Updated: Oct 5, 2022
Federal Series I Savings Bonds, or "I Bonds", are interest-bearing, inflation-linked savings bonds issued and backed by the full faith of the United States government.
Most fixed income securities, like government bonds and corporate debt, pay interest based on a fixed rate. This offers a persistent risk to fixed income investors in the form of purchasing power risk. As prices at the grocery store go up due to inflation, income from the investor's fixed rate debt investments do not. You may find the income from your investments purchase less than they did last year. How can you avoid this problem?
I Bonds offer a unique hedge to inflation due to the fact that they pay an interest rate directly tied to inflation. I Bonds also host some tax benefits as well:
Interest is paid lump sum upon redemption so the interest is tax-deferred until the bonds are redeemed or expire.
Interest is subject to federal income tax, but is tax-free at the state and local levels.
I Bond Interest Rates are made up of two parts:
Fixed Rate Set at issuance of the bond; does not change
+ Variable Rate Based on the inflation rate; resets semi-annually
Composite Rate Total rate; accrued monthly
Current I Bond Rates as of March 2022:
Fixed Rate: 0.00%
+ Variable Rate: 7.12% (annualized)
Composite Rate: 7.12% (annualized)
Now, before you say, "Wow, a tax-advantaged 7.12% rate of return guaranteed by the U.S. government! I am going to invest all of my money into I Bonds!", there are important limitations to consider.
First, there is a maximum an individual can invest into I Bonds each year:
Purchases are limited to $10,000 per person per year
An additional $5,000 is available if purchased using your federal income tax return
Second, there are penalties for redeeming the bonds early. I Bonds are issued with 30 year maturities and can be redeemed anytime after the first 12 months. However:
I Bonds have a minimum holding period of 12 months
Investors are penalized if they redeemed within the first 5 years
The penalty for redeeming before 5 years is forfeiting the interest of the previous three months. For example, if you redeem a bond after 24 months, you will receive the principal plus the first 21 months of interest.
Third, the interest rate is variable and is tied to the inflation rate, which you have no control over. Currently, inflation is high and the variable I Bond rate is 7.12% (annualized), however, it may fall in the coming years. Inflation is expected to remain high for the next few quarters and is expected to return to normal levels of 2% to 3% in the coming years. Remember, in their current form with a fixed rate of 0%, I Bonds will match, but never beat, inflation.
Are I Bonds worthwhile?
Other traditional inflation hedges, such as gold, commodities, or equities with pricing power, may be better options for investors with higher risk/return appetites.
However, if you are comparing "safe" investments, I Bonds may be a better option than some of its peers for the next few years. If you are considering other Treasury securities, such as TIPS, normal savings accounts, or bank Certificates of Deposit (CDs), I Bonds may pay better rates, depending on your time horizon.
Please be sure to first consult with a qualified financial advisor and/or tax professional before implementing any strategy discussed in this post.
How to buy Treasury Series I Savings Bonds: TreasuryDirect.gov
DISCLOSURE: Silverstone Financial LLC is a registered investment adviser. Information presented is for educational purposes only and does not intend to make an offer or solicitation for the sale or purchase of any specific securities, investments, or investment strategies. Investments involve risk and, unless otherwise stated, are not guaranteed. Be sure to first consult with a qualified financial adviser and/or tax professional before implementing any strategy discussed herein. Past performance is not indicative of future performance. Please see our disclosures page for additional information.