iBonds Revisited

I have written about iBonds on this site in the past and wanted to re-visit them.

IBonds are US government bonds and thus they are the “benchmark” for low risk debt instruments. IBonds have the following characteristics (which are well-summarized at the US Government web site here):

– a “fixed” interest payment that is set when you buy the bond. This component is set at the time that you make the original purchase and is constant throughout the 30 year life of the bond (or until you redeem it). This component has ranged from a high of 3.6% back in 2000 (before the government basically went with a zero-rate policy to prop up the markets) down to ZERO in the middle of 2008. It currently has a rate of 0.3%
– every 6 months you get a return equal to the inflation rate. This rate (for comparison purposes I am multiplying it by two to get an annual rate, although it is a tiny bit more if you are into statistical details due to compounding) has ranged from 5.7% (2.85% * 2) back in 2005 to NEGATIVE 5.56% in mid 2009 (which meant that EVERYONE who owned an existing iBond was getting NO interest for 6 months, because even if you bought one of those “golden” 3.6% ibonds back in 2000 that annual rate was less than this negative inflation component
– If you buy an iBond now, you get an annual rate for the next 6 months of 3.36%, which is basically the 0.3% “fixed” rate plus a bit more than 2 times the current inflation rate of 1.53%
– Your existing iBonds take the “fixed” rate from the year that you bought them plus 2 times 1.53% to determine the current yield; so if your rate was 1.55% (mid 2006 vintage) then you are currently earning about 4.6% / year
– There are also some tax advantages. You don’t need to pay state or local taxes on the iBond interest that you earn until you redeem the bond (you have the OPTION of reporting interest annually, which could be a good idea if you are buying them for a child and they are in a low interest rate bracket, but this is beyond the pale for the current discussion)
– One disadvantage is that you can’t get access to your funds for 12 months after you buy a bond issue. If you redeem them within 5 years, you lose the last 3 months of interest. After 5 years, there are no penalties

I wrote about iBonds most recently when their interest rate paid on ALL iBonds regardless of fixed rate component went to ZERO. I was interested in following up with them to see the current fixed rate being offered as well as the interest component.

Basically, iBonds are a GREAT deal right now. They provide inflation protection for when interest rates increase (which will drive inflation), they are the lowest risk class bond available (when the Federal government can’t float debt any longer we are all in big trouble), and they provide deferral opportunities for taxes.

In reviewing other debt alternatives (something I will come back to in additional posts), right now a 2-3 year CD is yielding 1.5% to 2% / year. This is less than the iBond is yielding now (although it is guaranteed, while the iBond can fluctuate and go down if there is deflation, although not below zero). Other government securities are in the 2% range (or less) and then you need to go up the risk ladder a bit to get even 3% or 4%.

The Federal government knows this and they want to keep the iBond program relatively small, I guess, because they are limiting the purchase of iBonds to $5000 / year. You can go online to treasurydirect.gov to purchase them (it is very easy to do) and they will sweep the $ out of your bank account. If you really put your thinking cap on you can buy some for you and some for your spouse but in general for most the $5000 cap will apply unless you have a comprehensive estate plan in place. For a while you used to be able to buy $30,000 / year of iBonds which in hindsight was a great purchase plan but they cut it back accordingly.

All in, iBonds should be considered by anyone looking for an effectively zero risk component of their savings. Right now banks and CD’s are offering almost nothing so this is a very viable alternative. You can’t get at your money for 12 months but since your purchases are only limited to $5000 / year this likely isn’t a significant deterrent.

Cross posted at Chicago Boyz and LITGM

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7 thoughts on “iBonds Revisited”

  1. The next to the last paragraph is not correct at all. The current limit is $5,000 online AND $5,000 over the counter at any bank for the same social security number. So a Husband. wife, and two kids could buy $40,000 each and every year. Need to read the rules carefully. And if you use the proceeds for the kids tuition, the parents bonds are tax free.

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  2. Incidently the “little bit more” is not due to “statistical details due to compounding” – it is the inflation on the base rate which I agree is only a “little bit more” but it is always more.

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  3. Agreed that you can get around these limits if you want to. For practical purposes, this is a pain in the rear. It seems like a pain to do this in paper format, I didn’t really think this was practical, but I guess it is if you already physically go to a bank a lot. I don’t do this.

    If you are married and your assets are held jointly then if you put them in each of your own names it will cause potential problems unless you have a really complicated estate plan already in which case you probably are buying treasuries in large $ amounts not ibonds anyways. I thought about this myself and decided not to do it.

    For kids, sure, you can put the ibonds in their names, but then this investing changes everything. You are giving them title to the ibonds, and if you want to do this, then there are favorable elements (their lower tax rates) and unfavorable elements (the fact that you can’t pull these dollars “back” later and that the child automatically receives the dollars). They can be used for education (without taxes) and this is a reasonable plan except that unlike 529 plans anything with their SSN (in their name) is counted for asset purposes for financial aid. All in this certainly COULD be a good strategy it is just larger than the purpose of describing iBonds.

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  4. Also this blog is a general resource and I am trying to give overall guidance not summarize every rule. I assume that if people think this is a decent idea than they are going to read the fine print before they jump in. But happy to get some comments that aren’t spam :).

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