More than half of taxpayers who receive refunds decide to save or invest the money, according to a 2022 survey by Lendingtree. If you're among the millions of Americans who plan to do one of these things, you might be thinking about putting the money in a high-yield savings account or investing in the stock market.
To be sure, both of those are excellent uses of your tax refund check. But there's one way you might consider saving and investing at the same time: by purchasing I bonds.
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A risk-free income investment
I bonds -- formally known as Series I Savings Bonds -- are a special type of savings bond issued by the U.S. government. They are designed to protect your savings from the damaging effects of inflation, with an inflation-based interest rate that changes every six months.
There are two parts to the yield paid by I bonds. There is a fixed-rate component, which is 0.40% for the life of any I bonds purchased through the end of April 2023. There is also a variable interest rate, which is 6.49% for I bonds purchased through the end of April and is guaranteed for the first six months. The fixed and variable component are added together to calculate the I bond's yield every six months.
Let's say you buy an I bond with your tax refund on March 1. You would get a guaranteed 6.89% yield through the end of August, at which point the yield would change to 0.40% plus whatever the then-current inflation adjustment is, and it would remain that way for the next six months.
There are some downsides to consider
There's no such thing as a perfect investment, so it's important to know the downsides.
For one thing, I bonds are intended as long-term investments. You cannot cash them in for at least a year. And if you decide to cash them in within the first five years, you forfeit the prior three months' worth of interest.
It's also possible inflation could completely disappear after a couple months, and after six months your I bonds could pay next to nothing -- and you can't get your money out for another six.
Tax refunds give I bond investors an edge
Another drawback to I bonds is that they are limited. For example, if you have $1 million sitting around, you can't just use it all to buy I bonds and enjoy a guaranteed 6.89% return. The Treasury limits I bond purchases to $10,000 per year per person.
However, this is the limit for electronic I bonds. There's a special rule that allows for an additional $5,000 in paper I bonds if they are purchased with a tax refund. You don't need to use your entire refund, and you can request I bonds in $50 increments. And to be clear, this is in addition to the standard $10,000 limit.
In other words, by using your tax refund to purchase I bonds, the total annual limit per person effectively increases from $10,000 to $15,000. That's why it can be such an excellent way to put your tax refund to work.
The bottom line on using your tax refund for I bonds
I bonds allow you save your tax refund in a vehicle that is just as safe as a savings account, but with a higher yield during inflationary periods. There are some drawbacks, but these are excellent instruments that can help protect your money's purchasing power. If you're trying to decide the best way to put your tax refund to work, you might want to consider I bonds -- especially if you've already maxed out the $10,000 annual limit.
