Articles for Financial Advisors

I Savings Bonds

I Savings Bonds

I Savings Bonds are issued by the U.S. Treasury and pay an interest rate composed of a fixed rate that lasts for the duration of the bond plus a variable inflation rate that is determined twice a year. These two rates combined (fixed rate + inflation rate) are referred to as the composite rate. At the end of 2011, the fixed rate was 0% and the annual inflation rate was 3.06%. Since I Bonds debuted in 1998, the composite rate for newly issued bonds has ranged from 7.5% (May 2000) down to 0% (May 2009 to present). The composite rate for I bonds issued November 1, 2012 – April 30, 2013 is 1.76%.

 
Individuals can buy only $5,000 in I Savings Bonds each year. Despite the limitation, advisors should seriously consider this asset for a portion of clients’ conservative money. Since 1999, I Bond rates have been substantially higher than money market fund yields every year. For example, money market funds had a total return of ~ 0.1% in 2012 while I Bonds returned almost 5%. Moreover, these often-ignored government securities have a number of advantages over TIPS:
 
  1. Interest payments are tax deferred for up to 30 years
  2. Interest is exempt from state income taxes if used for educational purposes
  3. In some instances, interest is exempt from federal and state income taxes
  4. Unlike TIPS, I Bond interest rates cannot fall below 0%
 
I Bond investors can cash in their bonds after five years without a penalty. After holding these bonds for one year or longer, the penalty is equal to three months’ interest. The $5,000 annual limit applies to each member of a family; a family of five could buy $25,000 of I Bonds each year. Starting in 2012, taxpayers can opt to have their refund paid in the form of I Bonds. This means each investor could effectively buy $10,000 worth of I Bonds each year (a $5,000 direct purchase plus a $5,000 tax refund). Because of this loophole, some investors are intentionally overpaying their taxes up to $5,000.

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