[Rewritten on November 3, 2022. Older comments were from 2018 when this same issue came up.]
The Treasury Department announced rates for new I Bonds sold between November 1, 2022 and April 30, 2023. These new I Bonds will have a fixed rate of 0.4% for life, plus a variable rate that adjusts with inflation every six months. The variable rate in the first six months will be 6.48%. When the fixed rate and the variable rate are combined, the composite rate for these new I Bonds is 6.89% in the first six months.
I Bonds for the Short Term
All existing I Bonds bought between May 2020 and October 2022 will continue to have a 0% fixed rate for life. They will earn a 6.48% variable rate for six months after they finish earning 9.62% for six months. The 6.48% rate is still higher than anything you can find in a safe investment.
If you maxed out on I Bonds in 2022, you’ll have an opportunity to buy I Bonds again in January 2023. All the reasons to buy I Bonds in 2022 are still valid in 2023. I Bonds remain a flexible principal-guaranteed investment. They’re great for short-term money that you might spend or reinvest into something else at any time after holding for one year.
TIPS for the Long Term
However, as long-term holdings, I Bonds now face strong competition from TIPS, which are another type of inflation-protected government bond (see Better Inflation Protection with TIPS After Maxing Out I Bonds for more background on TIPS). The Treasury Department raised the fixed rate on I Bonds because the yield on TIPS is much higher now.
As I’m writing this in November 2022, the yield on TIPS is about 1.6% for all maturities whereas the fixed rate on I Bonds is only 0.4%. In other words, TIPS pay 1.6% above inflation while I Bonds pay 0.4% above inflation. TIPS win over a longer holding period.
I Bonds Advantages
There are still valid reasons for continuing to buy I Bonds in 2023 and keeping the existing I Bonds despite their low fixed rates:
1. There is a limit on how much new I Bonds you can buy each year. If you don’t buy them, you won’t accumulate as much in these flexible inflation-protected investments.
2. I Bonds are guaranteed never to lose value.
3. The existing I Bonds already accrued some interest. Cashing them out will trigger paying federal income tax on the accrued interest. I Bonds are exempt from state and local taxes.
4. Cashing out I Bonds before five years will forfeit interest earned in the last three months.
5. I Bonds are tax-deferred. If your tax rate is high now and it will be lower when you retire, holding on to them until you retire will arbitrage the difference in tax rates.
These factors in favor of buying more I Bonds in 2023 and holding on to the existing 0%-fixed-rate I Bonds are all true. Still, there has to be a point when it’s better to switch to TIPS. If 1.6% real yield versus 0.4% fixed rate doesn’t do it, what if the gap grows bigger?
Quantify the Difference
We need to quantify the advantages of buying more and holding on to the low-rate I Bonds. Then we will see whether the advantages overcome the yield difference. I created a spreadsheet for comparing two scenarios:
A) Hold on to an existing I Bond. Defer tax to the future when the tax rate is potentially lower.
B) Pay any tax and penalty now. Invest the proceeds in TIPS in a taxable account. Pay tax on interest every year.
The spreadsheet is interactive. Assumptions are in blue. Please feel free to change those to numbers applicable to you. The other cells are calculated. Please don’t overwrite those.
You get the current value and the composite interest rate of your I Bond from the Savings Bond Calculator. If the bond hasn’t been held for five years, the value displayed by the Savings Bond Calculator already reflects the 3-month interest penalty.
In the scenario shown, I have an I Bond bought in May 2021 with a 0% fixed rate. It’s still subject to the early withdrawal penalty. In Scenario A, I would hold it for another 10 years. The average inflation in the next 10 years is assumed to be 3%. Finally, suppose I pay a higher tax rate in the next 10 years than the tax rate afterward.
Under these assumptions, I’m still better off switching to TIPS and just paying taxes every year at a higher tax rate. If my tax rates are more or less equal between now and the future, it will be even better to switch to TIPS because there isn’t much tax rate arbitrage. If I have room for TIPS in an IRA, it will be better still.
The result may be different under a different set of assumptions. So play with the spreadsheet with your own assumptions and different scenarios and see how it goes for you.
When to Cash Out 0% I Bonds
The early withdrawal penalty on I Bonds is the interest earned in the last three months. If you decide to cash out and switch to TIPS, you may want to wait until your I Bonds finish earning the 9.62% rate plus another three months for the early withdrawal penalty. If you find the 6.48% rate attractive, you may want to wait until you fully pocket the 6.48% rate as well.
