Why I Like US I Savings Bonds

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Lately, I've been adding the U.S. I Savings Bonds, or I-Bonds for short, to my security investment bucket.

In my opinion, they're an excellent bond to invest in, especially during high inflation periods like we're dealing with in 2022. Right now, I-Bonds are paying an unprecedented 9.6% through October 2022.

These bonds were created in 1998 to keep up with inflation and are geared toward retail investors. I-Bonds have some unusual and confusing aspects, so let's break down how they work so you can use them to your advantage.

How Do I-Bonds Work?

I-Bonds grow tax-deferred for up to 30 years. You are not taxed by the state — only at the federal level. You cannot cash out I-Bonds during the first year. And if you redeem your bonds during the first five years, you'll pay a penalty of three months' interest.

As of 2012, you can no longer buy paper bonds directly. The only option is via a backdoor method: Overpay your taxes, and request the refund to be paid in paper I-Bonds. The limit is $5,000.

Electronic versions (through TreasuryDirect) are available, but there's a maximum of $10,000 for each type of bond per year per social security number.

Get Around the $10K Limit

A common way people get around the $10k annual limit per social security number is to have other family members purchase I-Bonds in their name. Keep in mind that if used for higher education, the I-Bond must be in the parent's name to be tax-free.

Keeping Track of Paper I-Bonds

Many families have bonds in a safe, safety deposit boxes, or scattered around the house. TreasuryDirect's Savings Bond Calculator lets you input your paper bond information so that you see how much interest you earned over a specific period of time. You can also follow the instructions to save your inventory, so that you don't have to re-enter each bond every time you wish to calculate your returns.

When To Buy I-Bonds

When the rate is as high as it is right now, the best time to buy is immediately to take advantage of the record rates. Otherwise, it's best to buy U.S. I-Bonds on the last day of the month. This is because the interest accumulated is the same either at the first or last month. For the same reason, when selling, you are best to sell at the beginning of the month.

Calculating Composite Earnings Rates

So, how much can you make on your I-Bond? That depends on the current rate. An I-Bond has two components that together make the composite return:

  • Fixed Rate – Remains the same for the life of the bond. The fixed rate for newly issued I-Bonds is announced on May 1 and November 1 of each year. The rate applies to all I Bonds issued during those six months.
  • Inflation Rate – Based upon CPI and is also announced every six months, on May 1 and November 1. This inflation adjustment applies to both existing I-Bonds and newly issued ones, but the timing of that adjustment is dependent on the original issue date of any particular I-Bond.

Fixed rates and semiannual inflation rates are combined to determine composite earnings rates—an I-Bond's composite earnings rate changes every six months after its issue date. For example, the earnings rate for an I bond issued in March 1999 changes every March and September.

If you want to find the composite rates for your bonds, try the Treasury's online Savings Bonds Calculator.

Here's how the composite rate for I-Bonds issued May 2022- October 2022 was set:

Fixed rate = 0.00%
Semiannual inflation rate = 4.81%

Composite rate = [Fixed rate + (2 x Semiannual inflation rate) + (Fixed rate x Semiannual inflation rate)]

 = [0.0000 + (2 x 0.0481) + ( 0.0000 x 0.0481)]

 = [0.0000 + 0.0962 + 0.0000000]

 = 0.0962000

 = 0.09620

Composite rate = 9.62%

Your interest accrues monthly and compounds semiannually.

Related: Inflation-Proof Investments: 6 Ways to Protect Your Portfolio in 2022

I-Bond Pros and Cons

pros

  • The initial interest rate on new series I Savings Bonds is very attractive (and unheard of) at 9.62%.
  • The interest is tax-deferred until you cash them out. You only owe federal taxes, no state or local taxes.
  • They extend your tax-deferred accounts.
  • The fixed-rate part of the bond is “fixed” for the term of the bond. If the fixed-rate rises in the future, cash it out for a newer higher rate bond.
  • They are multi-purpose investments. Unlike retirement accounts and 529s, which save money for a specific use.
  • If used for higher education (college), no taxes are owed.
  • The total interest rate cannot be less than zero, even during deflationary periods.
  • Is more tax-efficient than TIPS in taxable accounts.
  • Since you are buying directly from the U.S. Treasury, there is no markup fee from your brokerage.

cons

  • Buying I-Bonds through the Treasury Direct's dated website can be challenging experience, especially for older people. And if you want to speak to a live person on the phone, you'll face higher than normal call volumes.
  • You have to trust the BLS to reproduce the inflation rate accurately.
  • The inflation rate is only adjusted two times a year. Should inflation run rampant, there may be a lag until the rates catch up.
  • There's no secondary market. To redeem the bonds, they must be sold back to the U.S. Treasury.
  • If held for a short period (five years) and you're in a high tax bracket, it may offer poor returns after taxes.

The Bottom Line: I-Bonds, Seriously?

Some may question my decision to invest in any U.S. bond. You've all heard about the mile-high deficits, the skyrocketing inflation rate, and talk of a possible recession.

While a recession may indeed be on the way, in my opinion, it won't be as severe compared to the one in 2008. If we did get a long-term deflation death spiral, then at least the invested money would be the same as if I had kept it in cash.

The best-case scenario that I still think is the most likely is that inflation will continue to rise. At one point, I-Bonds had a much higher fixed rate and annual limit ($60k) than currently, so I am kicking myself for not purchasing them ten years ago, but I digress.

