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With the market volatility we've experienced in 2022, many folks are looking at different types of investment vehicles. One that Richard Oring's clients have been asking about lately is the I Bond. Today, Rich explains what they are and more.I bonds are securities issued by the US Treasury, that are 20 year notes and continue paying interest for an additional 10 years, for 30 total. They can be purchased electronically or by paper. Rich explains the differences, and the limits on what you can buy.The interest rate on I bonds is comprised of a Fixed Rate plus an Inflation Rate - and we go through how these numbers add up for you, using a specific example for illustration.These I Bonds are exempt from state and local taxes, and the interest CAN be used to help pay for qualified higher education expenses, with restrictions. Rich explains those.As with all financial decisions, your situation is unique. Before making an investment, talk to your financial advisor, and/or CPA. You can also research this topic more at https://treasurydirect.gov/.
Welcome back to Financial Matters with Richard Oring. I am John Jaggy, joined as always by Richard Oring from New Century Financial Group. Rich, always good to be with you.
Thank you, Jaggy. It's always good to be with you.
Rich, one of the reasons I always like talking to you is I learned something in every one of our conversations. I've been reading a lot and hearing a lot in the news lately about these i-bonds. We're going to kind of dive into those today. Where do we start?
Not only have you been seeing, I've been getting a lot of phone calls from clients about the i-bonds. It's not something I personally sell because you have to go to the government directly to buy them, but I figured this would be a great episode to go over more about them. If my clients are asking, you're seeing in the news, let's talk about it. So i-bonds simply there are securities issued by the US Treasury with a 20-year maturity with a 10-year extended interest payment. So it's actually pays interest for 30 years. The interest is earned monthly, paid semi-annually compounding to the principal. So what that means is the interest is paid every month, every six months they credit that interest to your principal value and then the interest is based on that higher value now.
So that is literally compounding interest. So when we talk about saving for the future in retirement accounts where that interest can compound on itself, same principle here where you're gaining that interest and that's compounding on itself, adding your principle value. Do I have that right?
That is correct.
All right, so got to be a lot more than just the service level stuff here with what you described, but it really seems like they have been a hot topic all year as we said, Rich. How do you even buy them?
Sure. First off, I mentioned that you buy them directly from the government. You go to treasurydirect.gov. It's where you can create an account, you can do your research. There's educational information. That's the first place you would go to even just to learn about it, not just about i-bonds, about any of the fixed income offerings the government offers. There's two types of way to buy an i-bonds. One are called electronic i-bonds by purchasing electronically, and the other one is through paper. When you buy electronic i-bonds, it's $10,000 maximum per year per social security, but you could buy them in any denomination. You could buy $5, $100, 10,000 in one shot. I personally like to buy them by dollar cost averaging.
So I set it and I forget it basically for myself. So it's another forced way of savings where I set it up and I think actually I did every two weeks, not even monthly, and until I decided to do this podcast, I totally forgot that I even had them automatically bought until I reconciled my checking account. The other way of buying them is through a paper purchase, and that's usually done through your tax return. You can only buy a maximum of 5,000 though on the tax return and they're only sold in denominations of $50, $100, $200, $500, and even $1000. So then you're going to ask me, well, how do I do it right? I've done my tax return, I don't remember ever seeing a place on the 10 40 where I could buy the i-bonds.
Right, right, right.
Well, there's a form called an 8888, and that's the form where if you want to buy the i-bonds you can or direct deposit rate into your checking account. So the only way you would've known about that form is if you have direct deposit for your refund. If you have a refund of 5,000, you could do the 5,000 for the return plus 10,000 for each individual social security number for a total of 15,000 or 25,000 for the household if it's a married couple-
Got it. Okay.
... for joint return.
So what happens at maturity?
So at maturity on the electronic bonds i-bonds, they just redeem automatically. You don't have to do anything, it's great. You don't have to remember like, "Oh, I have to sell them." Nope. Because if you remember when you were a kid, remember getting those EE savings bonds?
Oh, yeah. Grandma and grandpa.
Right. And then 40 years later you're like, "What is this?"
Oh, it's money. Okay.
And those will have actually stopped paying interest, but they don't tell you. It's up to you to redeem it and know when they stop paying interest. And you can go on that treasury direct website and there is a place you could put the CUSIPs of your bonds EE and find out they're still paying or not. On the paper Bonds i-bonds, they're a little bit different. You actually have to redeem them. You have to send them in to redeem to get your money back. So what I would do is I would convert my paper i-bonds into electronic i-bonds. You go on their website, there's forms to do that. You can start the process and this way you don't have to worry about it in 30 years. If you forgot that, "Hey, my i-bonds matured and they stopped paying interest." They'll do it for you automatically.
