What are I Bonds?

Series I savings bonds, also called I Bonds, are bonds issued by the United States government that are tied to inflation. The “I” in I Bonds stands for inflation. 

I Bonds protect your funds from inflation because the interest earned reflects inflation. The interest rate is made of two components. One component is a variable rate intended to reflect the rate of inflation; the other component is a fixed rate. The variable rate usually changes every 6 months to reflect new inflation data.

So as inflation increases, the I Bond will yield a higher rate of interest. As inflation decreases, the I Bond will yield a lower rate of interest.

These bonds are backed by the federal government and are seen as very safe investments as long as the U.S. government doesn’t default on its debt obligations.

How is the interest rate calculated for I Bonds?

Interest on I Bonds is calculated monthly. Interest is compounded semiannually, meaning that twice a year (every 6 months) the U.S. government applies the bond’s interest rate to the new principal value. 

There are two parts to the I Bond interest rate, a fixed rate, and a variable rate. The variable interest rate is intended to reflect the inflation rate and usually changes every 6 months. 

The combined rate is also known as the “composite rate” or “earnings rate”.

Here is an example from the Treasury Direct website that looks at how they calculated the 6.89% interest rate from November 2022 to April 2023.

What are I Bond currently yielding?

To check out the latest rates being issued, head to the TreasuryDirect website. 

https://www.treasurydirect.gov/savings-bonds/i-bonds/

Take a look at some historical earnings rates which include the fix and variable rate:

November 2018 through April 2019	2.83%
November 2019 through April 2020	2.22%
November 2020 through April 2021	1.68%
November 2021 through April 2022	7.12%
November 2022 through April 2023	6.89%

How many I Bonds can I purchase each year?

In a calendar year, a person or business can buy up to $15,000 with of electric and paper I Bonds. 

• Up to $10,000 in electric I Bonds, and
• Up to $5,000 in paper I Bonds (with your tax refund)

The U.S. government stipulates that the $15,000 limit is for one Social Security Number or one Employer Identification Number. This means that you as an individual could buy $10,000 in electric I Bonds and $5,000 in paper I Bonds and if you own a business, the business could buy $10,000 worth of electric I Bonds and $5,000 worth of paper I Bonds. 

For Example, a Novato couple owns a business and files jointly. They could buy $40,000 worth of I Bonds.

Individual 1 – $10,000

Individual 2 – $10,000

Business – $10,000

Joint Tax Return – $5,000

You can also gift I Bonds to your children; you would just need to open up a Treasury Direct account for them.

How much does an I Bond cost?

Electric I Bonds must be purchased in increments of at least $25. For example, you could buy an I Bond for $570.89 or $9,956.01. The max for any calendar year is $10,000.

For paper I Bonds, you must purchase in increments of $50, $100, $200, $500, or $1,000. For example, you could by $150 worth of paper I Bonds or $4,550 worth of I Bonds. The max for any calendar year is $5,000.

How long can I hold an I Bond?

I Bonds can be held for as long as 30 years; unless you cash it before then.

You do not have to hold the I Bond for the full 30 years. However, if you cash in the bond in less than 5 years, you will lose the last 3 months of interest.

Is there a minimum amount of time I have to hold an I Bond?

Yes, you must hold the I Bond for at least 12 months.

After 12 months you are able to redeem your I Bonds, but if you cash in the I Bond in less than 5 years, you will lose the last 3 months of interest earned.

Are I Bonds taxed?

Yes. I Bonds are taxed at the federal level but are exempt from State and local income taxes.

How can I use my tax return to buy I Bonds?

Yes! Individuals and entities (with an EIN) can use their tax refund to purchase up to $5,000 in paper I Bonds.

For example, if a couple in Washington file a joint tax return they can buy an additional $5,000 in paper I Bonds. However, if that same couple filed individually, they could each purchase an additional $5,000 for a total of $10,000.

To purchase paper I Bonds, use IRS Form 8888, “Allocation of Refund (Including Savings Bonds Purchases).” Purchase prices start at $50, and you can buy in $50 multiples up to $5,000 per filing per calendar year. IRS Form 8888 provides detailed instructions explaining how to request bond purchases. You can also head over to the IRS Website or reach out to a tax professional or your financial advisor. 

Can I Bonds lose value?

No. The I Bond principle will never decline due to a negative earnings rate. 

If a couple purchased $20,000 in I Bonds and the earnings rate drops to 0%, the principle would always be $20,000.

If you hold these I Bonds in a period of deflation, the bond redemption value will not decline.

There is always a risk that the U.S. government might default on its debt. In this case, the I Bonds could be worth less or nothing.

How can I buy an I Bond?

To buy an electronic I Bond, head over to the Treasury Direct website.

https://www.treasurydirect.gov/savings-bonds/buy-a-bond/

To buy paper I Bonds, you will need to use IRS Form 8888, “Allocation of Refund (Including Savings Bonds Purchases).”

What are some pros and cons of I Bonds?

I Bonds have a few characteristics that can make them a good investment for some individuals. 

Pro #1

I Bonds do protect your investments from inflation. As the inflation rate goes up, the interest rate on your I Bonds will also increase. In times of high inflation, this can be a nice place to protect some of your assets.

Pro #2

I Bonds are exempt from State and local income tax.

Pro #3

The redemption value of the I Bond can not decline. So if you buy $10,000 worth of I Bonds and redeem it in 5 years, you are guaranteed to get at least $10,000 back. Generally, your principal amount will increase over the years as long as the interest rate is not zero. All interest is added to your principal amount during the holding period.

Pro #4

During certain times, the yield on I Bonds can be very attractive. In 2022, markets fell, and inflation rose, making the higher yield of an I Bond attractive. In May of 2022, the I Bond yield was 9.62% through November 2022. That was a great return when the S&P 500 was down almost 7% during that same time period. 

Con #1

While there have been periods of time where the return on an I Bond has been high relative to other investments, this is not always the case. There have been periods of time where returns have been less than 2% and even 0%. When inflation decreases so does the rate of return.

Con #2

The maximum amount of I Bonds an individual can purchase is fairly low at $15,000. For individuals with larger investable portfolios, investing in I Bonds can be fairly time intensive to manage for a relatively small portion of the overall portfolio.

For example, if you have a portfolio worth $1,000,000 and you buy $15,000 worth of I Bonds. Let’s assume that you get the highest rate of 9.62% for the entire year; that would be $1,443 and would represent about 0.14% of your overall portfolio return ($1,443 / $1,000,000). Even if a couple filing jointly maxes their annual I Bonds at $25,000 it would return $2,405 or 0.24% ($2,405 / $1,000,000). 

Of course, if you have a smaller portfolio, the impact on the overall portfolio return will go up. 

Con #3

There is a lack of flexibility with I Bonds due to the requirement that you must hold the bonds for at least 1 year and even then, if you withdraw it before 5 years, you will forfeit 3 months’ worth of interest.

Clear Creek Conclusion

In conclusion, I Bonds can be a great way to protect a portion of your nest egg from inflation. As inflation rates go up, so will the rate of return. In periods where inflation has been high, and returns in public markets have been lower, I Bonds can provide attractive returns. 

However, given the limited flexibility of the I Bonds (required to hold for at least 12 months) and the limited amount that individuals can buy ($10,000 – $15,000), this investment might not suit the average investor.

If you are looking for a low-risk investment that will protect those funds from inflation, then you should consider purchasing I Bonds.