the hassle.
The reason that I Bonds are paying such a high return is inflation. And, inflation is definitely an overall disadvantage. (Though I Bonds are one way to keep ahead of it.)
Model I Bond Returns in the NewRetirement Planner
Use the NewRetirement Planner to model I Bond returns and assess the impact on your near- and long-term financial plans.