Easy way to Invest your tax refund in I bonds

If you’re expecting a tax refund this year, the big question you’re probably pondering is what to do with it —take a vacation, pay off some credit card bills, earmark it for some home repairs.

Here’s one idea to chew on — buy inflation-protected Treasury I bonds, one of the safest investments around. And the Internal Revenue Service makes it easy by giving you a form to file with your taxes.

True, inflation has slowed, so interest rates on I bonds have dipped from the historically high annualized rate of 9.62% from last year. And they’re not a place to set short-term savings — you must hold an I bond for at least a year and you forfeit a quarter’s worth of interest if you redeem before five years.

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That said, I bonds are still no slouch. Bonds purchased before May earn an annualized yield of 6.89% for six months. That’s still the fifth-highest rate since the bond’s introduction in 1998, according to Treasury data.

“I bonds offer an attractive way to put your tax refund to work earning interest rather than spending it, which is what a majority of people do with their refunds,” Greg Bitz, a senior wealth advisor and certified financial planner at WBH Advisory in Baltimore, MD, told Yahoo Finance.

“I like to think of it as a forced savings tool. There are some limitations as to the amount you can save through your tax refund, as well as holding requirements timing wise. In spite of these limitations this is a good way to lock in an above average return in what is considered a risk free investment.”

Nuts and bolts

The I bond rate is made up of the fixed rate, which applies for the 30-year-life of the bond, and a semiannual inflation rate calculated from a formula based on the six-month change in the non-seasonally adjusted Consumer Price Index for all Urban Consumers (CPI-U) for all items.

“I bond purchases made before May of this year will include a 0.4% fixed rate component,” Ken Tumin, a senior industry analyst at LendingTree and founder of DepositAccounts.com, told Yahoo Finance. “The fixed rate stays with the I bond for its life. That is added on to the inflation component which changes every six months. That fixed rate component now is the highest it has been since 2018 and 2019 when it reached 0.5%.”

The overall 6.89% rate was set in November and applies for the six months after the bond is issued. New rates are set every May and November by the Treasury Department.

“The overall 12-month return for an I bond purchased before May will be at least 4%, which is pretty good considering the tax benefits that come with it,” Tumin said.

The bonds also earn interest for 30 years or until they’re cashed in, whichever comes first. They’re government-backed and guaranteed to keep pace with inflation. The interest is generally free from state and local taxes.

You might be able to partially or entirely exclude savings bond interest from federal income tax when you pay qualified higher education expenses at an eligible institution or state tuition plan in the same calendar year you redeem eligible I bonds. See IRS Publication 970 “Tax Benefits for Education.”

How to purchase I bonds with your refund

You can buy I bonds anytime with no fee from the U.S. Treasury’s website, TreasuryDirect. In general, you can only purchase up to $10,000 in I bonds each calendar year. But there are ways to increase that amount. For example, if you’re using your federal tax refund, you can buy an additional $5,000 in paper I bonds.

The bonds are sold in increments of $25 or more when you buy them electronically. Paper bonds are sold in five denominations: $50, $100, $200, $500, and $1,000 up to $5,000. I bonds are bought at face value, meaning if you pay $100 (using your refund), you receive a $100 savings bond.

To buy paper I bonds directly with your refund, you don’t need to open a TreasuryDirect account. Instead, follow the instructions on the Internal Revenue Service’s Form 8888 and file that form with your tax return.

Once your tax return has been processed by the IRS, your paper savings bonds will be mailed to you. You can opt to have the part of your refund that you don’t want to use to buy I bonds delivered to you either by direct deposit or by check.

The issue date on your bonds — which sets their interest rate — is the first day of the month in which the Treasury’s service center receives your refund money from the IRS. So if it logs in your I bond request anytime in March or April, the issue date will be the first day of that month, allowing you to earn that current annualized rate of 6.89% for the next six months.

You can also request bonds in the names of other people, say, your kids, to give as gifts. They will be mailed to you at the address the IRS has on file for you.

Once your savings bonds are issued, you should get them within three weeks. If you’re having a slice of your refund deposited directly into your bank account, you may receive your refund before your bonds.

You can also use your refund — or part of it — to buy digital I bonds, but you will, however, need to have a TreasuryDirect account.

To do so, complete Part 1 of the Form 8888 to request your refund be deposited directly into your TreasuryDirect account, then you can buy the bonds directly. On the first part of the form, check the box for the “savings” account option and enter your account number, according to the instructions on the IRS form.

“Buying I bonds with your refund this year can be a smart idea,” Derilyn Freeman, a certified financial planner and advisor at Prudential Financial told Yahoo Finance, if you don’t have any high-interest debt to pay off or emergency savings to fund.

“When you compare this option to money sitting in a checking or money market account that is now earning much less, if anything at all, I bonds can be a helpful way to grow your money and benefit from a historically high inflationary period.”