Why I Like I-Bonds in My Retirement Portfolio

I am a strong believer in the role that I Savings Bonds (I-Bonds for short) can play in the portfolio of the average retirement investor.

I-Bonds can actually help in two important ways.  First, they provide a measure of inflation protection.  Second, they can form all or part of what I call the “ride out the market storm” fund that all retirees should have.  This stable value fund should provide rock solid stability during turbulent or negative market conditions so that a retiree does not have to sell equities or stock mutual funds during a down market.

If you are not familiar with I-Bonds, they are savings bonds sold by the U.S. Treasury.  However, I-Bonds they are quite different from the savings bonds that baby boomers often received as gifts when we were children. I-Bonds carry an interest rate that has two separate components.  The first interest rate component is fixed for the life of the bond.  The second component is adjusted every six months (May and October) based on a calculation of inflation factors during the previous six month period.  This provides the inflation protection.  Mrs. GoTo and I have been buying I-Bonds for the past five years, with current interest rates as high as 8.2%.

The combined interest rate for I-Bonds purchased from now through April 30, 2009 is 5.64%.  Although the fixed rate component is pathetically low, you should also think about what might happen to inflation when Congress is through spending all of our tax dollars on bailout programs.

Unlike regular savings bonds or even Treasury Inflation Protected Securities (TIPS), interest is added to the I-Bond monthly but no tax is owed on bond interest until the bond is redeemed. This provides a nice tax deferral feature that is so helpful for retirees trying to manage their tax exposure.  On top of that, interest is exempt from state and local income taxes.

I-Bonds earn interest for thirty years and must be held for at least one year before they can be redeemed.  If a bond is redeemed during the first five years of ownership, there is a three-month interest penalty.  Thus, I encourage baby boomers to buy some bonds each year and plan on holding them for the full five years.  Then you can redeem what you might need to fill in any income gaps when the market is down.

Unfortunately, an individual is subject to a $10,000 annual limit on I-Bond purchases ($5,000 in paper bonds and $5000 in bonds purchased electronically.)  Thus, a married couple can purchase a total of $20,000 in I-Bonds each year.  This purchase limit used to be $30,000 so maybe the Treasury will change the rule again when it needs to borrow more money from us!

Here is a summary of Mr. GoTo’s favorite I-Bond features and benefits:

1.  Inflation protection – interest rate moves and is adjusted with inflation twice per year.

2.  Tax deferral – no taxes owed until redeemed.

3.  Security – if the Treasury defaults, head for the hills!

4.  Ease of purchase by opening an account at U.S. Treasury Direct.

5.  Easy tracking of bond purchase and valuations on your own computer by downloading and installing the Savings Bond Wizard.

6.  Can be redeemed and used to pay for qualified educational expenses with no taxes owed on accrued interest.

7.  Can be purchased in any amount ($25 minimum) online or in $25 increments ($50 minimum) in paper form.

Here is a link to more information on I-Bonds for your retirement portfolio.  You should definitely consider using I-Bonds in your portfolio.

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My Related Posts:

1. Bonds and Your Retirement Portfolio
2. Investing in Corporate Bonds for Retirement
3. Inflation and Retirement Investing
4. Protect Your Portfolio from Currency Devaluation
5. New Options for Investing in Inflation Protected Securities