By Ryan Zacharczyk, CFP®, MBA
If you are following a well-developed financial plan, you have some portion of your assets in cash, an emergency reserve. Unfortunately, this cash is not earning much interest. In fact, if you are getting .5% in annual interest, you are doing well in today’s environment.
It has come to our attention that there is a safe, secure financial product paying a 3.54% annual rate of return. This financial product is called an I-bond and you can learn more about I-bonds here: Treasurydirect.gov.
I-bonds are treasury bonds issued by the United States government and like Treasury bonds, are as safe an investment as we planners can find for you. Your principal is guaranteed by the federal government. The “I” in I-bonds stands for inflation, which means that the interest rate is a component of both a fixed interest rate and the CPI (Consumer Price Index) that will adjust up or down every 6-months based on inflation data. If inflation rises, the interest rate of the bond goes up. If inflation falls, so will the interest rate. Another great feature of an I-bond is that it is state tax free. This saves you a few percentage points of taxes for those in higher tax states (NY, NJ, CT, etc.)
I know what you are thinking, 3.54%…there must be a catch. There is, but nothing we can’t live with. Here are the important risks or components to I-bonds that you need to understand before diving in:
- Adjustable-Rate: The interest rate adjusts every 6-months and will adjust again in October 2021. As mentioned above, it may rise or fall, but my expectation is it remains relatively close to its current rate given recent CPI data.
- $10,000 cap: I-bonds only allow you to purchase $10,000 of value in a calendar year per person. So, if you wanted to purchase $50,000 in I-bonds, you would be limited to $10,000 for 2021 for you and a spouse. However, you could do the same in January of 2022 if rates still look favorable.
- Duration: I-bonds are 30-year bonds. However, they only require a 1-year lock up period. It means your money is off limits for a year. If you cash in before 5 years has passed, you are penalized 3-months of interest. Thus, if you were to cash in your I-bond after 18-months you would only receive 15-months of interest. Given the massive interest rate you will be earning, this penalty is certainly palatable, especially if you are currently earning .01% in your savings account, as most of you are.
Given the above stipulations, we encourage those that have a significant emergency reserve ($30,000+) to consider taking 10%-20% of your emergency cash, whatever you are comfortable tying up for a year, and purchase I-bonds. This will be considered the equivalent of purchasing a 1-year CD with these funds and will be the last cash you will use in the case of an immediate emergency or cash needs. If a year passes, the rate is close to the same, and the initial purchase is now accessible to you (even with the penalty), then you can purchase another 10%-20% of your emergency reserve. This would have the effect of building an I-bond ladder and getting a much larger return on your idle cash.
Obviously, we are here to answer any questions or help you if you are struggling with a decision on whether this is appropriate for you and how much you should consider investing in I-Bonds. Please feel free to call the office at 732-784-2380 and we can talk you through it. I-bonds are not purchased through us or Schwab but directly through Treasury Direct.