I Bonds: Thriving During Inflation

April 29, 2022  | By Manisha Gupta

Concerned about inflation, perhaps for the first time in your lifetime? For many families we work with, it’s been decades since even the adults have seen inflation rising this quickly. But, the U.S. government has a nifty, old-school instrument available to you during extended periods of inflation. 

The Series I bond, known colloquially as “I bond”, is a low-risk bond that is tied to inflation, thus generating a higher return right now, which means it is attracting attention from savers, investors, and the media. Here’s what you should know: 

What is an I bond?

The I bond is a U.S. government savings bond that earns interest based on both a fixed rate and a rate that is set twice a year based on inflation. The bond earns interest for a maximum of 30 years, after which ceases to earn any interest. 

I bond interest rates

The interest you can earn on an I bond comes from a combination of two rates: the fixed rate and the inflation rate:

• Fixed Rate: The fixed rate on the I bond never changes for the life of your bond. The U.S. Treasury announces the fixed rate for the I bond every six months (on the first business day in May and on the first business day in November.) The fixed rate then applies to all I bonds issued during the next six months. This fixed rate is an annual rate. 
• Inflation Rate: This is the rate that is adjusted for inflation every six months (it is also announced on the first business day of May and on the first business day of November.) The rate is based on changes in the non-seasonally adjusted Consumer Price Index for all Urban Consumers (CPI-U) for all items, including food and energy. 

Interest is earned on the bond every month. The interest is compounded semiannually: twice a year, the interest the bond earned in the previous six months is added to the bond’s principal value; then, interest for the next six months is calculated using this adjusted principal. The interest and principal are paid to you when you cash the bond.

Currently the fixed rate is 0%. The new semi-annual inflation rate announced today, May 2nd, is 4.81%. So, if you purchased an I bond today, your composite rate will be 0% + 2*4.81% + 0*4.81% = 9.62%. 

Wow! A 9.62% annual interest rate sounds amazing in the current environment of low interest rates! And keep in mind that since I bonds are issued by the federal government, there is no default risk or stock market volatility involved. 

Other important things to know: 

1. How to purchase I bonds: You can only purchase I bonds through the U.S. Treasury Department’s TreasuryDirect website. Simply create an account on the site and link your bank account. 
2. Maximum limit: There is a maximum purchase limit of $10,000 per Social Security number per year. A married couple can purchase a maximum of $20,000 a year in I bonds. If you have children, you can also buy $10,000 worth of I bonds for each child every year. However, the IRS considers this an irrevocable monetary gift to your children, similar to contributions to 529 and UTMA accounts. Therefore – unless you are 100% sure that you want to give the bonds to your children – I would suggest not getting carried away with this. 
3. Redemption and penalties involved: You have to hold the I bond for a minimum of one year; it cannot be cashed out before that. If you do surrender an I bond after the first year and before the end of five years, you will lose three months of interest earned (three months immediately preceding the redemption date) as penalty. After five years, there is no withdrawal penalty.

I bonds can only be surrendered through TreasuryDirect, so make sure to give yourself an extra couple of days to get the cash in your bank account. 

Should you consider buying I bonds?

Given the minimal interest rates that regular savings accounts are currently paying, it is definitely worth considering for long-term cash needs. (But remember, any cash you need in the next 12 months should not be invested in I bonds.) Here are some examples or situations for which I bonds might be best:

• You saved up for your dream vacation, but vacation has to be postponed for a few years.
• Cash for car down payment, but your favorite car is not currently available because of supply chain issues.
• Cash for home remodel project, but the project is delayed due to a schedule backlog.
• Cash needed for your child’s college tuition in the next two to three years, but don’t have a 529 account. 
• You have experience owning longer-term CDs, but are interested in a higher interest rate. 
• You are wary of the stock market and only like 100% safe investments. In that case, buying $10,000 worth of I bonds every year could make sense for your risk tolerance.

One caveat: You may hear that I bonds are a good place to keep your emergency savings, but I don’t agree. Since it may take more than four or five days to get the cash into your checking account, this isn’t the best account for that purpose. However, if you are someone who likes to have additional, liquid reserves, apart from your emergency account, I-bonds can be an appropriate way to do that. 

Tip: Visit the TreasuryDirect website for more information on the historical rate of I bond returns.