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How to Use I Bonds

John Lim

WITH THE RELEASE of March’s Consumer Price Index, we now know that a risk-free investment yielding 9.6% will be available as of May 2. I’m speaking, of course, about Series I savings bonds from the U.S. Treasury, which have lately been all the rage. To take advantage, all you need to do is open an account at TreasuryDirect.gov. Last year, it took me all of 10 minutes to open my account.

I first wrote about I bonds back in October 2021. Since November of last year, these bonds have yielded just over 7.1%, which is pretty terrific for a risk-free investment. Unlike traditional bonds, which have been absolutely pummeled this year, Series I savings bonds are far safer—because you’re guaranteed to keep up with inflation and there’s no interest rate risk, meaning they don’t lose value as interest rates rise.

A unique window of opportunity exists this month. By purchasing I bonds in April, you can lock in the current 7.1% interest rate for the next six months. After that, you’ll receive the new rate of 9.6% for the six months that follow. Because the interest earned on I bonds compounds every six months, your total return over the next 12 months will be 8.5%.

Thanks to these mouth-watering yields, there are some intriguing arbitrage opportunities available to investors. The strategies exploit the large difference in interest rate between I bonds and other investments. The most obvious opportunity: Buy an I bond with cash you have in bank accounts and money market mutual funds, assuming you don’t need to access that cash for at least one year. But here are five other strategies to consider:

1. Harvest tax losses among your bond funds.

Given the horrible drubbing bonds have undergone this year—and the worst may be yet to come—chances are good that you have sizable losses in many of your bond funds. If these bond funds are held in a taxable account, you can take advantage of tax-loss harvesting. By selling up to $10,000 of these bond funds and using the proceeds to purchase an I bond, you can use the capital loss to lower your 2022 tax bill while simultaneously reaping a guaranteed return of 8.5% over the next 12 months—assuming you buy in April.

2. Cash out of existing CDs and invest the proceeds in I bonds.

Selling certificates of deposits to buy an I bond makes great sense, even if it means paying a penalty for cashing out of your CD early. For example, if you have $5,000 in a 12-month CD with an interest rate of 1%, you’ll earn just $50 of interest. The same cash invested today in an I bond with a prospective yield of 8.5% would earn you $425 in interest, or $375 more. Even after paying any early withdrawal penalty on the CD, you’ll come out far ahead. Just keep in mind that I bonds can’t be sold until one year after the date of purchase.

3. Buy an I bond instead of prepaying your mortgage.

If you have a mortgage, chances are extremely good that your interest rate is well below 8%. The last time interest rates on 30-year fixed-rate mortgages were above 8% was in 2000. This presents an arbitrage opportunity for homeowners. If you can purchase I bonds yielding 8% or 9%, there’s no reason to pay down your mortgage early by making extra principal payments—at least not until you’ve invested the annual maximum in I bonds, which is $10,000 per individual, $20,000 for a married couple and $30,000 for a married couple with a trust. The interest you earn on that I bond will far exceed the interest you save by prepaying your mortgage.

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The same logic applies to a home equity line of credit (HELOC). I’m generally opposed to using leverage, but it could make sense to borrow cash from your HELOC and then invest the money in an I bond. According to Bankrate.com, many HELOC rates are still below 4%. Should the interest rate on your HELOC rise above that of your I bond, simply sell the I bond and use the proceeds to pay down your home loan.

While this strategy requires some effort—including paying attention to interest rates—the payoff isn’t insignificant. If your HELOC has an interest rate of 3% and you earn 8.5% on I bonds over the next 12 months, you would come out ahead by $1,650 on a $30,000 I bond investment, and that’s just for one year.

4. Run the math on student loans.

The average interest rate on student loans, both federal and private, is 5.8%. The average is 4.12% for federal student loans. The math that applies to mortgages and HELOCs also applies to student loans. Given the juicy yields on I bonds, it may be worth making the minimum payment on your student loans and investing the rest in I bonds. Again, this strategy could be reversed should I bond interest rates fall below that of your student loans.

