The Pros and Cons of I Bonds

You’ve built up your emergency fund. You’re maximizing your retirement accounts. And yet you have extra money. What should you do with it? Is there some kind of investment that has cash-like liquidity, and pays more than a bank account?

First things first. Your emergency fund is what you keep in “cash” or your savings account for a “rainy day.” This should be easily accessible, in full, at any time (read: “emergencies”), so you don’t want it invested in anything that’s either locked up or could potentially lose money. Right now you may even be able to find high-yield savings accounts paying more than two percent interest, which is a lot more than in the recent past when they were paying close to nothing. Bankrate publishes a list of high-yield savings accounts each month, replete with current rates and details.

Next up are your retirement and brokerage accounts. You are maximizing your retirement savings options, whether that is a 401(k) through your employer or an IRA, SEP-IRA, or individual 401(k) if you’re a business owner.  They’re fully diversified, with an eye toward growth, and use, in future years.

But what about that extra money you have right now? Is there something else you could invest in that pays a little more interest and doesn’t carry a lot of risk?

Series I Savings Bonds, or I Bonds, may fit that description. They’ve been around for quite a while. These are government-issued bonds with an interest rate that’s a combination of a fixed rate (which is set at the time of purchase and is most often zero) and a variable semi-annual inflation rate. Currently, the fixed rate is 0.40% and the variable rate is around 6.50% annualized. See chart for historical rate details.

As inflation rates change, the variable rate paid on I bonds changes as well.  So, if you were to purchase I Bonds now at the 6.5% variable rate and inflation decreases, in six months it could drop to zero or anywhere in between.  On the other hand, if inflation increases, the variable rate will increase as well.  The fixed rate stays the same for the life of the I Bond.

You are required to hold I Bonds for a minimum of twelve months, and to avoid paying a three-month interest penalty you must hold them for at least five years.

There are also limits on how much in I Bonds you can purchase each year.  This limit is $10,000 per person bought electronically from TreasuryDirect.com and up to $5,000 in paper form each year from your income tax refund (if you are getting one). The interest accrues for 30 years (if you choose to keep them that long), and the interest can be tax-deferred until redemption, final maturity, or other taxable disposition, whichever comes first.

This type of investment is not typically managed by your financial advisor, so you have to do a lot of the legwork to get this set up yourself. Series I Savings Bonds are not for everyone. But they might be a nice “happy-medium” if you have excess cash on hand. Consult your investment advisor and CPA to see if these are a good option for you.

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