When your I Bonds fully capture the 9.62% rate or the 6.48% rate depends on when the I Bonds were issued. I made this table as a handy reference:
| Issue Month | 3 months after 9.62% | 3 months after 6.48% |
|---|---|---|
| January or July | 4/1/2023 | 10/1/2023 |
| February or August | 5/1/2023 | 11/1/2023 |
| March or September | 6/1/2023 | 12/1/2023 |
| April or October | 7/1/2023 | 1/1/2024 |
| May or November | 2/1/2023 | 8/1/2023 |
| June or December | 3/1/2023 | 9/1/2023 |
Because I already have enough for short-term flexible spending (“emergency fund” type of usage), here’s my plan for 2023:
1. Check the Interest Rate Statistics page at U.S. Treasury (click on the second heading Daily Treasury Par Real Yield Curve Rates). If TIPS yields are still high in January 2023, skip buying I Bonds and buy TIPS for the long term.
2. Check again on the dates in the table above. If TIPS yields are still high at that time and the I Bonds with a 0% fixed rate have been held for at least one year, cash them out to buy TIPS.
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Peter H. says
As you point out, historically I-Bond fixed rates have been lower than TIPS yields. I believe the reasons for the lower yields reflect:
1. The tax differences you mention (plus the potential for certain taxpayers to avoid taxes entirely if I-Bonds are used for educational expenses)
2. The redemption feature (guaranteed liquidity at any point before maturity). You have to be confident to hold TIPS to maturity or accept market risk. For example, if you are trying to build a TIPS ladder, I-Bonds can effectively fill in the missing maturities.
3. Automatic reinvestment of all interest at the same real rate (full inflation protection of all interest). There is no guarantee that today’s TIPS yield will be available when it comes to reinvestment of interest (although that is the assumption in the TIPS yield calculation)
4. A much more valuable deflation option on I-Bonds — I think many people don’t appreciate this fully. You never give back past inflation returns on I-Bonds, whereas you do with TIPS and only the final principal payment is guaranteed. One result is that I-Bond returns are enhanced by deflationary periods, and even some 0% fixed rate I-Bonds have had (modestly) positive real returns if they experienced deflationary periods (last I checked there have been 2 such half-year periods since I-Bonds were first issued.)
In my view, the reason for buying TIPS or I-Bonds is to protect against unexpected inflation. A pure yield comparison based on expected (market-implied) inflation is an incomplete comparison.
Harry Sit says
All true. The question still stands: should you keep the 0% I Bonds no matter what? The benefits have to be quantified. Please feel free to supplement the analysis to take into account the additional consideration you brought up. The inflation number is an input value. You can change it to something else for additional what-if analysis.
Peter H. says
Unfortunately, there are many moving pieces, making an apples to apples quantitative comparison very difficult. Some thoughts:
1) if you are not otherwise at the annual I-Bond limit your spreadsheet can easily be used to see if it makes sense to sell the 0% and buy the 0.5% I-Bond.
2) the historical average discount of the I-Bond fixed rate to the immediately prior month-end 30-year real TIPS yield since 2010 is 0.97%. If the government has a rational process for setting the I-Bond rate perhaps that’s an estimate of the average value of the I-Bond benefits. The current discount is less than that average, suggesting I-Bonds are a relatively good deal.
3) as I said in my initial reply, I see both I-Bonds and TIPS as insurance against unexpected inflation. I-Bond insurance is more comprehensive. I don’t mind paying the higher premium because my focus is on locking in spending power, not making an extra few basis points. This is partially because my timeframe is 20-30 years, which is where inflation risk is the greatest. It arguably matters less with your indicated 5-year timeframe.
Harry Sit says
Nothing stops the government from setting the I Bonds fixed rate arbitrarily low. Maybe they have been overpricing I Bonds (i.e. setting the rate too low) all along. So I’m not sure the historical average 0.97% difference is a good indicator for the benefits. The benefits also vary by the tax rates, holding period, available space in tax deferred accounts, and so on. I also don’t mind paying a higher premium (receiving a lower rate) over TIPS. How much higher/lower is the question. Yes it’s difficult, but we still need to think about it. Otherwise we end up accepting I Bonds blindly at any price.
Peter H. says
We agree it’s complicated. The 0.97% average is surely imperfect, but it’s a data point. As is the projection of tax-effected yield in your spreadsheet. I was trying to present some other “thinking about it.”
A couple of years ago I compared the after-tax hypothetical return of an I-Bond with a 0.1% fixed rate and a TIPS with a 1% coupon over two thirty-year inflation periods: 1915-1945 and 1985-2015. I-Bonds beat TIPS in the first period, which was volatile and had significant periods of deflation. TIPS won in the second period, which had generally low and stable inflation. Another data point.
