Despite recent declines in yields, I-Bonds are still very attractive as part of an investor’s portfolio and offer a lot of flexibility in how they are used.
For one thing, they offer investors another chance at tax deferrals. The ability to defer taxes is a surefire way to increase compound interest rates. By avoiding paying taxes today, more of your money earns interest and so on. However, Uncle Sam only lets you avoid paying taxes on a certain portion of your investments. In 2023 — and excluding surcharges for older workers — that works out to $22,500 for 401,000 and $6,500 for IRA accounts.
With I-Bonds, investors have the opportunity to save an additional $10,000 per taxpayer per year. Investing your tax refund can save you an additional $5,000. And taxes on the interest from those I-Bond purchases can be deferred for 30 years. This offers another chance to earn interest on a portion of your portfolio that is out of Uncle Sam’s reach.
Because of the long tax-deferred compounding period and government guarantees, I-Bonds can be used as a vehicle for spending in retirement. Last year’s negative returns have reminded us that the market doesn’t always go straight up. Yield risk is real and can adversely affect a portfolio’s ability to fund retirement.
But by building a cache of I-Bonds today, investors have a pool for safe spending later. When the market is down, investors can tap into some of their I-Bonds and keep more of their money in stocks for the recovery. Or this cache of I-Bonds can be used to form a baseline for annual retirement spending. Finally, I-Bonds offer flexibility for spending.
Speaking of spending, tapping into I-Bonds early before age 30 is also an option. You can’t say that for 401,000 accounts. Meanwhile, IRAs face additional tax penalties if investors withdraw funds before a certain age. Do you have an emergency or want to retire early? I-Bonds can provide the financing.
Finally, while I-onds are an adjunct to 401ks and IRAs, they also have an added benefit as a college savings tool. Because they qualify for the government’s Education Savings Bond Program, I-Bonds can be used to pay for college tax-free.
When a parent sells an I-ond, all funds—both interest and initial principal—must be used toward higher education costs for the owner, a spouse, or a loved one. As long as the total proceeds from the bond sale are less than the amount of eligible college tuition, savers can skip paying taxes on the interest accrued. If the sale is for more, investors can avoid taxes up to the amount of college tuition. Given the new rules for 529 college savings plans and their ability to be transferred to IRAs, it might be beneficial to use I-Bonds to pay college expenses instead. It may make sense to use I-Bonds first and leave money in a 529 plan for future rollover/retirement.
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