I bonds were a popular option in 2022. With a combination of government-backed security and high-interest rates linked to inflation, their yield peaked at 9.62% in May 2022. But as inflation slows, people are wondering if I bonds are still worthwhile.
Let’s take a look at how I bonds compare to TIPS and other options; when they make sense, and how they fit into your retirement plan.
Inflation and the U.S. Treasury: TIPS vs. I Bonds
Bonds are a key component of any portfolio. Thanks to U.S. Treasury backing, they deliver a steady return, even through market volatility. However, that steady return is often lower than most other investment classes. And when inflation is high, lower returns can feel like losses.
To help investors deal with inflation, the Treasury offers two types of securities.
Treasury Inflation-Protected Securities (TIPS)
In most ways, TIPS are like any other Treasury bond. They’re available in 5, 10, and 30-year terms. Interest rates are set at auction. And they’re freely tradable on the secondary market, meaning they can be part of mutual funds and ETFs.
TIPS’ key difference is that the principal of the investment changes based on inflation. As inflation goes up, so does the principal. And in deflationary periods, the principal decreases. When the TIPS reaches maturity, you get either the inflation-adjusted principal or the original amount, whichever is greater.
I bonds—also known as Series I savings bonds—protect against inflation by using a variable interest rate. Every six months, the Treasury adjusts I bonds’ interest rates based on inflation. When inflation is high, this can lead to stellar returns. But when inflation slows, rates drop accordingly.
While the high rates are attractive, I bonds have a few key differences compared to TIPS and other bonds. First, the Treasury doesn’t permit any secondary sales. You can redeem I bonds after one year, but you forfeit three months of interest if you don’t hold them for at least five years. And since you can’t use retirement accounts to buy I bonds, the interest will be taxed as normal income.
When Are I Bonds a Good Fit?
As with any investment, the TIPS vs. I bonds decision is personal. You need to determine how they fit into your retirement investment portfolio. For example, are they a better fit than other options like CDs or traditional savings bonds?
Consider these factors when deciding if it’s a good time to buy I bonds:
- Inflation Protection: I Bonds can be advantageous when you have a future expense coming up because the returns are adjusted for inflation. This will help protect your purchasing power, especially if inflation rises unexpectedly.
- Liquidity: There’s no secondary market to sell the bonds and you’ll lose interest if you redeem in less than five years. Make sure you’re comfortable locking the funds up for that long.
- Asset protection: I Bonds are considered a safe investment because they are backed by the U.S. Government. This means that your investment is unlikely to lose value.
Pitfalls to Avoid with I Bonds
I bonds can be a lucrative investment, but they’re not a perfect solution.
Some of the downsides to I bonds include:
Taxes: When you redeem an I bond, you have to pay federal taxes on the accrued interest. This is often more than capital gains taxes would be, so you’ll need to plan your taxes carefully when cashing out. However, it’s important to note that your I Bond interest may not be taxable if you use the funds for higher education expenses.
Low investment cap: You can only buy $15,000 in I bonds per year—$10,000 electronically and $5,000 with your tax refund. For inflation protection in larger amounts, you’ll need to invest elsewhere.
Uncertain returns: I bonds are great when interest rates are high. But if you lock yourself in and inflation drops, you could miss out on other, more productive investment opportunities.
Building a Secure Financial Future
I bonds can be a valuable tool in times of inflation. But building a secure and comfortable retirement is about more than quick wins. Wealth management is a long-term process, and you need to consider your choices through that lens.
Before investing in I bonds:
Make sure you have an emergency fund to cover at least 3-6 months’ expenses
Pay off any high-interest debt
Maximize retirement account contributions to grow your savings over the long-haul
Understand the tax implications of redeeming I bonds
If you’re not sure how I bonds fit into your retirement plans, consider asking a fiduciary. They’ll approach your finances holistically to help you find the best investment options for your situation. Together, you can plot a course to the retirement of your dreams.
Ready to build a retirement plan that can thrive through ups and downs? Download our Essential Retirement Guide today.
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