If Inflation Has You Worried, There Might Be a Savings Bond for You

Paul Kieffer, CPA/PFS, CFP,® CLU, CAP, ChFC, CASL, CGMA, Regional Planning Strategist, August 2022

<p>If Inflation Has You Worried, There Might Be a Savings Bond for You</p>

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If there is a silver lining for investors during these inflationary times, it just could be the old standby gifts of grandparents to newborns – safe US savings bonds. More precisely, the Series I savings bonds, so called because the interest it pays is tied to inflation, which is now at its highest point in 40 years.

Series I bonds now pay 6.89% interest, far surpassing other current options for cash reserves. In addition to protecting your purchasing power, Series I bonds also offer the safety of government backing, unlike corporate bonds and equities.

This looks like a good opportunity, especially given increasing inflation and recent stock market volatility, which saw the S&P 500 plummet by more than 20% since January, capping its worst six-month start to a year since 1970. But there are some considerations that should be weighed before buying.

As with any investment, you should calculate how buying Series I bonds will affect your overall asset allocation, especially over the long term. For instance, switching from a 60% equity/40% fixed-income portfolio to 55% equity/45% fixed income (Series I bonds are considered fixed) may have a significant impact on your retirement plan.

But before we get too deep into these considerations, let us look at some background on Series I savings bonds.

Background on Series I Bonds

Interest rates on I bonds are set twice a year – in May and November – and comprise two components. The first is a fixed rate that applies for the life of the bond (the current rate is 0%). The second is a variable rate that changes every six months and is based on the Consumer Price Index, which is the rate of inflation.

This means that you are not locked in on the current rate paid when you purchase the bond. New rates take effect every six months from the issue date of the bonds. If inflation continues to increase, a higher interest rate would be paid on the six-month anniversary. Conversely, if the Federal Reserve (Fed) is successful in taming inflation, future rates paid on your bond will drop.

There Are Two Ways to Purchase I Bonds, Both Directly from the Federal Government

The first is in electronic form through TreasuryDirect. That requires you to set up a TreasuryDirect account if you don’t have one already. Electronic I bonds come in any amount of $25 or more. For example, you could buy a $101.34 bond. There is a limit of $10,000 per calendar year for individuals with a Social Security number or entities with an employer identification number (EIN) with the opportunity for gifting to others. A family of four can acquire $40,000 of I bonds per year electronically as long everyone uses their own Social Security numbers.

The other method of acquiring I bonds is by paper form using your federal tax refund. That allows you to purchase an additional $5,000 above the $10,000 electronic annual limit. Paper bonds are available in $50, $100, $200, $500 or $1,000 denominations.

Planning tip

If you already have reached the $10,000 electronic limit and are waiting on an overpayment from your tax return, talk to your accountant about applying some of the refund to I bonds so you can reach the combined $15,000 annual limit.

Cashing in Bonds

Among the limitations of I bonds are their redemption features. An I bond cannot be cashed in for at least 12 months, so if you are going to acquire I bonds, make sure that you will not need those funds for at least a year. In addition, if a bond is cashed in before it is five years old, you will lose the last three months of interest as a penalty.

Electronic bonds are redeemed through TreasuryDirect while paper bonds are sent to Treasury Retail Securities Services along with Form 1522. Also, some financial institutions will cash paper bonds for their customers.

Taxation Issues

There are a few intricacies to how interest is taxed on I bonds. Generally, they are subject to federal tax but not state or local tax. You have a choice to defer reporting the interest income until you cash in the bond, change ownership of the bond (such as gifting to a child or a charity), or the bond reaches maturity. Alternatively, you can choose to report interest annually as it is earned, which may be advantageous if the owner is in a lower tax bracket than they expect to be in when the bond matures (such as a child).

There is an opportunity to avoid taxation entirely if the taxpayer pays qualified higher education expenses at an eligible institution, but there are limitations. The bonds have to be cashed in the same year that the higher education expenses occurred for either yourself, your spouse or your dependents. You also have to have been at least 24 years old before the bonds were issued, which generally limits them to bonds owned by parents. And you cannot be married and filing separately.

In addition, the tax benefits begin to get phased out if your modified gross income is above $85,800 single ($128,650 married filing jointly). They are completely phased out at $100,800 single ($158,650 married filing jointly).

One final note on taxation: If someone passes away owning I bonds with deferred interest, the executor usually determines whether the interest is reported on the deceased’s final income tax return or by the beneficiary. Also, bonds inherited through a death do not count against the annual limits.

Key Takeaways

While the current interest rate on I bonds is certainly enticing, consider the implications of purchasing them:

  • They should fit in your overall investment plan, and unless you are purchasing significant amounts (such as gifts for family members) the annual limit may not allow enough to be purchased to move the needle of your overall portfolio.
  • The rate is tied to inflation, so if the Fed is successful in taming inflation, the bonds you purchase now may be paying a lower rate in just a few years because the rate is recalculated every six months.
  • They are backed by the federal government, making them a safe investment, but you cannot sell them to another individual and need to hold them for at least one year before they can be cashed in. Even then, you may be subject to a three-month interest penalty if you cash the bonds before they are 5 years old.
     

Finally, if you still have questions, consult your advisor to strategize how to incorporate Series I savings bonds into your overall financial plan.

For more information, please contact your advisor.


Paul B. Kieffer Biopic

About Paul B. Kieffer

As a Senior Client Experience Manager for Key Private Bank, Paul focuses on ensuring his clients’ wealth management plans are carried through to meet their unique financial objectives and grow and preserve wealth.

Partnering closely with the Relationship Manager, Paul coordinates the implementation of wealth management strategies with the relationship team and ensures clients have the tools and information to keep track of their financial situation and make informed decisions. He also synchronizes regular communications and updates with the team, and proactively delivers the latest insights and advice to benefit clients’ particular situations.

Paul most recently served as a Regional Planning Strategist for Key Private Bank. Prior to joining Key, Paul was the director of Wealth Planning at Wilmington Trust and was responsible for the delivery of planning services and the planning platform including scalable advice-oriented solutions, thought leadership and direct planning where appropriate. Paul contributed to thought leadership and solutions to the Corporate Executive Practice Group, including direct planning for Corporate Executives. Prior to joining M&T Bank, which acquired Wilmington Trust in 2011, Paul was a tax manager with a CPA firm.

He holds an MBA from SUNY Buffalo and completed their Graduate Tax program. Paul is a Certified Public Accountant and a Chartered Global Management Accountant and has the Certified Financial Planner™, Personal Financial Specialist, Certified Life Underwriter, Retirement Income Certified Professional®, Certified Advisor in Philanthropy, Chartered Advisor in Senior Living, Chartered Financial Consultant and Certified Retirement Counselor designations. Paul instructed courses in the Certified Financial Planner Program as an adjunct faculty member of Canisius College in Buffalo New York. He is currently the Treasurer and member of the Board of Directors for Musicalfare Theater in Amherst New York. Previously he served on the Board of Directors and as the Treasurer of the Make-A-Wish Foundation of Western New York and BNSME. Paul is a member of the FPA, AICPA and NYSSCPA’s.

1

Hanson, M. (2022, August 15). Average Cost of College & Tuition. EducationData.org. Retrieved August 29, 2022, from https://educationdata.org/average-cost-of-college.

2

SEC’s Office of Investor Education and Advocacy. (2018, May 29). An Introduction to 529 Plans. SEC.gov. Retrieved August 29, 2022, from https://www.sec.gov/reportspubs/investor-publications/investorpubsintro529htm.html.

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