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You may have heard about series I savings bonds recently.
The "I" stands for inflation—it pays interest that fluctuates with inflation.
It’s a great option when inflation soars and other investments like the stock market flounder.
These bonds are currently returning over 7%, with no risk of principal loss.
We’ll discuss these bonds in this article, hopefully helping you decide whether they are right for you.
How you earn money
Each month, interest is added to your balance.
This interest is a percent of the principle.
Initially, the principle is the amount of your purchase.
After 6 months, the principle is increased to include the interest earned in the prior 6 months.
This happens every 6 months, until you cash out.
Example
Let’s say you buy a series I bond for $1,000 with the current interest rate of 7.12% (annualized).
It turns out that 7.12% per year is just under 0.6% per month.
So, for the first 6 months, you will earn $6 each month.
This $36 will now be added to your principal, which will become $1036.
For the next 6 months you’ll earn 0.6% per month on this larger, $1036 principal (about $6.22 per month).
This process will repeat: every 6 months your principal will increase to your total balance.
If the interest rate is maintained (or increases) you will earn more per month.
This is not guaranteed—the interest rate for these bonds fluctuates with inflation.
If inflation drops, your interest rate and earnings will drop alongside it.
The table and plot below quantify what we’ve discussed in this example.
The table shows monthly earnings and principal for the first 2 years.
The plot shows balance growth in the first 10 years.
These assume the interest rate never changes!
In reality, it will change, but no one can predict how.
The interest rate will never be less than 0, even if deflation occurs!
| End of month | Principal | Earnings | Balance |
|---|
| 0 | 0.00 | 0.00 | 1,000.00 |
| 1 | 1,000.00 | 6.00 | 1,006.00 |
| 2 | 1,000.00 | 6.00 | 1,012.00 |
| 3 | 1,000.00 | 6.00 | 1,018.00 |
| 4 | 1,000.00 | 6.00 | 1,024.00 |
| 5 | 1,000.00 | 6.00 | 1,030.00 |
| 6 | 1,000.00 | 6.00 | 1,036.00 |
| 7 | 1,036.00 | 6.22 | 1,042.22 |
| 8 | 1,036.00 | 6.22 | 1,048.43 |
| 9 | 1,036.00 | 6.22 | 1,054.65 |
| 10 | 1,036.00 | 6.22 | 1,060.86 |
| 11 | 1,036.00 | 6.22 | 1,067.08 |
| 12 | 1,036.00 | 6.22 | 1,073.30 |
| 13 | 1,073.30 | 6.44 | 1,079.74 |
| 14 | 1,073.30 | 6.44 | 1,086.18 |
| 15 | 1,073.30 | 6.44 | 1,092.62 |
| 16 | 1,073.30 | 6.44 | 1,099.06 |
| 17 | 1,073.30 | 6.44 | 1,105.49 |
| 18 | 1,073.30 | 6.44 | 1,111.93 |
| 19 | 1,111.93 | 6.67 | 1,118.61 |
| 20 | 1,111.93 | 6.67 | 1,125.28 |
| 21 | 1,111.93 | 6.67 | 1,131.95 |
| 22 | 1,111.93 | 6.67 | 1,138.62 |
| 23 | 1,111.93 | 6.67 | 1,145.29 |
| 24 | 1,111.93 | 6.67 | 1,151.96 |
| ... | ... | ... | ... |
| 120 | 1,958.10 | 11.75 | 2,028.59 |
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How the interest rate is determined
The interest rate is the sum of two components: a fixed rate and an inflation rate.
As the name implies, the fixed rate does not change over the life of the bond.
It’s presently 0% and is typically very small.
Over the last 5 years it’s averaged less than a quarter of a percent, with a peak of half a percent in 2019.
The inflation rate updates twice per year, at the start of November and May.
This amount is set slightly higher than inflation, as measured by the consumer price index (CPI).
It’s currently 7.12%.
Your particular bond’s inflation rate will update 6 months after you purchase it: if purchased
January 1 you’ll get the November rate until July 1 (July-December you’ll get the rate published in May).
How do I sell the bond and receive my earnings
You will not receive any money until you decide to redeem the bond.
You can NOT redeem this bond within 12 months of purchase—your money will be "locked away" for the first year.
After that, if you redeem the bond within 5 years of the purchase date you will forfeit the last 3 months of interest (this may be negligible if/when inflation drops).
The bond will not earn interest after 30 years.
Hence, you will need to hold the bond for five to thirty years to avoid penalties.
Rules and restrictions
- You can purchase $25 to $10,000 of I bonds per year (per social security number) on
TreasuryDirect.
We explain this more below.
- You can purchase up to $5,000 more per year of paper I bonds using your tax refund.
These only come in denominations of $50, $100, $200, $500, and $1,000.
- The bond can not be traded—it can only be purchased and redeemed from the US treasury.
For a paper bond, your bank can facilitate the redemption for you (more on this below.
- You cannot hold this bond in your brokerage account.
You will have to account for this separately, an annoyance to some people.
- The bond can not be redeemed within 12 months of purchase.
- If redeemed within 5 years of purchase, the last 3 months of interest will not be paid out.
- The bond may be held longer than 30 years, but no interest will be paid after 30 years.
- The interest on a Series I bond is subject to federal income tax, but not state or local income taxes. Federal income tax can be waived if the proceeds are used for higher education,
see Education Planning.
Miscellaneous points and opinions
- If you’re looking for a safe investment—considering CDs or money market funds—the I bond may be an excellent alternative.
- Many experts expect inflation to cool within five years, so don’t count on the 7%+ interest rate over the lifetime of the bond!
In a few years, these bonds could be yielding less than half this, but no one can tell you for certain.
- These bonds may not be a good fit for high net worth investors.
Since you can only invest $15,000 per year in this bond, the impact may be negligible if you have millions.
Probably not worth the trouble of opening and tracking a separate account from your main brokerage.
- Retirees, or individuals desiring short-term periodic income, may not want I bonds.
Unlike dividend earning stocks and many other bonds, you won’t receive a penny until you redeem this bond.
- Since these bonds are held separately as paper certificates or in the TreasuryDirect electronic ledger, some people actually forget about them!
If you pass away, your family may not know that you purchased these and fail to track them down.
How do I buy one
You have two options: (1) buy electronically at any time from
TreasyDirect.gov or (2) buy paper I bonds with your tax refund.
Both have strict rules on the purchase amount.
Electronically, you can only purchase 25 to 10,000 dollars worth in a calendar year.
You can make multiple purchases in the year, say $25 then $30.02, but each one must be at least $25 and the sum cannot exceed $10,000.
The process can take about 15 minutes if you don’t already have an account with TreasuryDirect.
Creating an account will involve selecting a password, answering security questions and you’ll need to
provide your bank routing and account numbers to wire money for your purchase.
Once you’re set up, subsequent purchases should take just a couple minutes.
The second option, purchasing paper bonds with your tax refund, is limited to $5,000 per year.
Paper bonds may be purchased in denominations of $50, $100, $200, $500, and $1,000.
Summary
Series I savings bonds are a low-risk investment that provide returns above CPI-measured inflation.
In the current environment of high inflation and a floundering stock market, series I bonds provide relatively high returns.
Over the long haul, however, low-risk investments typically don’t keep pace with the stock market.
Restrictions including a max purchase amount of $15,000 a year, an inability to access any funds
in the first year after purchase, and inability to receive payments until redemption, make these bonds unattractive to some.
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