What Are IBonds And How Do They Work

Currently US Treasury Series IBOs are yielding 9.62%. It's a great rate, but you only have until October 28th to be able to lock that in. So today I wanted to talk about what are IBonds and give you some rules surrounding them just so you have some information in case it's something that's good for you. But first, I just wanted to introduce myself. My name is Warren Berger. I'm the owner of Luminary Financial Advisors, and we help people that are close to or just recently retired, create a financial plan that has an emphasis on saving taxes throughout your retirement. So let's talk a little bit about what Ibonds are and how they work. Ibonds are US savings bonds. So the principle that you invest is guaranteed by the full faith and credit of the United States. So it's, it's virtually risk free. When you think about investible assets, the bonds pay a rate of interest that is a combination of a fixed rate when the bond is issued plus a variable rate that's based on inflation, that changes every six months.

So the current fixed rate is actually 0% but you add on that inflation rate to that fixed rate to come up with what is called your composite rate, and that's really the rate at which you're earning interest on your money. So the key to the I Bond is really the variable rate, and that variable rate is recalculated every six months in May and November. And that rate is based on the consumer price index for urban consumers or the C P I U number. And essentially what they're doing is they're taking the difference in consumer prices for that six month period, and that becomes the next rate that you'll use for the next calculation. So for instance, right now we are in using the rate that was calculated last May to be able to buy IBOs. Say you were going to buy one tomorrow, you'd be getting the current 9.62% annual odd.

So 4.81% is what you would earn over the next six months if you were to buy that bond tomorrow. So what happens is when we go into November, you're going to have a new calculation, and that's going to be based on the rate of inflation between last May and this October. Now we saw really heightened inflation at the beginning of the year, the previous six months. We haven't seen that same rate. We don't know what that is going to print next month, but a lot of estimates have that around 6% or so. And like I said, we don't know what it's going to be. But let's just take for example, if it was to print next month at 6%, so in this case you were buying the ibond, tomorrow, you'd be locking in that six months at that 4.81% or half of the 9.62% annualized, and then you would also be locking in the next print. And we're taking, for example, that it would be 6%. We don't know that, but we think it could be. So you would have this second six months of this bond being compensated at a 6% annualized or 3% over that six months. So really what you'd be doing if we were to assume that you're going to have a 6% print next month, you'd be locking in that 4.81% for the first six months, 3% for the second six months. How these are rates, it

Would be very difficult to find if you were looking at, say, a money market fund or something like that. So we're seeing in this inflationary environment the rates of interest that we could accrue on these IBOs could be very beneficial. Let's talk a little bit about the taxation of the bonds. Because it's a US treasury instrument you're exempt from paying state and local taxes. So in states where that's an issue that's a real benefit. And in terms of the federal taxes, you can defer the interest accruing until you decide to redeem the bond at some later date. So there are some rules around these bonds. So let's talk a little bit about those. So first, there are purchase limits. So even though we have this great rate of return on these bonds, there's only so many of them that you're allowed to buy right now.

The limit is $10,000 per person per year. And then there are some other ways to be able to get your hands on these bonds as well. You can, you, if you're expecting a tax return, you can apply that tax return of up to $5,000 to the purchase of I bonds in addition to the $10,000 per person. And then if you have a living trust, that trust can also purchase bonds in the name of the trust. Also your business, if you have a Schedule C business, a corporation can also purchase bonds under the name of the entity. Now, there are also some rules about when you can get access to the funds once you've invested them in the bonds. The first one, and most important is that you can't touch those bonds for one year. So you have to understand that any money that you're going to put into these bonds, you will not be able to access for a year.

So you want to make sure that you're not using funds that you would want to have liquid or readily available. There's also a penalty if you redeem these bonds within five years, and the penalty isn't very onerous. It's, it's actually the three previous months of interest that you would have accrued will be forfeited if you decide to redeem these bonds within that five years. And oftentimes people, when they do decide to redeem the bonds, it's because the rate of, in the rate of inflation has gone down enough that the bond isn't as useful as maybe another asset that they might want to reinvest those funds into. So it's likely in that scenario that the rate of interest, that three months that you're giving up isn't that much. Anyway. So let's talk about some pros and cons of owning these IBOs. And for me, the pros are basically number one, the fact that it is a virtually risk free asset because it is guaranteed by the full faith and credit in the United States.

Two is in this inflationary environment that we're seeing the rates of return are very strong. And three, I think it's it could be a really good addition to your emergency fund or the fixed income portion of your allocation to your portfolio which is really the bond allocation to me. The cons are number one, the fact that you can't redeem them within one year. So you want to really make sure that you have enough liquidity for one year that you don't need this money during that time. Also, we need to keep into consideration that

We're not necessarily going to see heightened inflation for an extended period of time, so that rate could go lower. The fact is it's not going to go below 0%, but you may find yourself in a situation where those funds might be better used for something else. Maybe there's a money market that be offering a a, a better a rate of interest down the line, or you might want to put it back into the stock markets, things like that. But I think those are decisions you can make a little bit later as you see how the economy develops. So the last thing you need to know is where do, where do you buy these Ibonds and you buy them directly through the US Treasury at US Treasury Direct. I've actually included a link in the descriptions that will take you to US Treasury Direct, where they have directions on how to purchase these bonds.

And I just want to caution you, you know, don't just take this information and run out and go buy these bonds. Really talk to your financial professional or just do your own due diligence to make sure that this is a good solution for you because, you know, everyone has a different situation out there. I hope this has been a helpful overview of what IBOs are and how they work. I've included in the description section some useful flow chart checklist for people that are nearing retirement that I think might get your head around some of the issues that you might be thinking about as you approach. I've also included a link to my personal calendar. If you ever were interested in having a conversation about your own personal financial situation, I welcome you to reach out for a complimentary phone call and we can see if we can help. Thank you very much.