TJ says
Are you buying individual TIPS? If you’re buying a mutual fund of TIPS, aren’t you risking NAV loss?
Harry Sit says
Individual TIPS or TIPS fund or ETF is a secondary issue. At some price level the NAV loss is worth risking. Receiving below-market income is also a loss.
gmshedd says
Wouldn’t 5-year 4% CD’s (with 6 month penalties so you can buy your way out if inflation and yields go up rapidly) provide a higher yield and inflation protection, without as much principal risk prior to the 5 year maturity date.
Harry Sit says
A 5-year 4% CD with small early withdrawal penalty still doesn’t provide inflation protection. When you get out after inflation goes up rapidly, it’s possible the prevailing nominal yield does not catch up to inflation and the prevailing real yield turns negative as it did several years ago.
FinancialDave says
Harry,
I am not seeing how your future taxes figure into a decision in this comparison.
You try to compare the yearly payment of interest on TIPS to the accrued interest of the I-bonds, but you know you can pay interest on the I-bonds annually if you so desire, so that consideration does not seem to enter into the equation.
IMHO the biggest factor favoring I-bonds is that they can never lose money and right now if you buy an I-bond today it will pay you .5% ABOVE the inflation rate for however long you hold it — will your TIPS do that – no they won’t. In fact in a rising interest rate environment they are potentially going to be bad news, especially if rates rise to fast.
For instance let’s look at what would have happened if you had bought TIPS a little over 5 years ago on Dec 31st 2012 and held them to Dec 31st 2017. By my calculation you would have lost $24 for each $10,000 you bought of the Vanguard Intermediate TIPS fund. Some other funds may be different, but I think you can see that after 5 years your investment would still be underwater. That is why I don’t invest in TIPS, after seeing them lose almost 9% in 2013.
Harry Sit says
Having to pay tax every year when you hold TIPS in a taxable account is a disadvantage. Considering tax rates gives credit to I Bonds. Paying tax on I Bond interest throws away one of its advantages.
If you don’t want to sell I Bonds no matter how high TIPS yield is, its “never lose money” benefit becomes more theoretical. The yield on 5-year TIPS in December 2012 was negative 1.35% while the fixed rate on I Bonds bought at that time was zero. No wonder I Bonds did better.
Bruce Wilson says
I now understand how I-Bonds work a little better, thanks Harry.
I have now inventoried my I-Bonds and know which ones have the 0% fixed rate.
I don’t like the way Treasury Direct deals with tax notification on the single TIPS bond I own, – an Email of the 1099, you have to print. I fear they wouldn’t be to sympathetic if the interest was forgotten even if their Email didn’t go thru. I don’t plan to buy anymore TIPS simply for that reason.
I think I will keep my I-Bonds, but keep the 0% fixed rate bonds on my radar if i need cash.
I learned some today.
Thanks Harry and the other posters.
Harry Sit says
You can buy individual TIPS or a TIPS fund or ETF in a brokerage account as well. The broker does a better job in sending the 1099 forms.
FinancialDave says
Bruce,
Good point about keeping an eye on those 0% fixed rate I-bonds. Seems like a good long term plan to sell the 0% to buy a higher fixed rate with the proceeds. Other than the small tax involved, which would be paid eventually, if you have held them more than 5 years I can’t see a disadvantage to trading up, especially if you are in the 12% tax bracket like I am.
Carrie says
Hi Harry,
I was wondering why you would hold TIPs in an after tax account versus pre/roth accounts. If one liquidates I-bonds , the equivalent amount of $$s could be held in tax-advantaged account in TIPs while purchasing equivalent $$s of more tax-friendly stock index funds in after-tax account (just swapping the location). You’ve mentioned this strategy previously.
Tyler says
I won’t speak for Harry, but I assume he’s trying to defeat the obvious “no more room in tax advantaged accounts to buy TIPS with” argument. His point is that at some point even the unthinkable (buying TIPS in a taxable account) may make sense if the yield spread between I Bonds and TIPS is great enough.
Harry Sit says
The spreadsheet makes a direct comparison with TIPS in a taxable account in order to quantity the tax deferral benefit of I Bonds. If you have other ways to defer taxes as you suggested, it lowers the threshold to switch. I need to establish first that a threshold exists. Then we can talk about how to lower it.
