I Bonds are U.S. savings bonds that earn interest based on a combination of a fixed rate and an inflation rate.
Introduction to I Bonds
First issued in 1998, I Bonds, also known as Series I Savings Bonds or Inflation Bonds, are U.S. savings bonds that have an interest payment tied to a fixed rate plus a variable inflation rate (fixed + variable).
This composite rate adjusts every six months in May and November based on the Consumer Price Index, which is a common measure of inflation.
These bonds pay interest for 30 years unless you redeem them early. You cannot sell inflation bonds for one year after initial purchase and there is a a small, early withdrawal penalty if you sell before five years (interest from previous three months).
I Bond Rates
With U.S. interest rates at all-time lows it’s hard to find investment yield without stepping up your risk. Said another way, where can you safely park some cash and still get a decent return?
Well, if you’re looking for value (risk / return) then there is no better value in the market today than series I savings bonds. From a risk / return perspective I Bonds are the best value going right now.
Right now the fixed rate on inflation bonds is 0%, but the variable rate based on inflation is 3.56% semiannually, bringing the combined composite rate to 7.12% (0% + 7.12%). Here is a comparison of similar investment vehicles and the current, average rates of return.
|30 Year Treasury||1.75%|
|5 Year Jumbo CD||0.27%|
How do You Buy I Bonds?
The only way to buy I bonds is directly from the U.S. Department of the Treasury at TreasuryDirect.gov. You can purchase them individually or through an entity like a trust or LLC. You can also purchase them as gifts for adults 18 and older or children through a custodial account.
All series I savings bonds that are purchased directly are delivered and held in electronic form. The only way to purchase a paper I bond is through your tax return.
Min Investment – You can purchase as little as $25 in digital I Bonds or $50 in paper I bonds.
Max Investment – You can buy up to $10,000 in digital I bonds per person, per calendar year. You can also elect to buy up to $5,000 in paper bonds using your federal tax return.
Further, you can purchase $10,000 per person in I bonds as gifts. The purchase amount of a gifted bond counts toward the annual limit of the recipient, not the giver. So, in a calendar year, you can buy up to $10,000 in electronic bonds and up to $5,000 in paper bonds for each person you buy for. Let’s break this down with a simple example:
|Jointly Filed Tax Return||$5,000|
|Custodial Account – Child #1||$10,000|
|Custodial Account – Child #2||$10,000|
|Custodial Account – Child #3||$10,000|
|Custodial Account – Child #4||$10,000|
So a married couple with four children could purchase up to $85,000 per year if they each had a trust account. Obviously the amount you invest depends on your personal situation.
Pros and Cons of I Bonds
Look, there’s no such thing as 100% risk-free, but U.S. backed treasuries and savings bonds are about as close as you can get. With a lot of speculation and uncertainty in the markets today, you might be hard-press to find investment opportunities that are safe and provide a decent yield.
With interest rates at all-time lows and inflation worries lurking around every corner, inflation bonds are the perfect balance of risk and return.
- High yield interest rate (currently 7.12%)
- Easy to buy
- Low-risk product that helps protect your savings from inflation
- No state or local income taxes
- If you use the money for higher education, you may be able to avoid part or all of the federal taxes
- Limit to how much you can purchase each year
- Variable interest rate will drop with lower inflation
- You must hold the bond for at least 12 months before redeeming it
- If you redeem an I bond before five years, you’ll owe a penalty worth the interest of the previous three months
I Bonds vs EE Bonds vs TIPS
If you visit TreasuryDirect.gov you will see several investment options other than I bonds. Two of the most commonly purchased are EE Bonds and TIPS.
Series EE savings bonds, or EE bonds for short, are low-risk savings products that pay interest until they reach 30 years or you cash them, whichever comes first. The biggest difference is that they use a fixed interest rate.
Treasury Inflation-Protected Security (TIPS) differ from I bonds and EE bonds in that they have a variable interest rate tied to the CPI that also adjusts the principal amount. TIPS are also available on the secondary bond markets, whereas I savings bonds and EE bonds are bought and sold exclusively through TreasryDirect.gov.
|Instrument||I Bonds||EE Bonds||TIPS|
|Term||30 years||30 years||5, 10 and 30 years|
|Redemption||After 12 months||After 12 months||45 days|
|Annual Purchase Limit||$10k||$10k||$5mm+|
|Buy and Sell||Non-Marketable||Non-Marketable||Marketable|
|Tax Implications||Federal tax only||Federal tax only||Federal tax only|
Hopefully by this point it’s clear how great the current opportunity in I Bonds is. There is no crystal ball that will determine what inflation will do over the next 12-36 months, but if consumer prices continue to rise, series I savings bonds will continue to provide a great return. And if inflation subdues and fall in line with historical trends, you can always sell your I bonds and put your hard earned money into something else.