So that's really a smart thing to do because you think about how many times or something falls at the bottom of a drawer or the bottom of a to-do list and you forget about it. It's like finding the proverbial $20 in your winter coat at the change of the season. I was like, "Oh yeah, forgot I had this thing." But if you've done it and converted it to online or it's going to pay you automatically, you get the money as opposed to saying, "What is this thing and how do I cash it out and how do I turn it into money?" I love that idea.
I think I shared this on a previous podcast. I went to one of my friends' house and they had a EE savings bond from when they were a kid on the refrigerator. I was like, "Wow, that's interesting. I haven't seen one of this for a long time." And they were like, "Oh yeah, we were going through our attic and we found it." I'm like, "What are you going to do with it?" They're like, "We don't know yet." So about a month later, I still saw it there and I was like, "You guys do know you should go on and check to see if it's still paying interest." It stopped paying the interest, but the value was higher than the face value. So I was like, "Here's your vacation money. Do something with it, it's just sitting there doing nothing." So they were really surprised to hear that it was worth more than the face value. They had no idea.
This is why it's good to have a friend like Rich to come over your house and see what's on your refrigerator.
It all depends on what they're cooking that night-
... if I'm coming over.
Talk to me about interest rates. Rich. How are the interest rates on these i-bonds calculated?
Sure. There's actually two rates you have to know. There's the fixed rate, which you know when you buy the bond, and that usually is a fixed rate, doesn't change. Then there's a variable rate which gets changed every six months, and it's based on the consumer price index urban consumers. Basically that's like the CPI using towns, outside cities with over 10,000 people to see what their spending is like. Okay. So it's similar to the CPI but urban. And that gets reported every six months on May 1st and November 1st. So we just had an update. Today, we're recording on November 21st so on the 1st of November they came out with their new rates.
Now what's interesting is people sometimes get confused when their interest rate is going to get changed on their i-bonds. It doesn't mean that you bought a i-bond in March and it's going to change automatically on May and November. It's six months from the date of you bought that bond every six months from that date. But the new rates get reported every six months. So let me give you an example. I just mentioned you bought an i-bond in March and the next rate change, which you are going to see on your account is going to be on September 1st and March 1st.
Okay. So the rates get announced every six months, but your change in rate is going to be six months, 12 months, 18 months from when you bought it, and it's just going to reflect that most recent change. Do I have that right?
That is correct. So we talked about how you earn money on these i-bonds with the interest, the two different interest rates and so forth, but how do you get your money out?
A lot of times you might have an emergency, you might need the money sooner. Maybe it's going to be used for a goal you're saving for. So the first 12 months it's illiquid. You can't take it out. You're giving up that right to take the money out. If you take it out after the 12-month mark, before five years you could take it out, but you're going to lose three months of interest.
That's the penalty. Okay.
That's the penalty. So let's say you held it for 18 months, you redeem it, you're going to get paid on the interest for 15, not for the full 18.
Okay, got it. So what are the current rates as we sit here today recording November 21st, Rich?
Thank you for the timestamp there because that's important because we don't know when someone's going to listen to this podcast. So the rates which were issued for November, which are good till April 2023, the fixed rate is 0.4. That's not going to change. Now we quote rates on a semi-annual rate. So the semi-annual rate right now is 3.24% for a total rate of 6.89%. So you're probably saying it yourself, "Hey Rich, if I do the math, that doesn't really come out to 6.89." Well, if you really want to understand the formula, you got to go on treasurydirect.gov and here's the great part, you get the rounding up. Oh, so in this case you did get that extra 100th of a percent I guess, of the 0.89. So that's kind of nice.
All right, so besides the dollar amount restriction you mentioned off the top rich, what other restrictions are there on purchasing these i-bonds?
Okay, so I mentioned you need a social security number or actually a taxpayer's number. You have to be a US citizen or a US resident or a civilian employee of the US. You have to be at least age 18 to purchase them. Now that does not mean that you cannot purchase them for your kids. You definitely can. As a parent you can buy them for your children. If you own a trust, estate, a corporation, they can also buy i-bonds, but... Here's the but, they have to be purchased electronically, not through the paper method. Let's talk about this because a lot of people get hung up on this $10,000 number. Let's just go with a scenario. Husband and wife each buy $10,000. That's 20,000 right there, right?
Then let's say they have one child and they put another 10,000 in, so that's 30, and then they have a business with their different tax ID, they can purchase another 10,000. So you're talking about $40,000 all bought in one year because they're all separate tax ID numbers.
Oh, okay. Speaking of taxes, what kind of taxes are we looking at on the i-bonds themselves?
Great question. Uncle Sam definitely wants to get paid.
The good part is guess who's not getting paid on these? The state and the local townships, so they're not taxed, the state you reside in or the local tax you might have in some counties might have a local tax.