We invest in I-Bonds because they can be used for our children's education or for other expenses we may have in the future. We also have 529 accounts for our children, but I'm not entirely sold on how effective they will be when they go to college. I would rather hedge our bets, in case one of them does not go off to college, and keep our savings options open for other investments.

Additional Information

Readers, what other investments would you use that are not specific to education but can be used for education tax-free?

Further reading:

Larry Ludwig

Larry Ludwig was the founder and editor in chief of Investor Junkie. He graduated from Clemson University with a bachelor of science in computers and a minor in business. Back in the ’90s, I helped create some of the first financial websites for firms like Chase, T. Rowe Price, and ING Bank, and later went on to work for Nomura Securities. He’s had a passion for investing since he was 20 years old and has owned multiple businesses for over 20 years. He currently resides in Long Island, New York, with his wife and three children.

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15 Comments

  1. I’m a grandparent. Can I still purchase I-Bonds for my grandson to be used toward higher education

  2. “Fortunately, you can “upgrade” your I Bond anytime after one year. ” How does one upgrade?

  3. I started purchasing I bonds through payroll deduction back in 2000. I would also buy them at the bank when I got my tax return check and I would buy several $1000 bonds. They are now worth about $85000 and a large number of them have fixed interest rates of almost 3.5% and many are returning up 5.5 % to 6.1 % annually.
    The best investment I ever made. The new ones have a much lower fixed rate, but they still have advantages due to the state/local tax exemption.

  4. When my Dad died I bought five I Bonds with money that he left me as his investments matured. I made a bad mistake and put them in mine AND my husbands names. My husband gives what he has to his daughter but I would be afraid to give what I have to my children then need it later. Is there a way to remove him from my bonds without cashing them in?

  5. The article and the comments are not dated so I do not know how current and applicable they are today. Regardless, I would like to know the following:

    1. Are there any commercially available apps or services that would track and update a bond portfolio that includes a paper and electronic iBonds and EE bonds

    2. Can the free Wizard be used to include any types of EE or iBonds issued over time and does it update one’s portfolio without tedious manual entries? Does it post the total interest earned by the bond to-date?

    3. If I were to capture this portfolio in a spreadsheet and try to update it once a year to show cash value, total interest, current composite rate (broken down by fixed and valuable), date for next interest post, date when the bond matures, what would be the easiest way to do it?

    I am sorry if my questions are silly but I never dealt with these types of investments and I have to help out someone who has them.

    Thanks.

  6. Junkie,

    I totally agree with you that I Bonds are a great investment for a portion of the fixed income portion of a diversified portfolio. They certainly are more favorable than CD’s or bond funds at this point in the interest rate cycle. I have been purchasing I Bonds for over 10 years for myself and my grand children. I also use the Saving Bond Wizard to keep track of my inventory. You mentioned that there is no way to “save” the inventory and that you have to key in serial numbers each time you update values. I have not found this to be the case with the Wizard. I save my inventory each time I update values at the end of every month.

    1. Yes, I just saved the web page to my hard drive after I entered the serial numbers. Then when you open the saved page and press the “Return to savings bond calculator” button, it refreshes the values.

  7. Good article. I-bonds are basically CPI indexed dollars, plus a little in most instances. They are better than cash after the first year.

  8. junkie,

    I could recommend a lot of different investments that have many of these advantages. I investigated these a bit more. I don't know of any investments that guarantee principal like these do and have the credit quality of Treasuries. So, these are really not like other Treasury bonds, since you always get your principal back even if you sell before maturity. If you redeem before 5 years, you sacrifice interest.

    Given the low interest rates now, you might still be better off selling and buying newer ones when rates go up even if you pay a penalty. So, these aren't as bad as I thought.

  9. i-bonds sound good but the fact remains that all U.S government debt is overbought. So, the inflation protection is tied to an investment that has a low rate of return to begin with. (high price == low yield)

    Also, keep in mind that the inflation rate is determined by the same institution that issues the bonds. A conflict of interest. Does anyone really think that inflation is near zero right now? When i look at the goods that I buy, i say the answer has been no the past couple of years. WIthout even considering services like education and health care which don't count.

    i-bonds are good for that portion of your portfolio labeled 'capital preservation'.
    Mike

    1. Hi Mike,

      What do you recommend then that is flexible as I bonds in their use, keep up with inflation (at least what's reported by the BLS), and have the same tax advantages?

      I agree about government accurately reporting inflation, I've stated this a few times on my blog and tweets. Sites like Shadow Stats http://shadowstats.com/, which I subscribe to, offer an alternative (abit I also think flawed in some respects) viewpoint on inflation.

      In the end though can't you state that most bonds are about 'capital preservation'? Until a better option exists, I still think I bonds should be part of one's portfolio.

    1. Good question. I have a few I bonds earning more than that currently.

      I-Bonds are
      – tied to inflation (yes I understand you can get out early with a CD, abit with a penalty)
      – can be used for higher education tax free (at least for now as there has been some talk about changing the tax rules on savings bonds)
      – not taxed until you cash out

      As I mentioned I missed out during the early 2000's with the great fixed rate and big limit amount. So I'm not investing a huge amount in them per year, but they are part of our portfolio. As of late, I've been investing in more corporate and muni bonds than I-bonds.

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