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I-bonds for Roth?

Question: I was told by my bank that it is not possible to put I-Bonds in my Roth IRA. If not, why not? I want to make a contribution that will not shrink like my mutual funds. Suzanne, Los Angeles, CA

Answer: That's right. There are technical and legal reasons why it's almost impossible to do. For instance, the U.S. Treasury rules say you can't open an account to buy savings bonds electronically through Treasury Direct in the name of an IRA.

Here's the thing: I don't think you should do it anyway. It isn't a good idea even if you could convince a bank to go through contortions to do this transaction for you. In essence, you're wasting a valuable tax shelter with the I-bond. You buy an I-bond with after-tax money. The savings compounds tax free. That is, until you cash it in and then you pay ordinary income tax rates on the gain. The I-bond is like a non-deductible IRA.

By the way, I-bonds are a terrific fixed income investment for most people. I like owning I-bonds, just not in an IRA.

Another inflation-indexed security is the Treasury Inflation Protected Securities, better known as TIPS. These default-free securities are also designed to hedge the value of your money against the ravages of inflation. The big drawback with TIPS is that Uncle Sam requires owners of TIPS in a taxable account to pay income taxes on the inflation-adjusted gains before getting any of the inflation-adjusted money at maturity. That's why TIPS work best in a tax-sheltered account, like an IRA or Roth-IRA.

It would be a better idea to use TIPS in your Roth.

You do need to go through a broker if you want to own the TIPS directly. A number of brand-name mutual fund companies sell funds made up exclusively of TIPS, too.

You could also buy short-term CDs insured by the FDIC at your bank for your Roth. You wouldn't have any credit risk with the FDIC insurance. You'd earn a decent rate of interest. And by keeping the CD terms short you could always be earnings something around the prevailing rate of market interest rates.

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