Dear Liz: As you know, interest rates on certificates of deposit are extremely low. I was thinking of investing in government I-bonds. Can you discuss the pros and cons?
Answer: I-bonds are guaranteed by the U.S. government and currently pay an interest rate of 7.12%. But they do have some downsides.
The rate on Series I savings bonds is a composite of two rates: a fixed rate, which is currently zero, and an inflation rate, which changes every six months. The semiannual inflation rate is currently 3.56%, which translates into a 7.12% annual rate. This rate applies for I-bonds issued November 2021 through April 2022 and is good for the first six months you own the bond, according to Treasury Direct, the financial services site that allows you to buy securities including I-bonds directly from the U.S. government.
Although the rate can change, it can’t go below zero, so you can’t lose your principal. However, you also can’t cash in I-bonds for the first year, and if you cash them in before five years, you’ll lose the previous three months’ worth of interest.
Also, the bonds don’t pay interest to you directly. Every six months, the interest earned is added to the bond’s principal. That creates a new principal value, and interest is then earned on that value.
The bonds are exempt from state and local taxes but subject to federal taxes. You can opt to pay federal tax on the interest each year, but most people defer reporting the interest until they cash in the bond or it stops earning interest at 30 years, in which case it’s automatically cashed out and the interest reported to the IRS.
You can buy up to $10,000 in I-bonds electronically each calendar year. You can buy another $5,000 in paper bonds, but only if you use your tax refund to do so.