One year ago, we highlighted a high return and low risk investment, Series I Savings Bonds (I Bonds), which were yielding an annualized 9.62% due to the high inflation rate in the United States. Since then, the inflation rate has decreased and the inflation component of the I Bond yield declined to 3.38% as of May 1, 2023. As a result, investors have redeemed over $1.2 billion since the beginning of May.
Now that it has been one year since our original blog post and the one-year restricted redemption period is coming to an end, we want to review the return of the investment, compare it other low risk alternatives, and provide the optimal redemption date to redeem I Bonds if an investor chooses to do so.
How Did the I Bond Investment Perform?
One year ago, we discussed that the I Bond annualized composite rate of 9.62% would apply for the first six months and the new composite rate that would apply to the following six months would be approximately 6.1%. The actual composite rate applied to the following six month was 6.48%, so the investment turned out a little better than we expected. The calculation of the actual return is shown in the table below.
As the table shows, the one-year actual rate of return for I Bonds purchased prior to November 1st, 2022 was 6.51%, even after forfeiting three months of interest for cashing the I Bonds in prior to the five-year mark. This represented a great return on cash that would otherwise be sitting in a bank account.
Key Takeaway:
I Bonds purchased last fall were a great way to achieve an attractive return on a low-risk investment.
How Will I Bonds Perform Going Forward?
I Bond inflation adjustments are calculated by using the change in the Consumer Price Index for All Urban Consumers (CPI-U) over the previous six months and are released each May 1st and November 1st. The most recent inflation adjustment for the six-month period beginning on May 1, 2023 is 3.38%, as calculated below:
While the fixed rate component was increased to 0.90%, I Bonds purchased before November 1, 2022 keep the fixed rate component of zero for the life of the bond. Therefore, the yield of I Bond’s purchased in the six-month period prior to November 1, 2022 will be 3.38% for the six-month period starting one year after the purchase date.
Key Takeaway:
I Bond yields will decrease to 3.38% one year after the purchase date for bonds purchased last fall.
How Does the New I Bond Yield Compare To Other Low Risk Investments?
With the increase in interest rates over the last year, the yield of other low risk investments has increased. For example, current one-year CD rates and US Treasury bond rates are between 5.0% and 5.5%. When comparing these yields to the new 3.38% rate for I Bonds purchased last fall, the new I Bond rate does not look attractive.
The most relevant comparison would be to the US Treasury Inflation Protection Securities (TIPS), another security issued by the US Treasury designed to protect against inflation. Currently, the real yield for most TIPS securities is approximately 2%, as shown in the chart below:
Source: https://fred.stlouisfed.org/
This means an investor could purchase a 5-year TIPS and earn a 2% real yield plus the rate of inflation which would exceed the current I Bond rate. While there are differences between CDs, US Treasury bonds, and US TIPS, these investments currently offer higher yields when compared to I Bonds purchased last fall.
Key Takeaway:
I Bonds purchased last year are yielding 3.38% and currently have a lower yield than short term CDs, US Treasury bonds, and US TIPS.
Tax Implications of Redeeming I Bonds:
When you redeem any savings bond, including I Bonds, you are effectively taking money out of a tax-deferred investment and will owe federal income taxes on your earnings, unless you elect to claim the interest annually. Interest income from saving bonds is exempt from state income taxes.
For example, if you redeem a $10,000 I Bond issued in September 2022, the value would be $10,651 in September 2023. This would create taxable income of $651. If you are in the 32% federal tax bracket (plus the 3.8% net investment income tax), the federal income tax would be $233. If you are redeeming a significant number of I Bonds or I Bonds you’ve held for many years, it’s important to consider how the additional income may impact your tax situation (e.g. higher tax brackets or potentially Medicare IRMAA surcharges).
I Bonds have an advantage over US Treasury Bonds and TIPS as taxes can be deferred until redemption; so it’s important to consider that redeeming the I Bond will eliminate this advantage going forward.
I Bond interest can also be exempt from federal tax if the proceeds from the eligible savings bonds are used for qualifying educational expenses. To qualify for this exemption, an individual must meet specific criteria.
The two most notable criteria are that the individual taking the exclusion must have issued the bond in their own name and been at least age 24 when the bond was issued (i.e. bonds purchased in the names of children do not qualify) and that the available exclusion phases out for those at higher income levels. The exclusion is fully phased out at modified adjusted gross income of $158,650 for married couples filing a joint return and $100,800 for single individuals in 2022.
What Are Other Considerations When Redeeming I Bonds?
While I Bonds that yield 3.38% in the current environment compare unfavorably to other low risk investments, there are additional considerations an investor should think about before redeeming I Bonds.
- I Bonds accrue interest for 30 years, without the risk of principal loss. US Treasury Bonds and TIPS can experience interest rate risk where the value of the bonds can decrease below the purchase price if interest rates increase.
- I Bonds also have annual purchase limits which restrict purchases to $10,000 per person or entity in a calendar year. If you redeem your I Bond and later decide you would like to repurchase I Bonds, you will be subject to the annual purchase limits which would restrict the amount and timing of I Bonds you ultimately can acquire.
- If you redeem an I Bond before holding it for 5 full years, you will you forfeit the last three months of interest you earned.
Key Takeaway:
There are other considerations an investor should think through before redeeming an I Bond including taxes and forfeiting the last three months of interest if redeeming before 5 years.
When Is the Optimal Time To Redeem an I Bond?
For those planning to redeem I Bonds, there are a couple of things to think about. First, interest is paid once per month on the first day of the month. There are no pro-rated amounts for partial months. Therefore, individuals should redeem shortly after the first day of the month as no extra interest will accrue for holding additional days during the month.
Second, individuals will forfeit the last three month of interest as a penalty for redeeming before the 5-year holding period. Therefore, individuals planning to redeem should hold the I Bond for 3 months into the 3.38% reset period. Failure to do so would cause them to forfeit interest at a 6.48% annual interest rate, rather than the lower 3.38% rate.
I Bond inflation rate adjustments are published on May 1st and November 1st each year. However, the updated rates do not apply to all I Bonds at that time. Rather, I Bonds purchased in a month other than May or November will receive the May 1st and November 1st rate update in the month they reach their six-month anniversary. The following table from Treasurydirect.gov clarifies when the rates take effect based on the purchase date of the I Bond.
Therefore, if you bought an I Bond any time within the last 5 years, the optimal redemption date of your bond will be three months after the new 3.38% rate applies to your I Bond. The following table provides the optimal redemption date to consider in order to minimize the three-month interest penalty:
Key Takeaway:
If selling an I Bond, it is optimal to wait three months past the 3.38% reset period and then sell early in the month.
Conclusion:
I Bonds were a great opportunity in 2022 and early 2023 to earn an attractive return backed by the full faith and credit of the U.S. Government. With inflation rates decreasing and other low risk investments providing better yields, now is a good time to reconsider whether it makes sense to continue holding I Bonds long-term.
I Bonds have some very attractive features to consider before deciding to redeem them. If you choose to redeem them within 5 years of purchasing them, it is worth considering the optimal redemption dates to minimize the three-month interest penalty.
If you are interested in working with a Family CFO that can help determine if inflation protection is right for your portfolio, guide your family’s financial decisions, and provide advice designed to put your interests first, we would love to connect to see if what we do is right for you.
