As I was sitting at my gate to board the plane, I looked around and thought about how each passenger has their very own unique reason for why they are flying today. Work? Pleasure? Family? Emergency? Is Charlotte, North Carolina their final destination? Every person on this flight has a unique set of circumstances as to why they are traveling today.
Similarly, we all have unique financial situations. Therefore, providing blanket advice isn’t always the best option. However, I wanted to share some considerations for any investors who jumped at the chance to purchase Series I Bonds when the rates were high.
According to Investopedia, Series I Bonds are government savings bonds that earn a combined fixed interest rate and variable inflation rate (adjusted semiannually). Series I Bonds intend to give investors a return plus protection from inflation. The rates were at an all-time high in 2021 and 2022 because part of the interest rate factor was based on the inflation rate–better known as the “I” in I Bonds. Investors can purchase up to $10,000 annually per individual. For many investors who had cash on-hand, sitting in a low-interest bank account, this was a great vehicle to stash cash for some time. However, the Federal Reserve has slowed inflation by raising interest rates, making these bonds less attractive. In November 2021, interest rates on these shot up to 7.12%1, and then 9.62% in May of 2022, making them an attractive option; however, The interest rate is 3.38%1 for bonds issued in October 2023.
As of the date of this blog, you can open a savings account with an online high-yield bank, such as Capital One 360 Performance Savings or Ally bank, and receive a 4.25-4.3% (variable) rate with no maximum or minimums, no fees and no restrictions on using the funds. We’re just at the spot of nearly tipping the scale of better interest rates with other investment options. I Bonds have lost much of their appeal, and we had always hoped that was the case as inflation rates came down over the last year.
Consider the terms for the I Bonds. You must own the bond for at least 12 months. The bonds fully mature after five years of the date of purchase. If you redeem the bonds after 12 months and before five years, the investor will pay a penalty of the last three months of interest. Every investor bought the bonds online through Treasury Direct Online and can look at the details of their bonds online by logging into their account.
Purchase date: Note the month and year of the bond purchase and be sure that you have held it for at least 12 months before redeeming. If the interest rate isn’t great, and you want to redeem the bond, consider waiting three months after your rate resets before cashing it out. Then, you will have the lowest interest rate penalty to pay!
Timing is everything. It’s best to hold onto your I Bonds and redeem them just after the 1st of the month, so you get the full last month of interest as your penalty and after earning three months of the lower interest. Say you bought it in January 2022 and purchased it at 7.12% rate. In May, you got the 9.62% interest, then 6.48% in November, and 3.38% in May of 2023. Consider waiting until October 2023 so you only lose the prior three months of 3.38% interest and none of the 6.48%.
Some might want to see what your annual rate of return is. There are some online calculators to help you find that information, such as this one.
Unless you decide to hold out for the full five years, you will be paying the small penalty fee of the last three months of interest. The more significant cost that any investor would want to consider is that any interest earned will be taxed at your ordinary tax rate: 10%, 12%, 22%, 24%, 32%, 35%, or 37%. Let’s say your purchase price is $10,000, and you have earned $350 of interest. In the year that you redeem the bonds, you would pay ordinary income tax rates on the $350 of interest. If you were in the 22% tax bracket, it would add $77 of tax to your return for 2023. It may not be a significant tax liability, but it does add to your taxable income in the year of redemption. You would receive form 1099-INT at tax time with the details of the taxable interest to report.
Generally speaking, if you bought I-bonds in the last three years, you should consider your situation and needs. Did you earmark these funds for a goal or purchase? You may find a comparable rate for an online bank or a short-term high-rate CD if you do not need the cash when you redeem them. Current CDs are at 5% for 12 months. Or leave the I Bonds until you know how you want to use the proceeds. If you invest for the long term, you can put those dollars into retirement (if eligible) or non-qualified brokerage accounts.
Whatever you decide to do, remember that your average interest rate on the I Bonds was worth the time and hassle in opening, funding, redeeming, and paying tax on the interest. We loved these rates based on the current high inflation, but we hope that inflation sticks with more historical increases going forward; therefore making I Bonds a less attractive asset in the long run. We’d recommend consulting a financial advisor to provide their expertise and knowledge on what is best to help you meet your goals. Because like everyone on my plane, we all had the same destination, but all came with unique circumstances.
Sources
1. https://keilfp.com/blogpodcast/when-to-cash-out-i-bonds/