I Bonds: What They Are and How to Buy

I bonds are a safe way to guard your money against inflation, but what do you risk by keeping your money out of the market?
Jul 28, 2022

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Inflation is up, the stock market is down, and I bonds have suddenly come into vogue due to an unprecedented interest rate of 9.62%. But while I bonds can help protect your savings from inflation, that doesn't mean they're right for everyone.

What are I bonds?

I bonds, also known as Series I savings bonds, are a form of bond that earns interest from a variable semiannual inflation rate based on changes in the Consumer Price Index for All Urban Consumers, or CPI-U. An I bond's rate combines two different rates: a fixed rate and an inflation rate. The fixed interest rate remains the same throughout the bond's life. Its inflation rate is announced by the Bureau of the Fiscal Service and can change twice a year, in May and November.

The combination of an I bond's fixed rate and inflation rate creates its composite rate. This is the interest rate an I bond will actually earn. Currently, I bonds are offering a composite rate of 9.62%.

As its name suggests, an I bond's inflation rate is heavily impacted by inflation. As inflation changes, the inflation rate adjusts to offset those changes. This can help protect your money's purchasing power.

And while that 9.62% I bond rate is making a splash in the news now, it may change in six months when the new inflation rate is set. You're also required to hold your bond for at least a year before you can cash it in, and there are interest rate penalties for cashing in before five years.

» Learn more. What is a bond?

I bond tax benefits

The interest you earn from I bonds is subject to federal income tax but not state or local income tax.

An education tax exclusion can help you exclude all or part of your I bond interest from your gross income if you meet several conditions:

  • You cash your I bonds the same tax year you claim the exclusion.

  • You paid for qualified higher education expenses that same tax year for yourself, your spouse, or your dependents.

  • Your filing status is not married filing separately.

  • Your modified adjusted gross income was less than $98,200 if single or $154,800 if married filing jointly.

  • You were 24 or older before your savings bonds were issued.

» How to invest in bonds: A quick-start guide for beginners

Are I bonds a good investment?

Whether I bonds are a good choice for you depends on your financial goals and timeline. I bonds can be a safe immediate-to-long-term savings vehicle, especially in inflationary times. I bonds offer benefits such as the security of being backed by the full faith and credit of the U.S. government, state and local tax-exemptions and federal tax exemptions when used to fund educational expenses. Remember, though, there are penalties for withdrawing the money too soon, and interest rates are adjusted every six months.

Take the following example: Say you bought $10,000 worth of electronic I bonds in May 2022 (the maximum amount of electronic I bonds you can buy in one year). Your fixed rate would be 0% and your inflation rate would be 4.81%. Your composite rate would be calculated as follows:

[Fixed rate + (2x inflation rate) + (fixed rate x inflation rate)] = composite rate

Or, in real numbers:

[0 + (2 x 0.0481) + (0 x 0.0481)] = 0.09620

This composite rate of 9.62%, applied to $10,000 in I bonds, would earn a guaranteed $481 in interest over the next six months — but you cannot cash in your bond until you've held it for a year. So why even mention the six-month take? Because your rate is only guaranteed for six months. After that, the rate can go up or down.

Assuming interest rates stay the same as they are now, and after adding your first six months of interest ($481) to your principal of $10,000, you could earn $985 total in interest after one year. But if you cash in your bond before you've held it for five years, you'll lose the last three months of interest you earned. If the rate stays the same, that would mean you'd subtract $252 from your interest and exit the bond agreement with your $10,000 in principal and $733 in interest for a total of $10,733, minus any tax owed.

But bonds are meant to be held long-term, and rates likely will change over time. If you kept your $10,000 bond for 30 years, you wouldn't lose any interest to penalties, but there is no guarantee your rate would stay the same. This can make it difficult to know exactly how much you can make investing in I bonds over a long period  — though that is true for most investments.

Should you buy I bonds?

I bonds are everywhere in the news right now, but does that mean they're worth it?

"I bonds are a good place to park some cash that you will need in the intermediate term (one to five years). For example, placing cash in I bonds that you will use for a down payment in a couple of years makes a lot of sense," said Kenneth Chavis, a certified financial planner and senior wealth manager at LourdMurray in Los Angeles, in an email interview.

If you're investing for a long time frame — for example, for retirement — you may want most of your portfolio allocated toward stocks instead. You can think of dipping stock markets as a sale. Keeping money invested in a volatile market is generally a sound strategy — historically speaking, odds are good your investments will rebound.

"There is a lot of talk about I bonds because of the current six-month rate, but at the end of the day, these investments should only be a small portion of a more robust investment portfolio," said Kendall.

What’s more, I bonds may not be as convenient to buy and manage as other securities. While many investors turn to bond exchange-traded funds (ETFs) for quick and easy diversification, I bonds are only bought and sold through the U.S. government via TreasuryDirect, not on secondary markets through brokers.

» Learn more about Bond ETFs

How to buy I bonds

Here's how to buy Series I bonds:

1. Pick which types of I bonds you want to buy

There are two types of I bonds, paper and electronic.

Paper I bonds can only be purchased by mail when filing a federal income tax return. This alone can make it difficult to purchase them.

Electronic I bonds can be purchased online by creating an account on the TreasuryDirect website.

2. Decide how much you want to invest in I bonds

Paper I bonds have a minimum purchase amount of $50 and a maximum of $5,000 per calendar year. You can buy them in increments of $50, $100, $200, $500 and $1,000. Electronic I bonds have a minimum purchase amount of $25 and a maximum of $10,000 each calendar year. You can buy them in any amount up to $10,000.

If you buy the maximum amount of paper and electronic I bonds, you can buy up to $15,000 worth of I bonds each year.

3. Figure out how long to keep your I bonds

"Most bondholders hold the bond for at least 12 months. If they sell the bond before the 12 months, they receive no interest," Clark Kendall, a certified financial planner and founder of Kendall Capital in Rockville, Maryland, said in an email interview. "If they sell a bond after holding it for less than 5 years, they lose 3 months of interest on the bond."

If you hold the bond for five years or more, you won't lose any interest. I bonds can earn interest for 30 years unless you cash them out before then.

Neither the author nor editor held positions in the aforementioned investments at the time of publication.

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