Moe Howard says
Just to wade in here. I have been buying iBonds for a long time and I use them for fixed piece of my portfolio. (Yes, I have some bond funds). A lot of my iBonds have passed the 5 year mark so are essentially cash. I have this available for emergencies. Unless you need the money, I don’t see a good reason to incur a tax hit. When I do sell some, of course, I will start with the 0% base ones.
Barry says
One thing I never see modeled and wonder about is how living in a high income tax state such as CA ( 9.2%) affects the impact of holding a TIP bond in a taxable vs tax deferred account – the difference being that in the taxable account no state income tax is paid on TIP interest whereas in tax-deferred accounts all returns of any kind are subject to both Fed and State tax when distributed.
Don says
Harry:
Thank you for this analysis. I have also been thinking about trading in old I bonds with
low interest for TIPs. I think yours is the first article I have seen that really makes a quantitative
comparison.
I think there are two potential benefits of I bonds that are not in your calculator. One
is that I bonds do not lose value during deflation. Someone on Bogleheads forum noted
that for 2008-2018, the deflation benefit of I bonds could be considered an average of 0.3%
per year (although it all happened in 2 six month periods). But to quantify the true value
of this effect one would need to assess or guess the frequency with which deflation might
occur in the modern age. The other potential advantage is if we compare I bonds to 10 yr
TIPs or an intermediate term TIPs fund (SCHP) then if
one can buy I bonds with sufficiently high real rates and have the choice to hold onto them
longer than 7-10 yrs one gets to hold onto the high real rate. I think you compare with holding
30 yr TIPs for 22 yr period but I would not want the rate risk associated with that term.
The I bond gives you a choice to hold or cash in depending if rates go up or down.
I think people who bought I bonds before 2008 and have held them have gained substantially
from this. However, my gut feeling is that one would need to have I bond real interest rates
close to 1% than the current 0.5% to have much likelihood of this benefit. So my current
thought is to sell I bonds and only buy TIPs for the present time.
But quantifying both of these potential advantages I bonds
requires speculation on future real rates and I would be interested in your thoughts
about them even if they are qualitative thoughts.
Don
DonK says
One thing not mentioned but may be helpful to some: I-series bonds can be used for your child’s education expenses, e.g. tuition, taking advantage of the education tax exclusion to avoid federal tax on the interest. For those with grown kids who wish to help a Grandchild going to college, transfer (gift) the savings bond to your Child and let them use it to pay the Grandchild’s tuition.
Harry Sit says
If you gift an existing bond to your child by removing yourself as the primary owner of the bond, the interest accrued so far is taxed to you.
“I want to give my bond to someone else. Will I owe taxes?
Yes, you will owe tax on whatever interest the bond has earned up to the time you reissue it to another person. We provide an IRS Form 1099-INT. The new owner will owe taxes on any interest earned from that point forward.”
https://www.treasurydirect.gov/indiv/research/indepth/bond-reissue.htm
Matt says
Hi Harry,
But, qualified education expenses should be tax free, and as far as I know, a 529 would qualify correct? So, if the ibond was cashed in and placed into a 529, taxes wouldn’t be owed correct?
Thanks
Harry Sit says
Correct in some cases. Your income has to be below a limit, and there’s a limit on the 529 plan beneficiary. See Cash Out I Bonds Tax Free For College Expenses Or 529 Plan.
Barry says
Harry – Wondering why neither you nor anyone else replied to my Nov 23 comment/question regarding the impact of holding TIPs in a taxable account for those living in states with a high state tax rate. Wondering if I’m missing something because It seems to me to be a question that is likely relevant to many investors. I’m not sure how to analyze it mathematically, but my seat of the pants sense is that the tax deferral advantage of holding any type treasury bond including TIPs in an IRA is going to be offset to some significant degree by the penalty of accruing state tax obligations on the interest, whereas treasuries including TIPs held in a taxable account are exempt from state tax. So in my case living in California, TIPs held in an IRA will eventually be taxed at 31% (22% federal and 9% state), while TIPs held in my taxable account will be taxed annually at 22%. And I’m guessing that an annual tax of 22% is better than a deferred tax of 31%.
FinancialDave says
Barry,
The short answer is that anything held in a taxable account is generally going to be less efficient than the same investment held in an IRA (Roth or Traditional).
Think of it this way – you have probably already paid 31% tax on the funds that went into the taxable account to buy the TIPs, so on day 1 you are equal to your Roth account (and also your traditional IRA because they are equal for same tax rates.) The minute you pay the first tax on anything in your taxable account it loses to the other two forms of tax advantaged accounts.
