How Do “I Bonds” Work?
On our Secure Your Retirement podcast, we’ve been having a lot of people ask about something that is all over the news: I Bonds. With the traditional bond market doing so bad, I Bonds are certainly something to consider.
However, we do want to explain I Bonds to you further so that you can decide if they should be a part of your retirement planning or not.
What are I Bonds and How Do They Work?
An I Bond is a bond that is issued by the government, and “I” stands for inflationary. Due to the high inflation, these I Bond concepts have started to pick up steam. The reason I Bonds are so popular right now is that they’re paying 9.62% in interest.
With the stock market struggling and inflation creeping up, I Bonds offer an attractive option that is government-backed and guaranteed interest. However, the interest can move around a little bit, and this is something that we’ll explain shortly.
I Bonds are easy, too.
In fact, I Bonds are almost a “no-brainer,” and it’s very easy to start investing in these types of bonds.
How Do You Buy I Bonds?
An I Bond must be purchased by an individual, so it’s not something that an advisor can help you with. Instead, you can quickly and easily purchase them from TreasuryDirect.gov. The site is an official government website, and you can create an account and purchase the account directly through a bank draft.
Most people are going to buy these items directly, so you won’t receive a physical paper bond.
However, you can get a paper bond, too. How?
- If you receive money back on your taxes, you’ll fill in a form for an I Bond
- The government will send you a paper bond
For most people, it’s likely easier to purchase all of your I Bonds online because they’ll be kept digitally on the government’s website. Otherwise, if you lose the paper bond, you may lose all of your investment, too.
I Bond Limits
I Bonds do have limits, so you can’t just go out and put $100,000 into I Bonds today. The limit is $10,000 per person. You can:
- Buy $10,000 for your child
- Give $10,000 to someone else
However, your child or that person will not be able to buy their own I Bond because you’ve already purchased it on their behalf.
Speaking of limitations, the current interest rate is 9.62%, but the rate is only guaranteed for so long. A few things to know are:
- I Bond rates adjust every six months
- Rates can go up or down
- Must be held for 1 year
The interest rate provides a fixed rate of 0% under the current rule, but with high inflation, the bond is at 9.62%.
If the government does bring inflation down in the near future, you’ll see the interest rate on I Bonds come down. For example, if the government can get inflation back to a normal level, you’ll likely see these bonds fall to a 2% – 4% interest rate.
Through our experience, the optimal time to hold the bond is five years.
You can cash out the I Bond after a year if an emergency pops up or something similar, but the government will take the last three months of interest as a penalty. If you hold on to the bond for five years, you won’t be penalized for cashing in your bond.
In fact, you can hold the I Bond for up to 30 years and still earn interest on it. After 30 years, the bond will stop accruing interest.
How to Sell I Bonds
When it comes time to cash in your bond, you can do it directly in the same portal where you purchased your bonds. It’s straightforward to purchase and offload these bonds.
How Are I Bonds Taxed?
When it comes to taxes, the bonds are issued by the federal government. What this means is that in most cases, you won’t have to pay state income taxes on the interest from the bonds. However, you will need to pay taxes to the federal government.
What type of tax will you have?
Let’s assume that you purchased $10,000 in I Bonds that have grown to $15,000. You’ll pay no taxes on the $10,000, so there’s no return on this because it’s capital. Instead, you’ll have to pay on $5,000, and it’s considered ordinary income and not a capital gains tax.
So, you need to consider all of this when buying I Bonds, but based on the current interest rate, they do make sense to invest in at 9.62%.
Plus, being backed by the government, I Bonds are one of the safest investments that you can make.
Do you want to learn more about I Bonds or need help with your retirement planning?