At a time when investors worried about inflation are considering putting money into everything from bitcoin to commodities, there’s an old fashioned—and uber safe and simple—way to keep at least some of your cash from losing value: U.S. Savings Bonds.
The U.S. Treasury announced yesterday that I bonds issued between now and the end of next April, will earn interest at an annual rate of 7.12% over the first 6 months after purchase. That’s the second-highest initial interest rate ever for these bonds.
You can purchase digital series I bonds on the U.S. Treasury’s Treasury Direct website, with a minimum investment of $25, and a maximum of $10,000 per calendar year, per Social Security number. (So a couple can buy $20,000 worth.) You can cash your bonds after a year, but you’ll lose three months worth of interest if you cash out before you’ve held them for five years. Or, if inflation persists, you can choose to continue earning interest over the next 30 years, compounded semi-annually, with the rate reset every six months.
In addition to the $10,000 limit, the bad news about newly issued I bonds is they won’t pay much if and when inflation does come under control, as the Biden Administration and the Federal Reserve are predicting. That’s because each I bond’s interest rate has two components — the inflation rate that adjusts every six months and a fixed rate designed to provide a return over inflation, that is constant for the whole 30 years. And the fixed rate on I bonds purchased now is a big fat 0%, as it has been since May of 2020. By contrast, the fixed rate in the first three years of the I bond program (it started in 1998) ranged from 3% to 3.6%. Since existing I bond holders get the 7.12% inflation rate too, that means those old-timers are now earning a combined annual interest rate of more than 10%, courtesy of Uncle Sam. (Apparently, it’s not only bitcoin investors who benefit from being HODLers.)
The 7.12% rate looks particularly attractive when compared with bank certificate of deposit rates, which have haven’t risen with inflation. Currently, the best annual interest rates offered on 1-year CDs top out at 0.65% to 0.75%, while even five-year CDs are paying at best around 1.2% a year.
So should you stash $10,000 of spare cash in I bonds now? Remember, if you choose to redeem your bonds before five years, you lose the previous three months of interest—just as there’s a penalty for cashing out of a CD early. That means if you wanted to put cash in I bonds for a year, you would get a 7.15% annual interest over the next six months, and then whatever new interest rate was set over the course of three more months. In other words, you’d come out ahead of buying a one year CD.
As for tax considerations, I bonds have it all over CDs. I bond interest is exempt from state and local income taxes and you can elect to defer federal income taxes on your earnings until you cash the bonds in. (CD bank interest, by contrast, is taxed annually, as it accrues, even if you’re reinvesting it all.) One other tax advantage of particular interest to parents and grandparents: if you cash in an I bond to pay for higher education, the interest may not be federally taxable at all. But to take advantage of this income exclusion, your modified adjusted gross income must be below a certain amount—in 2021, the income exclusion begins phasing out at $83,200 for singles and at $124,800 for couples. That number gets adjusted annually for inflation.
To purchase I bonds, set up an account with TreasuryDirect, and link it to your bank or money market account. You can also buy I bonds by signing up for Treasury’s payroll savings option, which sets up recurring purchases of electronic savings bonds with money taken directly out of your paycheck.
The only way to buy paper I bonds these days? Direct your tax refund be used to purchase them. So if you file your 2021 tax return by early April, and are due a refund, consider directing it into I bonds and you’ll be guaranteed six months of that 7.12% interest rate. (Note that you can purchase up to $5,000 of I bonds with your refund in addition to $10,000 purchased online through Treasury Direct.)