How Can I Bonds Help You to Earn Higher Interest in Inflationary Times?

The Fed just announced that the interest rate on I Bonds, or Inflation linked savings bonds will be 7.12%, effective November 1, 2021. There is a fixed component and an inflation adjusted variable component, and in this case, the fixed component is zero, and the inflation portion is 7.12%. The variable inflation rate you earn on these bonds is adjusted every six months in May and November based on inflation as measured by the Consumer Price Index. In inflationary times, many people are looking for a safe place to put their cash where they can still earn better interest than a money market or savings account.

These bonds have a duration of 30 years, so you continue to earn interest as long as you hold them for this amount of time. You cannot redeem these for one year, so they are not ideal for someone who thinks they may need the cash within twelve months. If they are redeemed prior to holding them for five years, you only lose three months of interest, which is not that terrible.

What are the advantages of using I Bonds?

I Bonds are principal protected, meaning you cannot lose the money you invested
These are federal income tax deferred, so you do not pay income tax on the interest income until these are cashed in.
I Bonds are state and local income tax free, so these are never taxed at the state and local level
These bonds also have an education tax exclusion, in that qualified taxpayers can use the bonds to pay for qualified education expenses on a tax-free basis. There are additional requirements to qualify for this, and part of these are an income limitation.

As with most investments, there are some things an investor needs to be aware of.

You cannot cash in the I Bond for at least one year after purchase, and if you cash them in prior to holding them for five years, you forfeit the last three months of interest
These can only be purchased electronically at Treasurydirect.gov and they must be held there
There is a purchase limit of $10,000 per calendar year per social security number, so a couple can purchase up to $20,000 per year.

These are not the right choice for everyone. For example, if you need the cash for potential emergencies, you would not want to have all of your cash tied up in I Bonds for the first year and not be to redeem the bond. For many investors, it offers the opportunity to protect a portion of their portfolio from the effects of inflation.

About the Author

Patti Hughes is a Chicago Fee-Only Financial Planner. Lake Life Wealth Advisory Group provides comprehensive and objective financial planning, retirement planning, and investment management to help clients organize, grow and protect their assets through life’s transitions. She is a fiduciary, and does not sell products or earn commissions, so she truly acts in the best interests of her client