Many of us have our assets spread across various account types. We have retirement savings in IRAs and employer sponsored retirement plans. We create 529 college savings plans for our children. Our brokerage accounts are invested in mutual funds and ETFs. And we keep cash in checking and savings accounts to fund our daily expenses and provide a cushion for emergencies.
As investors, we often consider a long-term horizon and invest with the goal of growing wealth while outpacing inflation. Conversely, since we often consider cash for short-term needs, it is common to overlook opportunities to make the most of these accounts.
However, with recent high inflation and higher interest rates, there are many opportunities to maximize your cash in the form of I bonds, certificates of deposit (CDs) and online high-yield savings accounts. If your existing savings are earning less than 4%, you have options to obtain a higher rate.
There are benefits and considerations for each.
I Bonds
I bonds are a type of savings bond issued by the U.S. Treasury, making it a safe savings vehicle as the bonds are backed by the full faith and credit of the United States government. The interest rate on an I bond adjusts every 6 months and is a combination of a fixed rate and an inflation rate. The interest accrues monthly and is compounded semiannually. In this way, the bond’s value grows due to both earned interest and an increase in the principal value.
Newly purchased, I bonds have a current nominal yield of 4.28%. One major drawback is that you cannot withdraw from your I bonds within 12 months. Also, if you cash in your I bonds within five years, you’ll forfeit the last three months of interest. If inflation falls, so will your yield.
I bonds are taxable at the federal level but exempt from state and local taxes. You can purchase an I bond for as little as $25, and up to a maximum of $10,000 in one year (per person). You can purchase I bonds by visiting treasurydirect.gov and linking your bank account.
Certificates of Deposit (CDs)
A CD is a type of savings account offered by banks and credit unions. Bank CDs are insured up to $250,000 per depositor, per FDIC-insured bank, per ownership category. The National Credit Union Administration (NCUA) issues credit union CDs to the same limits. When you purchase a CD, you agree to keep your money in the CD for a specified amount of time. Most CDs have different maturity rates of anywhere from 3 months to 5 years. There are penalty fees for early withdrawal and some institutions may require a minimum deposit.
CDs can be attractive because, unlike I bonds, they have a fixed rate that is not tied to inflation. If you believe inflation may be slowing, you may be more inclined to consider a CD instead of an I bond. There are many online banks offering CDs with rates close to 5%.
Interest earned from CDs is taxable at the federal level as ordinary income and due each year, and generally at the state level as well.
Savings accounts
Online banks have become increasingly popular in recent years. Because these banks do not have “brick and mortar” locations, they have much less overhead than a traditional bank. This allows these banks to offer higher interest rates and lower fees. Like traditional banks, most online banks are insured by the FDIC.
Many online banks are currently offering interest rates of just over 5%. A high-yield savings account is a good option if you would like to earn a higher rate, while maintaining access to your money. Unlike a CD, there is no specified amount of time you need to keep your cash in a savings account and most banks do not require a minimum balance. Websites such as bankrate.com provide general marketplace rates for several products and update their listing of banks and associated interest rates monthly.
Interest earned from savings accounts is subject to yearly federal and state income taxes.
I bonds, CDs and high yield savings accounts are all options to maximize your cash savings to take advantage of higher-than-expected inflation and high interest rates. You’ll want to consider your own personal tax situation and liquidity. Please speak with your advisor if you have questions about your situation.
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