5. Consider building an I bond “war chest” for retirement.

If we’re entering a new era of higher inflation—say 4% to 5% per year—it may be worth raising an I bond war chest. Unless the purchase limit on I bonds is raised, building a substantial I bond portfolio will take time. But such a portfolio can have many benefits, particularly for retirees.

Inflation is one of the great risks for retirees, and the longer the retirement, the greater the risk. An annual inflation rate of 5% over 13 years, for example, would cut the dollar’s purchasing power almost in half. Stocks provide some degree of inflation protection, but at the cost of sequence-of-return risk. I bonds protect against both inflation and sequence risk. A sizable I bond portfolio could provide income during the pivotal years just before and after one retires, when sequence risk is at its highest. Also, a substantial I bond allocation could allow retirees to hold more stocks in the remainder of their portfolio without losing too much sleep. Furthermore, an I bond could serve as a ready source of liquidity for spending shocks during retirement.

How to go about building an I bond war chest? Say you’re married and 10 years from retirement. If you set up a trust, you could purchase $30,000 a year in I bonds over the next 10 years. With some tax planning, you could increase that limit to $35,000 a year, because an additional $5,000 in paper I bonds can be purchased each year with your tax refund.

That means that, all told, you and your spouse could purchase up to $350,000 in I bonds over the course of 10 years, confident that those dollars will maintain their inflation-adjusted value. Should you retire with stocks at all-time highs, you could hold onto your I bonds and sell stocks to generate income. But if stocks are in the dumps, you could begin liquidating your I bonds, giving your stock portfolio time to recover.

John Lim is a physician and author of “How to Raise Your Child’s Financial IQ,” which is available as both a free PDF and a Kindle edition. Follow John on Twitter @JohnTLim and check out his earlier articles.

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Santosh K
Santosh K
1 month ago

I haven’t been able to find a certified person who can stamp my treasurydirect application form. My local Chase banker say they can’t do it. Who can help?

booch221
booch221
1 month ago

Are there any I-bond mutual funds or ETFs?

Jonathan Clements
Admin
Jonathan Clements
1 month ago
Reply to  booch221

In a word, no.

Philip Stein
Philip Stein
1 month ago

I have a question I hope some HumbleDollar readers can answer for me.

Let’s assume you invest $10,000 in a Series I Savings bond. If after one year from purchase you need, say, $1000 to meet an expense, can you redeem just $1000 and leave $9000 to remain and collect interest?

Last edited 1 month ago by Philip Stein
Humble Reader
Humble Reader
1 month ago
Reply to  Philip Stein

Answer from TreasuryDirect: “You can cash a minimum of $25 or any amount above that in 1-cent increments. If you cash only a portion of the bond’s value, you must leave at least $25 in the TreasuryDirect account. Redemptions are comprised of principal and interest. (In a partial redemption, we pay interest only on the partial amount you cash.)”
Applies to electronic I-bonds held in TreasuryDirect account.

Mike Roberts
Mike Roberts
1 month ago

I-Bonds sound interesting, but I’ve always taken issue with the “risk-free” description that I see everywhere. Just because the US government hasn’t defaulted on Treasury debt so far doesn’t mean that it couldn’t happen at some point in the future. After all, the US government is over 30 trillion in debt and has unfunded liabilities a few multiples of that.

IAD
IAD
1 month ago
Reply to  Mike Roberts

What investment do you recommend to address the risk of the US Government’s default? Please don’t say gold since that isn’t truly a feasible option.

Humble Reader
Humble Reader
1 month ago

Thank you John. The I-Bond article finally prompted us to dig out our stash of paper savings bonds and do something with them. The bond face values totaled to just over $4,000. Some had been gifted at graduations or at our wedding. Some were bonuses from a long-ago employer. Needless to say they were all very fully matured. When redeemed at our bank the total came to just under $9,000. Over $6,000 was interest. We reinvested the $9,000 as I-bonds at TreasuryDirect. Even with the tax we will pay on the interest it still seems like Found Money 😁

johntlim
johntlim
1 month ago
Reply to  Humble Reader

Great! It’s always nice to “find” money.

