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What's not to love? The US savings bond that earns 7% with inflation protection, yet gets ignored

·4 min read

Savings accounts are accumulating paltry interest, the stock market gyrates under the weight of pandemic uncertainty and inflation is raging.

What’s a saver to do?

The government, it turns out, has provided a shockingly lucrative alternative – and taking maximum advantage requires action by year’s end.

It’s an inflation-protected, government-backed instrument that currently enjoys a whopping 7.12% annualized yield. Don't expect to see that rate on any billboards, though, and it’s easy to see why I bonds, as they are called, have been overlooked by average investors.

For starters, it’s a U.S. savings bond, which some may have dismissed a quaint relic of mid-century, post-war America, an investment with all the sex appeal of a Chevrolet nestled among Ferraris.

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For another, the Treasury Department limits investors to purchases of no more than $10,000 worth of I bonds per calendar year. That’s chump change to some affluent older workers striving to push their nest egg into seven-figure territory in pursuit of a comfy retirement.

But hey, I bonds are a safe place to put idle or underperforming cash and provide a decent return.

“I think if you are going to be able to hold the bonds for at least a year, it’s absolutely something to consider,” said Ted Jenkin, a certified financial planner and CEO of oXYGen Financial. “This is perfect for people in the middle class and even those who are higher net worth.”

I bond rates have seen a spectacular rise. With the new rate set every six months based on inflation, they rose from 3.54% in May and from 1.67% in November 2020.

If inflation continues to gallop, as some expect, the rate could rise further. If inflation eases, as the Biden administration predicts, the rate will fall – but it can’t fall below 0%.

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How I bonds work

Here are the basics:

I bonds can only be bought directly from the Treasury, not through securities dealers, which is a possible reason why they are largely off investors’ radar screens. Because they can’t take commissions on them, brokers have no incentive to promote them.

The bonds mature in 30 years, but they can be redeemed after 12 months with forfeiture of three months of interest. Given the low-interest rates on bank and savings accounts, investors are still likely to come out ahead even if they take the penalty by comparison. The penalty disappears if I bonds are held for at least five years.

Like Treasury Inflation-Protected Securities, or TIPS, they are subject to federal income taxes but catch a break when it comes to state or local income taxes.

Then there’s the $10,000-a-calendar-year limitation. For those who want to soak up more I Bonds, they could max out by buying them by the end of this month then again after the start of the new year. Or family members could open their own accounts and create a pool. A family of four could amass $40,000 in I bonds in a single year.

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What are the risks with I bonds

Downsides? The biggest is the inflation adjustment, which takes place in May and November. If inflation abates, so will the I bond interest rate. What’s more, the I bond used to have a base rate in addition to the inflation adjustment. But the base rate has fallen to 0%, so the entire price reflects what is happening with inflation.

Consider, however, the alternatives. Even the most lucrative CDs and interest checking accounts earn about 1% or less, Bankrate figures show. The yield on the 1-year Treasury bill was 0.17% Wednesday.

Kevin Lao, director of financial strategies at Imagine Financial Security in St. Augustine, Florida, said he thinks I bonds work well as an enticing place to park cash for people with short-term goals, such as those planning to purchase a house.

“There’s not a lot of yield out there” among other investments, he observed, and it's hard to know how inflation will go, but this “might be an opportune time” to sign up for an I bond until the future becomes more clear.

Inflation chart by year

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This article originally appeared on USA TODAY: Inflation-proof saving? These Treasury I bonds could be your answer

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