If you usually get a tax refund, this might be a good year to use it for something different. The increase in inflation and current low interest rate has created the ideal environment to invest in a lesser-known asset: U.S. Series I Savings Bonds (I-bonds).
Background on I-bonds
I-bonds are 30-year bonds issued by the U.S. Treasury and backed by the U.S. government. They were introduced in 1998 as a risk-free asset that can be used for education, retirement, or emergencies. Since they are indexed to inflation, they offer inflation protection. I-bonds’ interest structure is based on two components: a fixed rate and an inflation rate. Together they make a composite rate, which is the rate of interest earned over six months.
The fixed rate for an I-bond is set when purchased and never changes throughout the life of the bond. The current fixed rate is 0%. The variable inflation rate, currently 7.12% through April 2022, adjusts in May and November of each year. If inflation slows, I-bond interest rates will decrease. If inflation accelerates, I-bond rates will remain high.
After an I-bond’s purchase, it must be held for a minimum of one year or for as long as 30 years. No interest is paid during the life of the bond, but instead interest is added to the value of the bond. Selling the bond before five years will forfeit the last three months’ worth of interest.
There are many benefits to I-bonds. They are essentially risk free and protected against capital losses. Even if inflation rates are negative, I-bond inflation rates will never drop below zero. In that sense, they function like a savings account, whereas the principal can only increase.
Interest on I-bonds is free from state and local taxes and subject to federal tax at the time the bonds mature or are redeemed. Some or all of the I-bond interest earnings may be excludable from your federal taxable income if sold to pay qualified higher education costs at an eligible institution in the same calendar year.
The minimum I-bond purchase is $25 and the maximum is $10,000 per individual. That means, for example, a household of five people can purchase up to $50,000 worth of I-bonds each year.
How to Purchase an I-Bond with Tax Refund
There are only two ways to purchase I-bonds: through Treasury Direct or with a tax refund.
You can use a portion or your entire tax refund to purchase up to $5,000 in paper I-bonds per calendar year. (This is in addition to the $10,000 per individual.) When using your tax refund, the amount requested must be divisible by $50. Your remaining tax refund balance can be deposited into a Treasury Direct account or bank account or mailed as a check. Bonds can be requested in your name or the names of a primary owner, co-owner, or beneficiary and for up to three registrations-yourself and spouse (if married filing jointly) or someone other than yourself. Bonds ordered for yourself and your spouse will be issued in the names listed on your return.
The IRS website provides detailed instructions for buying bonds with your tax return. The request will be processed in two parts, and you should receive the bonds after the remainder of your refund is processed. The IRS will then forward your request to the Treasury Securities where it will be processed, and your bonds will be sent to the address on your tax return.
This a good year to take advantage of I-bonds
Many fixed income investments are earning a negative yield, but the recent spike in inflation and accompanying low interest rate is good for I-bonds. If you would like to take advantage of this rarely used investment by transferring your tax refund, contact your Rodefer Moss tax advisor today.