Munro Richardson
Munro Richardson
1 month ago

One additional idea to deal with the annual $10,000 cap ($15,000 if you use your tax refund) on I bond purchases that I don’t see mentioned often — purchase I bonds as a gift today that will begin to earn today’s interest rates to distribute as a gift in 2023.

A couple could each buy $10,000 for themselves in 2022, purchase another $5,000 via tax refund, and buy $10,000 in gifts for the other spouse today to distribute to each other in 2023. That’s $45,000 total.

If for whatever reason interest rates stay at current levels (or go higher), they could delay the gift and purchase another $10,000. There is no timeline on distributing I bonds in your “gift box” in your Treasury Direct account.

Summary of how this works is explained here: https://thefinancebuff.com/buy-i-bonds-as-gift.html

Remember: the annual limit of $10,000 per person applies — whether purchased or gifted.

Last edited 1 month ago by Munro Richardson
Chris Beal
Chris Beal
1 month ago

Could a person charge a customer service fee of $30 to help someone set up an account and buy a bond through Treasury Direct?

JOHN GARRY
JOHN GARRY
1 month ago

Can I bonds be held within a Roth or IRA?

James McGlynn CFA RICP®
James McGlynn CFA RICP®
1 month ago
Reply to  JOHN GARRY

No. Nice try. I checked.

Ellen Crouch
Ellen Crouch
1 month ago

Thank you for the trust angle. I hadn’t thought to buy a bond using our living trust. Looking at the hoops to jump through to establish an account for our trust, it may well take me into May. It would still be a good idea even if I could not make the April purchase wouldn’t it?

johntlim
johntlim
1 month ago
Reply to  Ellen Crouch

I would think so. My guess is that the interest rates on I bonds will remain attractive for some time to come.

Guest
Guest
1 month ago

The HELOC is intriguing to a point. If, as expected, HELOC rates continue to rise, your profit spread will continue to narrow. And if it gets close to or becomes unprofitable and you sell the I-Bond early, you lose 3 months interest. Needs to be considered.

Warren Grafer
Warren Grafer
1 month ago

Not sure I understand why it would be better to buy an I-bond in April rather than wait to buy until May when the new higher rate is in effect? In April the underlying interest rate is zero, and might it not go up slightly in May?

parkslope
parkslope
1 month ago
Reply to  Warren Grafer

Treasury Direct provides details about how interest rates are determined and when they adjust.
https://www.treasurydirect.gov/indiv/research/indepth/ibonds/res_ibonds_iratesandterms.htm#change

Last edited 1 month ago by parkslope
Jonathan Clements
Admin
Jonathan Clements
1 month ago
Reply to  Warren Grafer

The real (after-inflation) return on I bonds bought today is zero — and, for bonds bought in May, will likely remain zero. But you are guaranteed to keep up with inflation, and we now know the inflation adjustment for the next six months for bonds bought today and what the inflation adjustment will be for the subsequent six months, which is how you get that guaranteed 8.5%. That looks pretty compelling compared to current bond market alternatives.

parkslope
parkslope
1 month ago

In case there is any confusion, if you purchase an I bond before May 1 it will earn the Nov 1, 2021 – Apr 30, 2022 rate of 7.1% for 6 months from the date of purchase and will then earn 9.6% for 6 more months. If you wait until May 1, your bond will earn 9.6% for 6 months and then reset to the inflation-adjusted rate that will become effective on Nov 1. Thus, purchasing now will earn you a guaranteed 8.5% for the next year, while purchasing on May 1 or after will earn you 9.6% for 6 months and a yet to be determined rate for the following 6 months that could be higher or lower than 7.1%.

Rick Connor
Rick Connor
1 month ago

Thanks John for reminding us of the April milestone.

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