You don’t need to be told that we’re living in unprecedented times. From sharp GDP growth to record inflation rates, we’re living in an economy that is expanding and changing rapidly.
If you’ve been following the bond market at all, you know that the Treasury Department made a shocking announcement about I bonds in November of this year.
Here, we’re going to answer questions you may have about I bonds from what they are to how to buy them.
Let’s dig in.
In this post you'll learn:
What Are I Bonds?
Series I savings bonds or I bonds are government-issued debt securities that accrue interest at a rate adjusted for inflation twice a year. Rather than having a single interest rate used to determine your return, I bonds have two: an inflation rate that changes every six months with the economy and a fixed rate that will not change throughout the entire life of the bond. These rates combine to give you a composite rate.
On November 1st of this year, the U.S. Treasury Department announced that I bonds will earn a variable rate of 9.62% for the next six months.
This new rate will apply to all new I bonds issued in the next six months before it is adjusted again at the beginning of May, at which time the variable rate may increase or decrease.
These bonds are considered to be incredibly safe investments because there is no risk of value depreciation. Interest accrues and compounds semiannually (every six months) for up to 30 years or until cashed out. Earnings are automatically deposited back into the bond. I bonds do not require high minimum purchases and offer tax advantages and protection against inflation.
The variable semiannual inflation rate for I bonds is 9.62% and the fixed rate is 0.00% (which has been the case for the past several years). This makes the composite rate 9.62%, the highest rate we’ve seen since 1998 and the second-highest rate on record.
All new bonds issued between now and October 2022 and existing bonds less than 30 years old will earn 9.62% interest. This rate is unheard of for I bonds and interest-earning deposit accounts.
As of May 2022, the national average rate for an interest-bearing savings account is 0.06% and for a 1-year CD is 0.17% APY according to recent FDIC data. At the top digital banks, the best you’ll get on a 1-year CD is about 1.25% APY (currently held by Bask Bank).
As you might expect, there is no way to tell for sure what the inflation rate will be six months or a year from now. May 2022 may bring a much lower earnings rate depending on inflation, which is expected to slow in the next six months.
Who Are I Bonds for?
If you are looking for somewhere safe to park your cash, these bonds may be for you. Many financial advisors and investment experts are recommending these securities to help hedge against inflation. If you can afford to lock some money up for at least five years (to avoid the early withdrawal penalty), an I bond is a good way to guarantee a small return.
Series I savings bonds tend to be best for investors seeking low-risk investments, but they shouldn’t be your only investment. They are good for medium- or high-net-worth individuals who want to diversify their portfolio and lower net worth individuals who want to secure a small portion of their wealth after maxing out contributions to a retirement account.
You are eligible to purchase an I bond if you meet one of the following requirements:
- You are a United States citizen living in the country or abroad
- You are a United States permanent resident
- You are a civilian employed by the United States anywhere in the world
Children under the age of 18 may qualify to own an I bond if purchased on their behalf by an adult. Parents and adult custodians can open a TreasuryDirect account for a child and use that to purchase I bonds, making the child become the bond’s beneficiary.
It is common for I bonds to be used to help pay for education and retirement or gifted to younger individuals. Using I bonds to pay for education comes with tax benefits. Any bonds you purchase for yourself count toward your own annual purchase limit but bonds purchased as a gift do not. When you buy a bond as a gift for someone else, it counts toward their limit.
There are electronic and paper bonds. Electronic bonds are available in penny increments of $25 or more and paper bonds are available in denominations of $50, $100, $200, $500, and $1,000.
The main advantage of I bonds over other investment vehicles is that they freeze your money and thus protect it from losing value due to inflation for as long as it is still earning interest.
I bonds are also one of the most secure investments you can make. The U.S. Treasury has never defaulted on bonds before, so there is virtually no risk of bond holders losing their principal.
Another pro is that you do not have to pay state and local taxes on interest and you can avoid federal taxes too. There are no fees associated with purchasing or cashing out I bonds.
I bonds are an ideal method for saving for education. In fact, many people consider them to be good alternatives to 529 savings plans.
I Bonds vs. EE Bonds and Treasury Inflation-Protected Securities
Another type of bond you can purchase from the U.S. Treasury is a Series EE savings bond or EE bond. EE bonds share many similarities with I bonds: they mature after 30 years, are sold at face value, and earn interest monthly.
