There’s a way to fight rising inflation with your tax return. Here’s what to know
- You can bypass the individual purchase limit on Series I bonds, an inflation-protected investment, by using your tax refund to buy up to $5,000 in paper assets.
- However, rates may change every six months, there are redemption restrictions, and you may prefer electronic I bonds.
If surging costs are a concern, you may consider using your tax refund to bypass the purchase limits on Series I bonds, a nearly risk-free and inflation-protected asset.
Annual inflation rose by 7.5% in January, growing at the fastest pace since February 1982, according to the U.S. Department of Labor, affecting everyday expenses like energy, food, shelter and more.
Some investors have turned to I bonds, paying a 7.12% annual rate through April, to preserve purchasing power, according to financial experts.
"The rate is eye-popping for a government-guaranteed asset," said certified financial planner Leslie Beck, owner of Compass Wealth Management in Rutherford, New Jersey.
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Although Treasury inflation-protected securities, or TIPS, also adjust for inflation, the values drop as interest rates rise, Beck said, whereas I bonds protect your principal.
While there's generally a $10,000 individual purchase limit per calendar year, there are ways to get more, such as using up to $5,000 of your tax refund to buy paper I bonds.
You can ask to receive all or part of your refund in paper I bonds by completing part 2 of Form 8888 with your return. But your filing must be error-free to receive the assets.
"What I really like about this program is that it's an option for people to use their tax refund to build wealth," said Eric Walters, CFP, managing partner and co-founder of Summit Hill Wealth Management in Greenwood Village, Colorado.
Many taxpayers see refunds as "free money" and diverting funds may be a unique way to buy more than the usual I bond purchase limits, he said.
It's also a chance to save a little extra for college since earnings are tax-free if used for qualified education expenses.
Downsides of I bonds
While it's easy to see the appeal of I bonds, there are some key downsides to consider before piling in, experts say.
There are two parts to I bond returns: a fixed and variable rate, adjusting every six months based on the Consumer Price Index. This means you can secure a 7.12% rate through April 2022, but it may shift in May, depending on inflation. This chart shows the history of both rates.
"These things are floating rate bonds with a base rate of zero," Beck said. "So you could be stuck with a 0% return for a long time if inflation goes back to what it was for the last 10 years."
Another downside is you can't redeem I bonds for at least one year, which makes them inadequate for an emergency fund you need to tap for short-term expenses. And you'll pay the last three months of interest if you cash in I bonds within five years.
Moreover, there are drawbacks to owning paper I bonds, such as the risk of loss, theft or damage. "You tend to put them away and forget that you have them," said Beck.
You can replace missing I bonds or convert paper bonds to electronic ones through TreasuryDirect. However, each process has a few steps, making it less convenient than assets in a regular brokerage account.