Couples can fight inflation with 7.12% risk-free interest on $40,000 with this year-end move

• With the cost of living ticking up, investors may consider I bonds, an inflation-protected and nearly risk-free asset, paying a 7.12% annual rate through next April. 
• A couple may each buy $10,000 before the end of 2021, and another $20,000 in January 2022, for a total of $40,000 in I bonds.
• But these assets may not be right for everyone, and investors need to know the downsides before piling in, experts say.

With a rising cost of living, investors may be eyeing I bonds, an inflation-protected and nearly risk-free asset, paying a 7.12% annual rate through next April. 

While I bonds have relatively low purchase limits, couples may leverage a year-end strategy to increase their holdings.   

Annual inflation rose by 6.8% in November, growing at the fastest pace since November 1982, according to the Labor Department, affecting everyday costs such as energy, food, shelter and more.

Even affluent clients are getting a little bit nervous, said certified financial planner Jon Ulin, managing principal of Ulin & Co. Wealth Management in Boca Raton, Florida.

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As investors seek to preserve purchasing power, I bonds may be an attractive option. However, there are risks to consider before piling in, financial experts say. 

How I bonds work

I bonds, backed by the U.S. government, won't lose value, and there are two parts to returns: a fixed and variable rate, which adjusts every six months based on the Consumer Price Index.

"Right now, long-term Treasuries, certificates of deposit and savings accounts are earning essentially zero," said Christopher Flis, CFP and founder of Resilient Asset Management in Memphis, Tennessee.

"But the [I bond] inflation adjustment is where you will make a little bit of bang for your buck," he said. 

While current investors may lock in a 7.12% annual yield through April 2022, the variable rate may change in May, depending on inflation. This chart shows the history of both rates. 

One major downside is investors can't redeem their I bonds for one year, and they pay the last three months of interest if cashed in before five years.

"You can't use this to pay your bills every month," Ulin added.

I bond purchase limits

Another downside of I bonds is the annual purchase limits. Individuals generally can't buy more than $10,000 in electronic assets per calendar year.

However, with the year-end approaching, an individual may buy $20,000 by purchasing $10,000 by Dec. 31, 2021, and another $10,000 on Jan. 1, 2022, or later.

A couple may double those amounts for a total of $40,000, as long as they buy assets individually (they can't be co-owners). 

And filers getting a tax refund may receive up to $5,000 per return in paper I bonds, which is riskier due to theft or loss.    

Someone may also purchase more I bonds through businesses, trusts or estates.

For example, let's say there's a married couple who each owns a separate business. They may buy a total of $40,000 in I bonds by Dec. 31, 2021 — $10,000 per individual and business — and they can buy another $40,000 on Jan. 1, 2022, for a total of $80,000. 

"You can go from zero to a meaningful amount of I bonds in a very short period of time," Flis explained.

Of course, there's no way to predict how I bond rates may change every six months, and investors need to consider the opportunity cost of tying up cash that may be allocated elsewhere, Ulin said.

"Try not to become enamored with a 7.12% rate because that can be misleading," Flis said. "The historical inflation component of those bonds can tell you what could happen in the future."

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