The biggest difference between EE bonds and I bonds is that EE bonds earn a fixed interest rate and I bonds earn a variable interest rate that is dependent on inflation. EE bonds guarantee a return equal to double your principal investment after 20 years (adjusted if needed by the Treasury Department), but I bonds offer no earnings guarantees.
Which Treasury bond is best depends on the market. If inflation rates are high or expected to increase, I bonds will likely end up earning more interest over their lifetime. But if inflation rates are fairly low, EE bonds will likely earn more interest. Given how much inflation has increased this year, I bond holders are coming out on top.
Treasury Inflation-Protected Securities or TIPS are also similar to I bonds. TIPS are designed to hedge against inflation as well, but they differ from I bonds in several important ways.
First, TIPS are riskier because the principal is adjusted for inflation and deflation. You lose principal if the U.S. economy goes into a deflationary period and gain principal if the U.S. economy goes into an inflationary period. TIPS are available in terms of 5, 10, and 30 years and purchased at auction rather than at face value. You can purchase between $100 and $5 million. Rates for TIPS change and you must visit a Treasury auction to bid.
Rather than earning interest monthly, TIPS earn interest just twice a year at a fixed rate. Interest is paid on the adjusted principal until the account reaches maturity. Unlike I bonds, you can sell TIPS before they mature. TIPS and their interest are exempt from state and local tax but subject to federal tax.
There are a few important considerations to keep in mind when purchasing I bonds
The first is that I bonds have a low minimum purchase requirement. You can open an electronic I bond with as little as $25 and a paper I bond with as little as $50 (note that you can no longer purchase paper bonds at banks).
You can purchase up to $10,000 in electronic I bonds per calendar year and up to $5,000 in paper bonds. If you purchase an I bond as a gift, that amount will not count toward your annual purchase limit. Instead, it will count toward the recipient’s limit, and they will also be the one who is responsible for paying taxes on it.
Series I savings bonds are issued at cash value. Your bond will never be worth less than you paid for it and it is not possible to lose money on this investment. (There is no guarantee that you will earn money, but you will not lose any.)
If you decide to cash in your I bond before it matures, you may do so without incurring a penalty if you wait five years to do so. If you choose to cash out within five years of opening the bond, you will pay an early withdrawal penalty equal to the last three months’ interest. You can keep your bond open for as long as you like, but it will not continue to earn interest after 30 years. You must keep your bond for a minimum of one year, at which time it becomes liquid.
I bonds themselves are tax-exempt but the interest you earn is subject to federal income tax. You may enjoy additional tax benefits if you use your bond to finance education under the Education Savings Bond Program.
How to Buy I Bonds
Ready to join the wave of people purchasing I bonds for the first time at this incredible rate?
First, decide whether you will purchase an electronic or paper bond.
To purchase an electronic bond, visit the U.S. Treasury website at TreasuryDirect.gov.
You will need to create a TreasuryDirect account using your tax identification number and an email address.
At this time, you will link a bank account and personalize your profile. From your account, navigate to the bonds purchasing page and enter the amount you would like to purchase. Register the I bond in the name of its intended recipient (if you are purchasing for someone other than yourself, provide their information).
To purchase a paper bond, you will need to use your IRS tax refund. This is the only way to purchase paper I bonds. You will use Form 8888 to allocate your refund to be used for the purchase of a U.S. Treasury bond and specify that you want an I bond. You used to be able to purchase paper I bonds at banks and credit unions, but this is no longer possible.
You can purchase up to $10,000 in electronic I bonds per year and use your tax refund to purchase up to $5,000 worth of government I bonds per year. These limits can be combined for a total of $15,000 in I bonds.
How to Cash Out
When you’re ready to cash out your electronic I bond, visit the TreasuryDirect site again and navigate to the ManageDirect page. From there, link the bank account you would like to send the funds to and transfer the money.
To cash out your paper I bond, visit a bank or credit union and present your bond and identity verification documents.
While you won’t get rich from an I bond alone, this investment is a sound one, especially at the current earnings rate. We recommend I bonds to anyone looking for a safe investment to add to their portfolio. This type of security is ideal for conservative investors, not aggressive investors looking for an opportunity to grow their wealth dramatically. You do not risk losing your investment when you purchase an I bond.
The more you can afford to spend at the current earnings rate of 9.62%, the better, but any amount will likely be a worthwhile investment. When the bond turns liquid after a year, you’ll probably end up with more cash than you would have with another deposit account if you choose to cash out.