So in reality you really want to minimize the amount of income producing stocks/bonds in your taxable account as this only makes it less efficient – so put your bonds in your IRA and be happy about two things:
1. Less growth of your IRA which reduces RMDs.
2. No current taxes just because your bonds are throwing off income and thus your taxable account is becoming more like a Roth account. The only types of income you want to see in your taxable account are 100% qualified dividends or LTCG.
Dave
Barry Wasserman says
Dave – Thanks for the reply. I appreciate having someone knowledgable and interested enough to look at this with me. I had to read your reply a couple of times to think it through. Here’s my thought now:
Your key concept, which I understand and agree with, is that the most tax efficient and therefore most desirable income to generate in a taxable account is qualified dividends and LT cap gains. So purely from a tax efficiency point of view, that would mean holding stocks in a taxable account and bonds including TIPs in a tax-deferred account. But of course to do exactly that would mean you are determining your stock/bond allocation based on your tax deferred vs taxable account space instead of the more important factor of risk tolerance for stocks. I’m sure that’s not what you meant, but it’s a crucial and complicating point because, as in my case, I desire to hold a higher allocation of bonds than can fit into my tax-advantaged space.
So that means some form of bonds needs to be in my taxable account, and I’m trying to figure out how to do so most tax efficiently. The first answer might be tax-exempt munis, but for my tax bracket, I prefer the risk/reward of more secure CDs, I-Bonds, and TIPs. So for me the decision is which of those three should be held in the less desirable taxable account. I would now say that I-Bonds are first because that’s the only option anyway and they are already tax-deferred. TIPs would be the second choice because at least you’re avoiding the state tax portion that you’d be accruing in an IRA. The least desirable choice in a taxable account would be CDs or other nominal bonds or bond funds as they are there least tax efficient.
With this train of thought, I’m realizing that my question needed a more complicated answer that factors in each individual’s tax-deferred capacity in relation to their most appropriate stock/bond allocation. Your answer is the conceptual starting point, but not the end point. As somebody wisely said: Investing can and should be kept simple, but taxes never are.
Harry Sit says
Barry – You don’t need to guess whether an annual tax of 22% is better than a deferred tax of 31%. Maybe it’s easier if you break down the decisions.
1) If I have an opportunity to put more money into a tax deferred account, should I do it or should I forego that opportunity and just pay the tax to keep the rest in a taxable account? Answer: I should put more money into the tax deferred account, because in the worst case I just pay the tax and convert to Roth. A Roth is always better than a taxable account.
2) Now that I have the money in the tax deferred account, should I convert to Roth? Answer: It depends on my outlook for taxes in the future. If I don’t convert, it’s because I think it’s better not to convert. In other words the tax deferred account I keep is better than a Roth, and I should think of it as a “super Roth” from this point onward.
3) I need to invest in stocks and bonds (including I bonds, TIPS, and CDs) and I don’t have enough room for everything in my “super Roth” and Roth accounts. What should I leave outside those accounts? Answer: The investments that throw off the least amount of taxes, taking into consideration both the distributed income and the capital gains upon sale. Leaving TIPS outside is better than leaving CDs outside but if I didn’t have to choose between the two I would keep them both inside.
Peter H. says
Barry – back to your original question: have you specifically confirmed that CA taxes distributions of Treasury income from an IRA? I don’t know the answer, but it seems that is not the case in every state. For example, NJ appears to make an exception (see publication linked in this thread https://www.bogleheads.org/forum/viewtopic.php?t=231484). If CA does impose this tax, to come out ahead in the tax-deferred account you’d indeed have to expect your future tax rate (at the time you take distributions) to be lower to account for the state tax. Maybe you will be in a lower bracket, live in a different state, etc. But I think you probably have to make that call ahead of time. It’s not clear to me how a Roth conversion down the road solves this unless CA imposes state tax on a distribution of Treasury income but doesn’t impose it in a conversion.
On the general question of what bonds to hold in a taxable account, TIPS can be less advantageous than nominal Treasuries. It depends on how you own them. In a fund, they are similar. You pay tax on the distributions from the fund. But if you own TIPS directly, you pay tax on the inflation component (increase in principal) even though you don’t receive that increase in cash. While conceptually you can argue that the government taxes inflation in either case, paying tax on income you don’t actually receive means you have to come up with the cash to pay the tax elsewhere. This amounts to an interest-free loan to Uncle Sam. At 2% inflation, a 22% tax rate, with a $100,000 TIPS portfolio the loan is about $440 a year. That’s $440 that isn’t earning you anything.
