The little-known type of bond that’s paying 7.12% in interest right now

 The little-known type of bond that’s paying 7.12% in interest right now

The personal finance community has been buzzing this week about a little-known type of government-backed savings bond paying as much as the stock market usually pays over the long-term: A mouth-watering 7.12% that’s pretty much as safe as anything out there.

They’re called Series I savings bonds and the government sets the rate of interest for these bonds every six months based on inflation, so people have until April 2022 to take advantage of this rate.

“Series I savings bonds you buy between now and the end of April 2022 will earn interest for the first six months at an annual rate of 7.12%,” according to the Treasury Department’s FAQ. “That’s the second-highest rate ever!” (The S&P 500 index is up almost 25% this year, but you’re dealing with more risk there.)

The reason why these bonds are so much higher than usual — previously, they made headlines in a Wall Street Journal column in May when they were at 3.54% — is because of inflation.

Transient or not, the current inflation benchmark for these bonds is the consumer price index in urban areas (CPI-U), which measures how much people in urban areas pay for a “market basket of consumer goods and services.” Compared to last year, it’s up 5.4% (not seasonally adjusted) and the Treasury Department has adjusted its rates on Series I bonds accordingly.

“I-Bonds are definitely a hot story right now and with Social Security set for an almost 6% cost-of-living adjustment next year, it’s not surprising that bonds tied to inflation are seeing a hefty yield,” said Brett Horowitz, CFP and wealth manager at Evensky & Katz/Foldes Financial Wealth Management in Coral Gables, Fla.

Horowitz isn’t sure how long these rates will last. “The Fed keeps using the term transitory to signal their belief that it’s a short-term phenomenon,” he said. “If the Fed is right, the rate will come down rather quickly.”

However, Horowitz added, the rates have stayed high and don’t seem to be slowing down.

These bonds are curious, because investors can buy them directly through the Treasury’s website, Treasury Direct, rather than through financial advisors or brokerage accounts, which the WSJ pointed out as one reason why they’re relatively unknown.

Here are a few things investors should know about these bonds

  • You can cash out the Series I bond after one year and get interest. If you cash out before you get zero interest, just your money back.

  • If an investor cashes out before five years, they lose the previous three-month period’s interest as a penalty. (So you’d get nine months of interest if you hold for a year).

  • You can only buy up to $10,000 worth of Series I bonds per calendar year, and only $5,000 if they’re paper bonds rather than electronic ones via the Treasury’s website.

  • Investors can hold the bond for up to 30 years; they’ll continue to accrue interest every three months.

  • The Treasury announces new rates every six months. The announcement for the next six-month period is in April 2022.

  • Investors pay federal income taxes on any profits.

So if you invested the maximum amount of $10,000 for a year, and, say, the interest rate didn’t change in April, you would end up with around $530 if you cash out after a year, after a penalty of around $175.

While that example illustrates the three-month penalty, Horowitz noted that it’s very possible that the next six months will look different — when we find out the interest rate for those six months in April

“Who knows what that rate will be come April of 2022? I-Bonds have a fixed rate and an inflation adjustment and the fixed rate is 0%,” Horowitz said. “So if inflation does come down to 1-2%, that rate will plummet. In fact, the rate set in November of last year was 1.68%, so we could see that again fairly soon.”

This is in CD-territory, and one of the reasons why people don’t use these bonds much is because jumping from one bank to another (chasing CD interest rates) and then to the Treasury can be kind of a pain, Horowitz said.

“With all that being said, if someone came to me and said ‘is this a good idea?’ I would validate their strategy and have no qualms about recommending it,” he said. “But I would probably bring down their optimism a little bit because it’s not like they can take $100,000 and make 7% for the next 20 years.”

Correction 11/2: A previous version of this post misstated how these bonds are taxed. The interest is taxed as ordinary income, not capital gains.

Ethan Wolff-Mann is a Senior Writer and Chief of Staff at Yahoo Finance. When he is reporting, he focuses on investing, consumer issues, and personal finance. Follow him on Twitter @ewolffmann.

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