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I Bonds: What are they, how do they work and should I be investing in them? Thumbnail

I Bonds: What are they, how do they work and should I be investing in them?

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Reader Question: 

I’ve been hearing a lot about I bonds recently.  What are I bonds and how do they work?  Should I be investing in them?


Answer: 

What are I bond and how do they work? 

Series I bonds have been a hot topic over the last several months, so it's not surprising they’ve entered your news feed.  I bonds are a type of savings bond issued by the US government that are designed to protect the buyer from inflation.  In order to achieve this goal, an I bond has both a fixed rate of interest and a variable rate that changes with inflation.  

Both the fixed rate and the inflation rate are announced twice a year (March 1 and November 1) and then will apply to all I bonds that are issued during the next 6 months.  As the name indicates, the fixed rate will not change as long as you hold the I bond.  The current fixed rate is 0%.  The inflation rate can, and usually does, change and these changes will apply to the interest paying on your I bond every 6 months.  If you would like to see all historical rates (fixed, inflation and the composite)- check out this chart.   As we have all experienced, inflation has been particularly high in 2022 and that has led to an inflation rate for I bonds issued between March 1 and October 31, 2022 of 9.62%.   It is this very high inflation rate component of I bonds that has been catching people’s attention.  

I bonds earn interest from the first day of the month you buy theSeries I bonds have been a hot topic over the last several months, so it's not surprising they’ve entered your news feed.  I bonds are a type of savings bond issued by the US government that are designed to protect the buyer from inflation.  In order to achieve this goal, an I bond has both a fixed rate of interest and a variable rate that changes with inflation.  m.  Twice a year, all the interest the bond earned in the last 6 months is added to the principal value of the bond.  This increases the bond's value which means you will be earning interest on a larger value for the next 6 months.  This process is called semiannual compounding.  

There is a maximum purchase limit of $10,000 per person in electronic I bonds within a calendar year.   You may also elect to purchase up to $5,000 in paper I bonds when you file your taxes using your tax refund.  The minimum purchase for an electronic I bond is $25.  You will also pay taxes on the interest payments from your I bond.  The interest is only taxed at the Federal level and not for state or local taxes.   The interest income is taxed at ordinary income rates similarly to CD or money market savings interest.  You can elect to pay the taxes all when you redeem the bond or you can pay every year as you go- most people pay upon redemption as they receive a 1099-INT form reporting the total interest earned.     


Should I be investing in them? 

Sure, 9.62% interest on an extremely safe government bond sounds like a great deal.  However, the inflation rate can and will change over the life of the bond.  I bonds come with a 30 year maturity which means you can earn interest for up to 30 years.   However, you may decide you would like to redeem the bond before the full 30 years are up.  You are allowed to cash in (redeem) your bond at any point after 12 months.  However, if you redeem the bond in less than 5 years, you lose the last 3 months of interest.  For example, let’s say you decide to redeem the bond after 12 months, you will only receive 9 months of interest.  

I bonds are currently a great option for those who wish to earn a higher rate of interest on their savings compared to the money market or with a CD.  If you have some savings that you feel confident you will not need to access for at least 12 months, it is certainly worth taking a look at buying an I bond by October 28.  That is the final deadline to ensure you are issued the I bond by October 31 with the 9.62% rate for 6 months.  Remember that you are locking in a 0% fixed rate and that the inflation rate will change over time.  

If you are unsure whether you may need some of your savings over the next year, it does not make sense to purchase I bonds with that money.  If you have longer term savings goals such as retirement, using extra cash flow to contribute funds to your work retirement plan or a Roth account (if available for you) will be a better investment over the long run than an I bond.

If you are interested in purchasing I bonds, you can buy them via Treasury Direct .  If you do not have an account, click on create a new account and follow the steps to set up your account and then purchase I bonds.