Harry Sit says
Peter – California taxes IRA distributions all the same. Paying tax on income you don’t receive also happens when you must pay tax on automatically reinvested dividends, which doesn’t make reinvesting dividends a bad thing. The inflation part is automatically reinvested back into the bond. You earn interest on it. You get it when you sell or when the bond matures.
Peter H. says
Harry – you are right. The dividend reinvestment analogy is useful. You effectively get the bond return on the tax payment. My “interest free loan” point was not correct.
Barry Wasserman says
Barry
Liz says
Hi, Do not know if this thread included this , but it is a valuable addition to the idea of funding college ( or now any private school tuition). Ibonds with earnings can be cashed and immediately put into a 529 account that is owned by you and has a beneficiary of your choice. The interest income taxes are still deferred and you take care of the kids. My children attended college with money from EE bonds that funded a 529. Thank for all the information offered at this site!
Richard Sharon says
Harry, I have a different question – When do you buy I -Bonds? Can I use the same logic, ie fixed rate of the I-Bonds is greater than the Real rate of TIPS, then its probably worth buying I-Bonds? Thanks
Harry Sit says
Yes. I just bought this week. Buy as much as you’re allowed now because the fixed rate is much better than the real yield on TIPS. See recent post Overpay Your Taxes to Buy I Bonds for a Better Yield Than TIPS.
Paul Goode says
Hello,
I follow you quite closely and I was tempted to sell but I m now earning 1.78% which of course is far more than current CD’s. Would you still sell today if you had the option?
Thank you
Paul
Harry Sit says
I sold when TIPS were paying more. Now TIPS are paying less. I won’t sell now, and I bought more last month.
Bob says
Live in Florida no state income tax – looking at future inflation issues 3-6% – how long do I need to hold before selling -looking to hold 5 and10years – are ETF a good way to go? Or buy I I I bond or tips
Harry Sit says
Have a diversified portfolio. I Bonds are guaranteed to match inflation. Stock ETFs may beat inflation but they aren’t guaranteed. Invest in both.
JF says
Suggest you look carefully at this chart before you purchase I Bonds:
https://www.treasurydirect.gov/indiv/research/indepth/ibonds/IBondRateChart.pdf
Current interest rates are for 6 months only and first 3 months there is no interest at all. If you look at the last 10 years, average rate of return has been 1-2% per year. Please note that the fixed rate is permeant for the life of the bond and so when inflation calms down that’s basically all you’re going to get. Current fixed rate is 0%! There’s some favorable tax treatment and no interest rate risk, but why not just consider EE bonds, which are guaranteed to double in 20 years, which implies annual compounding interest rate of about 3.6%. Other than the early 2000’s, when I Bond rates were around 10% or higher, the last decade has been a total dud until now. Feels like a place to put a few thousand per year as an inflation hedge and nothing more. Am I wrong here?
Harry Sit says
You’re missing that you have total flexibility in how long you hold I Bonds. When inflation calms down and you have better options elsewhere, you can just cash out and invest in something else, whereas you have to commit to the full 20 years to get the 3.53% yield from EE Bonds. If you cash out EE Bonds before 20 years, you get only 0.1% per year. If you’re willing to hold the full 20 years, you might as well buy the regular 20-year Treasury for a higher yield (3.72% as of today).
JF says
Harry, thanks for your response. The flexibility of I Bonds is a big plus. Question: if I want to buy some bonds now and then transfer them out or sell when rates go down, do you recommend I buy in my kids’ names or through a small business? I already purchased the max for my wife and I. Thank you.
Harry Sit says
Buying in your kids’ names gives an irrevocable gift to your kids. The money still belongs to your kids when you sell. If you’d like to keep the money under your control, buy for your business. You can take money out of your business when you sell.
Robert says
I redeem my $20,000 in Ibonds and purchase $20,000 in 5 year TIPS at auction with a coupon of 1.6%. In 6 months I get a little more than $160 in the first coupon payments. What am I supposed to do with that $160 to keep it inflation protected? I can’t buy another TIPS bond for $160. OTOH the Ibond interest gets automatically reinvested.
Am I missing something or is this a disadvantage of making the switch to TIPS in the above case?
Harry Sit says
It’s only a small amount. You can put the $160 in a TIPS fund or ETF, or put it back into I Bonds.
Robert says
What if I redeem the $20,000 in Ibonds and put it into 30 year TIPS at auction with a coupon of 1.6%? Won’t nearly a third of the total return (59 coupon payments each of $160) be going into into the Ibonds? Doesn’t that have a significant effect on the overall return?