So you're buying this from the federal government, this whole transaction is between you and the federal only?
That's correct. So federal taxes. How's Uncle Sam going to get paid and when do they get paid? Well, the good thing is you don't have to pay the tax until you redeem them or to maturity. Now you might be thinking yourself, "Well, if I buy 10,000 every year for the next 20 years, that's a lot of tax." That's not the case because you got to remember each year it's a different series. So if you're buying it for 10 years and eventually in the mature, only one 10th is maturing at a time.
Okay, so let me follow up on that. Say I have it and say it's not automatically paid out. It's the paper version. Am I going to get dinged on my taxes when it matures or when I cash it out? Is it whichever comes first?
Whatever comes first. So Jack, nobody really wants to pay any taxes. So there is a way to get around paying the federal taxes even on the i-bonds. If you qualify, and when I say qualify, talk to your accountant, talk to your financial advisor to find out your particular situation to see if you qualify because not everyone's going to be the same in this scenario.
Or if you do your own research, check out the IRS publications, Treasury Direct has information on this. Make sure you fit into this criteria. That's my disclaimer. So i-bonds can be used to pay for a qualified higher education expense. But if you remember earlier I said in this situation, a parent could buy an i-bond for a child. Do not do that if you plan on using it for college expenses. All right. The rule is they must be bought by somebody who is 24 and can't be put in the minor's name to qualify to be used for a qualify higher education expense.
So it's got to be bought by an adult over the age of 24, not in the minor's name for it just to qualify. That's the first part of it. Okay.
That's correct. So if I wanted to buy these and use them for my children's tuition, I would be buying them under my name or my wife's name.
That money could be used for me, my wife, or any dependent on my tax return for this college expense to be qualified. Okay.
This is the part where I want you to double check everything because there's AGI limits, adjusted gross income limitations, and you need to check to see if your income is too high, where you're not going to be able to do that. That's where you can get hung up if you don't know the rules. And if you do qualify, you can't just cash them out and then just pay for the tuition. You got to follow a form form 8815. It'll be part of your 1040. This is the form which shows you the exclusion of interest for EE bonds and i-bonds issued after 1989. Make sure that you're cashing in the i-bond the same year you incurred the expense for the qualified education.
So this has got to be done. In our example here, we'll say it's for a child in college. When you incur that expense, you've got to cash it out the same year as that expense so you can document all that on the same year as tax return. Okay. I'm with you.
Rich, from everything you've described so far, these i-bonds do sound like those government EE bonds to an extent. Right?
You're absolutely correct. There are so many similarities between the i-bonds the Double E and even other kind of bonds offered by the government, but there's so much to go into. There's too much for this particular episode.
Fair enough. There are plenty of differences. Any final thoughts for our listeners that are thinking about these i-bonds, Rich?
Do your research. I always say this, every investment has pros and cons. You have to understand what the pros are. You have to understand what the cons are. You have to make sure that the investment meets your particular situation. So do your research, talk to your financial advisor, talk to your accountant. Do the research yourself. Go online. Look at the IRS publications, go to the treasurydirect.gov. Again, just do your research.
This really is important, and again, yet another vehicle that I didn't know a lot about, so I'm kind of glad we guys look under the hood at least a little bit on the surface level here today, Rich. 2022 has been a heck of a year in terms of the markets and finances and the world itself. Without getting into politics, it's been a wild ride. So I think it's best for our listeners to have as many options and vehicles to know about, to research, to think about what's best for their individual situation. Rich, I know a lot about a lot. For our listeners that want to come talk to you about anything related to their financial future in their specific individual situation, what are the best ways to find you?
Okay, it's a perfect time. January's right around the corner. It's a great time of the year to get a fresh start, look at your finances and know where to go forward. Call me. Call me to discuss maybe a financial plan. Look at second opinion on your investments. Call me (609) 924-2049 extension 126. You can always schedule time to talk to me by going to my website, www.ncfg.com, or shoot me an email at email@example.com.
Richard Oring from New Century Financial Group. That's what the NCFG stands for. All your contact info will be linked in our show notes, of course, and with that, wish you and your family a very happy holiday season. We'll talk soon.
Richard Warring's Branch office has one airport place, Princeton, New Jersey 08540. The branch phone number is (609) 924-2049. Securities offered through Royal Alliance Associates, Inc. Member FINRASPC. Advisory services offered through New Century Financial Group, LLC. A registered Investment Advisor, not affiliated with Royal Alliance Associates, Inc. New Century Financial Group, LLC, and Royal Alliance Associates, Inc does not offer tax advice or tax services. Please consult your tax specialist for individual advice. We make no specific comments or recommendations on any tax related details.