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]
Composite rate = 9.62%
Your interest accrues monthly and compounds semiannually.
I-Bond Pros and Cons
The Bottom Line: I-Bonds, Seriously?
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.
- TreasuryDirect – I Savings Bonds Rates & Terms
Readers, what other investments would you use that are not specific to education but can be used for education tax-free?
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