Harry Sit says
You can redeem and put it into TIPS when you accumulate $1,000 in coupon payments.
Paul says
I just read
https://www.morningstar.com/articles/1121096/when-inflation-surfaced-tips-flopped?
Between Harry’s article and the one from Morningstar, I just think TIPs are too complicated for me.
Besides, what I need is a non-IRA inflation adjusted bond investment that does not throw off taxable income until I cash the bond (thanks to RMDs and IRRMA). That’s I-Bonds. Paper I-Bonds are better because you can hold them even after they mature if the income would be inconvenient just now. Electronic I-Bonds at Treasury Direct are automatically cashed when they mature. Fortunately, the bonds I buy today at Treasury Direct won’t mature until I’m over 100. I will need to manage the ones I bought in 2000. Hate to see them go; they are paying over 13% right now.
Harry Sit says
With all due respect to Rekenthaler, I disagree with how he characterized the performance of TIPS. If inflation continues at 10% a year for the next five years, TIPS won’t drop by 15% in each of the five years. You can’t treat one episode of short-term performance as a permanent feature of TIPS.
The point of this post is to show that the nice features of I Bonds have a long-term opportunity cost when the fixed rate is so much below the going rate in TIPS. It’s nice to have a non-IRA inflation-adjusted bond investment that does not throw off taxable income until you cash the bond but you end up with less money than just paying the taxes. Unless of course you have those old I Bonds that still have an above-market fixed rate.
Peter H says
Taxes are due on paper i bonds when they mature, same as electronic
Paul says
Peter H,
I’d assumed paper I-Bonds were like paper USSB. Taxes due when I cashed them. If the Treasury is going to cash the paper bond for me while the bond is still sitting in my safe deposit box, how does that work?
Peter H says
Per TreasuryDirect site:
For paper savings bonds
The 1099-INT will only come when someone cashes the bond or the bond matures. The interest will be reported under the name and Social Security Number of the person who cashes the bond or who owns it when it matures. The 1099-INT will include all the interest the bond earned over its lifetime. If you are the new owner who gets that 1099-INT, you must prove to the IRS that a portion of the interest was previously reported to a different owner.
John Endicott says
“Taxes are due on paper i bonds when they mature, same as electronic”
True. However, paper bonds aren’t automatically cashed out and the 1099-INTs for paper bonds are only sent out after the bonds are cashed out. People “get away” with not cashing out/paying the tax on paper savings bonds (I, EE, E, H, etc) at maturity all the time, usually because they paper bonds were essentially filed away in the back of a drawer somewhere decades ago and forgotten about. Eventually, once the owner remembers they have a mature bond and cashes it out, the owner is supposed to file an adjusted tax return for the year the bond matured. I suspect most don’t do that, but instead pay the taxes on the current year’s tax forms. Unless they get audited, I suspect they “get away” with that too.
Harry Sit says
If you take a “catch me” approach to taxes, you’ll find many “opportunities” to “get away” with. See Paying Taxes: By The Book Or Catch Me.
John Endicott says
” Unless they get audited, I suspect they “get away” with that too.”
Note: I’m not suggesting anyone count on “getting away with it”, Just pointing out that the rules aren’t as rigorously enforced as one might think when it comes to paper bonds, and people do “break” the rules, mostly out of ignorance, and rarely get called up on it.
It’s best to follow the rules and pay your taxes when they’re due (at cash out or maturity, whichever comes first). if for no other reason than there’s really no benefit to holding a savings bond beyond its final maturity, as you aren’t earning any more interest on it, so would be losing out to inflation from the moment it matures until the time you finally cash out.
John Endicott says
“If you take a “catch me” approach to taxes, you’ll find many “opportunities” to “get away” with. ”
True, as my follow-up post points out, I was not suggesting one take a “catch me” approach. I was just pointing out that with paper bonds, unlike electronic, tax forms are not automatically generated and as a result people (often out of ignorance of the rules, though, there are those who are playing “catch me”) do “get away” with what the OP wrongly thought the rules allowed them to do.
Robert says
“You can redeem and put it into TIPS when you accumulate $1,000 in coupon payments.”
That would take over 3 years of sitting in a MMF with a negative real rate of return.
My point is that there is reinvestment risk with TIPS that doesn’t exist with Ibonds. Over 30 years that risk is not insignificant. So for most people the annual return will not be 1.6%, but less than that if they do what you advise above or invest coupons in Ibonds. We would be looking at a return more like 1.1%. If they simply forget about the 59 coupons as they land in the MMF, the return will be less than 1%.
