Government Interest Rate Gift???
One of the most common questions I get is how to earn a decent return on conservative investments or cash. With inflation ticking higher and interest rates still at rock bottom levels, bank accounts are paying near 0% and our purchasing power is going backwards. The low-rate environment has benefited borrowers but been much less rewarding for savers. With the 10-year government bond paying about 1.5% and recent year over year inflation coming in at 6.8%, it’s painful. Well, a small benefit just popped up due to the high inflation numbers and the way that government issued savings bonds, specifically I Savings Bonds work.
Some of you may be familiar with government savings bonds as they have been around for many years but haven’t been a very popular investment more recently. A unique characteristic of I Savings Bonds is that they have an annual fixed rate as well as a semiannual inflation rate that makes up the total interest paid. It will come as little surprise that the current fixed rate is 0%, however, because of the recent spike in inflation, the inflation-based interest rate is 7.12%, the highest in almost 22 years! So how do you take advantage of this?
Here are some things to know:
- You are limited to $10,000 of I Savings Bond purchases per year. If you’re married you and your spouse can each buy an I Bond, so that would make $20,000. Since we are currently at year end, you could buy bonds this year and again in January to save up to $40,000. You can also buy bonds for family members such as children, and certain entities. The rates mentioned are for bonds issued through April 2022.
- I Bonds have limited liquidity. You can’t sell them for at least 1 year. If you cash them in between years 1-5 you sacrifice the previous 3 months of interest. After year 5, you keep all of the interest. The interest earning period runs for 30 years so if you want you can hold onto them for a long time.
- As noted before, the inflation interest term is semiannual and will likely change in six months. Let’s look at a worst-case scenario. Say you buy a $10,000 I Savings Bond now at the annual rate of 7.12%. In six months the total value will be around $10,360. If inflation drops dramatically, or even goes negative the total interest rate credit on I Bonds can’t be below 0%, but you could earn 0% the second six months. Since there would be no interest earned during that six-month period, the three-month interest-rate penalty would be $0. You would effectively have earned the equivalent of a 3.56% annual interest rate in the worst-case scenario. This is about 6 times higher than any bank account I can find right now and even 5 year CDs are only paying around 1%.
- These bonds are federally insured so your principal is protected.
- One additional way to get I Bonds and potentially save more than the $10,000 purchase limit is to ask for any tax refund due to you to be paid in I Bonds, which can be done up to an additional $5,000, using Form 8888.
- To purchase I Bonds go to www.treasurydirect.gov and open an account.
In summary, if you have idle cash sitting in a bank account and don’t have any need for it over the next year, you will likely earn much more interest buying I Bonds at this moment than you would leaving it sitting in a bank account. I guess banks could rapidly increase their interest rates, but does anyone doubt that will happen or is it just me?
As always, if you have questions or would like to speak to me regarding any financial matters, feel free to reach out at advisor@blakegallion.com.
