Michelle Singletary: Now is a good time to buy this inflation-indexed savings bond

Rising inflation has been bad for consumers with the escalating cost of gas, groceries and rent causing people on the financial edge to struggle even more.

But for investors with money to spare and who are looking for safety, inflation has been good for Series I Bonds, which the Treasury Department announced will be paying 9.62% until the end of October.

Financial experts warn investors about chasing returns. However, this may be a good time to consider I bonds.

“When inflation goes crazy like it is now, at least I bonds keep pace with inflation,” said Carolyn McClanahan, a certified financial planner who founded the fee-only Life Planning Partners based in Jacksonville, Fla.

Here’s what you should know about this type of savings bond.

What is an I bond?

Series I Savings Bonds, which were first issued in 1998, are designed for inflation protection. There are two components to the return for the bond – the fixed rate and the inflation rate.

The fixed rate, which right now is zero percent, stays the same for the life of the bond.

“The fixed interest component is abysmal, but when inflation is high, the return on the I bonds are adjusted for the inflation rate and your return is higher.” McClanahan pointed out.

The inflation rate changes, every six months. The fixed rate of return and the semiannual inflation rate are announced by the Treasury Department each May and November. The inflation rate component is based on changes in the Consumer Price Index for all Urban Consumers, or CPI-U.

For I bonds issued from May 2022 through the end of October 2022, the overall rate is 9.62%.

“Every six months from the bond’s issue date, interest the bond earned in the six previous months is added to the bond’s principal value, creating a new principal value. Interest is then earned on the new principal,” the Treasury explains.

The bonds are sold at face value, so you pay $100 for a $100 bond.

Where can I buy I bonds?

To buy and own an electronic I bond, you must establish a TreasuryDirect account. Go to treasurydirect.gov to set up an account. The minimum purchase for an electronic bond is $25.

How much in I bonds can I purchase?

Individuals can purchase up to $10,000 in electronic I bonds in a calendar year. You can also purchase up to $5,000 in paper I bonds using your federal income tax refund, bringing the possible total to $15,000 for individuals for the calendar year.

By the way, bonds you receive as a gift count toward the annual limit.

Are I bonds taxable?

You have to pay federal income taxes on the interest you earn. But you can defer federal taxes on earnings for up to 30 years.

If you use the bonds for qualified higher education expenses you may be able to avoid paying federal income tax on your interest. You can find more information about the education exclusion in IRS Form 8815.

The bonds are exempt from state and local income taxes.

What do I lose if I cash the bond early?

An I bond earns interest for 30 years, but you have to hold it for one year. If you cash the bond before five years, you lose the previous three months of interest. After five years, there’s no penalty for cashing out early.

What’s good about an I bond?

If you are looking to protect your principal and guard against inflation, which means making sure the money you save today can buy the same amount of goods or services in the future, then bonds are just what you are looking for with rising inflation.

“I bonds offer a high guaranteed inflation-adjusted interest rate that is unmatched among other investments,” said Christine Benz, director of personal finance for Morningstar.

Even if inflation decreases, you’re guaranteed at least six months of the yield available at the time of purchase, and there is no secondary market for I bonds so there’s no price volatility, Benz said.

Buying an I bond is a good way to beat what banks are paying.

“If somebody has money that they want to set aside for an emergency fund that they want to make money on, an I bond is a good way to do that,” McClanahan said.

There’s also this: “The bonds are backed by the full faith of the federal government,” said Marguerita Cheng, a certified financial planner and chief executive of Maryland-based Blue Ocean Global Wealth.

What’s the downside of an I bond?

I bonds aren’t as liquid as some other investments, which means you forfeit some flexibility, Cheng said.

“They’re not a good choice if you need regular access to your funds,” Benz said. “A money market fund or something along those lines would be a better option.”

Yes, that 9.62% rate is very attractive now, but how long will the bonds be paying such a great rate?

“If inflation retreats, so will the return on your I bond as the interest component resets every six months,” McClanahan said.

“The problem with the I bond is when inflation is low, you hardly make anything on it.”

I bonds can be a part of your overall portfolio, but they definitely shouldn’t be the focus – or a heavily weighted part – of it, said Ernest Burley, a certified financial planner and owner of Maryland-based Burley Insurance and Financial Services.

“In the long run, I bonds won’t beat a nicely diversified portfolio in the market at outpacing inflation,” Burley said.

One caution from McClanahan: Be sure to designate a beneficiary for your bonds.

“These bonds have to be held at TreasuryDirect and can cause some hassle if the owner dies or becomes incapacitated,” she said.

“Make sure you put beneficiaries on all your savings bonds purchases to keep these from going through probate.”