The TIPS return, with coupons instantaneously reinvested in the bond, exaggerates the return nearly everyone will actually get over 30 years.
Harry Sit says
Coupon payments in I Bonds, as you were talking about in comment #21, until they add up to $1,000 for another TIPS. How did it change to a money market fund all of a sudden? If you’re concerned about the reinvestment risk, you can minimize it by choosing a low coupon TIPS, such as the 0.125% 2052 TIPS (CUSIP 912810TE8) currently selling at a deep discount of 62 cents on the dollar.
Dunmovin says
One overarching consideration from my perspective in cashing out Ibonds is the tax ramifications, i.e. I initially buy for capital preservation. If one is required to take IRA MRDs, coupled with (marginal tax on) soc sec, pension, other interest income, etc . and that person has minimal if any debt (manage expenses!)…I plan on what taxes I want to pay and factor in the low/minimal/no taxes into the (negative) return and that is a main driver for (in)action. One cannot plan on what taxes they will pay if part of the calculation includes interest income that can’t be controlled, i.e. from TIPs…I have no choice to include that each year as a component of income!
larry summ says
so and I bond purchased March 1, 2023 will pay 6.48% variable rate for 6 months? or
only until the month till the next variable rate change?
sorry if this is basic
Harry Sit says
An I Bond stays on each rate for six months before moving on to the next rate.
John Endicott says
As Harry says, I-Bond gets each rate for 6 months, so in your example, the March bond would pay the 6.48% variable rate for six months and then it would start paying the next variable rate (the rate announced in May) for 6 months, followed by the next variable rate (announced in Nov.) for 6 months, and so on.
That rate behavior was the drive forcing behind treasury direct’s servers being overwhelmed at the end of October – people were looking to lock in the 9% variable rate for 6 months before it was too late.
Hongyan says
Just a very basic question. If I understand correctly, only holding TIPS to maturity can guarantee it is not subject to market risk. So in the case of purchasing individual TIPS, I just need to hold it to maturity. But how about the case of TIPS ETF or mutual fund? I got confused here because there does not seem to be a fixed “maturity date”. Am I always subject to market risk?
Harry Sit says
It depends on whether you’re liquidating a large percentage on a pre-set schedule or you’re investing for the long term and only liquidating a small percentage at a time. See Two Types of Bond Ladders: When to Replace a Bond Fund or ETF.
D.D. says
I am puzzling over the spreadsheet and would appreciate clarification, so I can better comprehend I bond computations:
(1) Is the formula in cell B29 meant to contain B9, or should it instead
contain B28?
(2) Does the value in cell B9 include the 3 month penalty or not? If
I use the savings bond calculator and assume the redemption date is
11/2022, the value in B9 seems to include the 3 month penalty.
Thanks.
Ravin says
Harry,
Thanks for the article.. Now that we are in 2023, and 4-month (17-week) TBill at last week auction is paying is 4.684% and with interest rates likely to increase for next few Fed meetings, would you consider investing 2023 max allowed $10K per person/account into I-Bonds or switch to a Tbill.
I did not quite follow which TIPS ETF/fund you are referring to if switching out of bond ladder to TIPS… Could you please clarify?
Thanks
Ravin
Harry Sit says
I’ll only switch from I Bonds to TIPS, not to nominal T-Bills because T-Bills don’t have inflation protection. I have a list of TIPS mutual funds and ETFs in Better Inflation Protection with TIPS. A TIPS ladder works better if you will liquidate in one lump sum or over a short period. See Two Types of Bond Ladders: When to Replace a Bond Fund or ETF.
Tom H says
I have a question about first year I Bond interest taxation. I plan to report the interest each year on my 1040. What do I report for the first year for a July bond? Do I report zero, because I cannot actually withdraw anything at the end of the year? Or perhaps I should report the interest earned for July-September since if I could withdraw, 3 months interest would be forfeited. Or do I report all the interest earned for July-December, because by the time I would file in April, the prior year’s interest would not be forfeitable? Leaning towards zero.
Harry Sit says
You report the increase in the redemption value as of December. See I Bonds Tax Treatment During Your Lifetime and After You Die.
Tom H says
OK thanks, Harry. None of my options were correct! December’s interest is not posted until January, so the Treasury Direct calculator provided a redemption value that only includes the July and August interest postings as of December 31. That’s what I will report, even though the interest is “not eligible for payment” yet. Sorry for posting my question in the wrong topic.