You may have recently heard people discussing investing in I bonds to help with inflation. Having a way to protect your funds from the rising costs of, well, everything lately can be appealing, especially since we don’t know what the future will bring. But what, exactly, are I bonds, and should you buy them now?
The U.S. government created I bonds specifically to help fight inflation. They can be a good investment choice for people who are uncomfortable with risk. But they aren’t the only thing you should keep in your investment portfolio.
Before investing in them, it’s essential to understand what they are, how they work, and just how much of a return you’ll see on your investment.
What are I bonds and how do they work?
During times of high inflation, the interest on regular savings accounts can’t keep up with rising prices. Pretty quickly, the money you have today doesn’t go as far as it once did. To help combat this problem, the U.S. Treasury Department introduced Series I Savings Bonds, aka I bonds, in 1998 to encourage more people to save and help protect their money from inflation.
To accomplish both, the interest rate offered on I bonds is a composite of two numbers: a fixed rate and an inflation rate. They protect you from inflation because as inflation increases, so does the combined interest rate on your I bond.
The Treasury Department sets the fixed rate. It doesn’t change for the life of the bond and applies to all I bonds issued within a six-month period. New fixed rates are announced May 1 and November 1 each year. Fixed rates may increase or decrease depending on the economy’s strength. When you purchase an I bond, the fixed rate will remain your interest rate until you cash it in.
Unlike the fixed rate, the inflation rate changes on all I bonds every six months. The inflation rate is based on the Consumer Price Index for all Urban Consumers (CPI-U) for all items.
As of May 1, 2023, the combined rate is 4.30%. It will remain that until November 1, 2023, when the Treasury Department will adjust the rate based on the economy and inflation reports.
I bonds earn interest monthly. The interest is compounded and applied to the bond’s new principal value every six months. The new principal value is the sum of the previous principal, plus the interest earned over the last six months.
Purchasing and cashing in
There are two ways to purchase I bonds.
You can purchase electronic I bonds online through a TreasuryDirect account. You can buy between $25 and $10,000 annually per person. After you purchase an I bond, you can monitor its current worth through the same website. It will be cashed out automatically when it matures after 30 years.
You can also purchase a paper version of an I bond. They have a minimum purchase amount of $50 and increase in increments of $100, $200, $500 or $1,000 up to the annual limit of $5,000. Paper bonds must be purchased with your Federal tax return using a particular form.
Purchase limits on electronic and paper bonds are separate. For example, one person can purchase $10,000 in electronic and $5,000 in paper for a maximum total of $15,000 per year.
You must hold I bonds for at least 12 months, but you can let them mature for up to 30 years. After the first year, you can cash it in at any time. However, if you’ve owned it for less than five years, you’ll lose the last three months of interest.
What are the benefits of I bonds?
There are four main benefits:
- They offer protection against inflation. Prices tend to rise in the long term, and your money will be worth less in the future due to inflation. This is one reason why investing in stocks, bonds or other assets is so important. I bonds, in particular, are a relatively low-risk way to help protect against inflation. When inflation rises, so do the inflation rates on the I bond. This helps you preserve the purchasing power of your money.
- I bonds have some tax advantages. They’re exempt from state and local taxes. However, you’ll have to pay federal taxes on the interest you earn, either annually or after cashing it in. In some instances, federal taxes may be waived if you use the money for qualified higher education expenses.
- They’re low risk. The U.S. Treasury backs I bonds, which means there is little chance of default. Although investing always carries some risk, an I bond is likely to return the principal amount you invest along with interest. How much you earn depends on how long you let it mature.
- I bonds are an accessible way to invest. You can invest as little as $25 if you buy electronic ones, and you can purchase multiple throughout the year. This low initial investment makes them much more accessible to everyday people, unlike other investments that require thousands of dollars.
What are the drawbacks of I bonds?
Along with benefits, they also come with some drawbacks:
- They can’t be cashed in for the first year. I bonds must be held for at least a year after you purchase them. After that time, you can cash them in whenever you’d like, though if you do it right away, you likely won’t see much interest accumulate. Additionally, if you don’t hold it for at least five years, you lose the last three months of interest, which will eat into any profit you make.
- I bonds have investment limits. The Treasury Department limits how many each person can purchase in a single year. Each year, you can buy up to $10,000 in electronic per Social Security Number and an additional $5,000 in paper using your federal tax return. Compared to other investment opportunities, that is relatively low. Plus, you can only invest through the Treasury Department, not your brokerage or retirement account.
- Your heirs may have to pay estate or gift taxes. If you pass away before the bonds are cashed in, your heirs may have to pay federal estate or gift taxes and state estate or inheritance taxes, if applicable.
What about EE bonds?
In addition to I bonds, the Treasury Department issues EE bonds.
They’re are similar in a few ways:
- They earn monthly interest and have a minimum purchase amount of $25.
- They must be held for the first 12 months after purchase.
- If you sell EE bonds before owning them for five years, you’ll lose three months of interest.
Unlike I bonds, EEs earn only a fixed interest rate that stays the same through its life. The Treasury Department guarantees that the value of your EE bond will be double what you paid for it at 20 years of maturity.
Deciding between investing in I or EE bonds comes down to a personal preference and your beliefs about what inflation will do in the future. Be sure to research your options carefully to make the best decision, especially since you’ll lose money if you redeem either type before five years have passed.
Who are I bonds best for?
I bonds appeal to individuals who are looking for low-risk investments for an intermediate time (more than one to three years but less than 10 years). They can be suitable for retirees who want to see their savings keep up with inflation and earn more than a typical savings account or EE bond. If you’ll be retiring within five years or have plans to buy a home or make another big purchase, putting some money into I bonds can be a helpful way to protect your savings from inflation.
You must hold I bonds for at least a year and, ideally, for at least five years. So it’s best to build up your emergency fund before investing in them.
If you have decades before you retire, you may earn a better return with other investment types until you get closer to your retirement date. Stocks, ETFs and Index Funds are likely to earn more than an I bond will return over the long term, although they can be riskier investments.
Be sure to do your research. Consider working with a financial adviser to help you determine the best path for you and your retirement.
Bottom line
I bonds are a low-risk option for investors looking for a safe place to save money for a rainy day. Remember to thoroughly research investment considerations, including I bonds, before you purchase and understand each type of investment’s potential risks and rewards.
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