Series I bonds: Are they a good investment?

Series I savings bonds (I bonds): The "I" is for inflation. These US savings bonds are designed to help protect against inflation.

Inflation is a very powerful force that reduces the value of your money over time. Without a well-defined strategy and an ongoing plan to protect against it, you could experience reduced purchasing power (your money won’t stretch as far as you would like) and put your short-term savings and long-term investment goals at risk.

With inflation at a 40-year high, many people are looking for ways to protect the value of their cash, and I bonds could be a good solution. Here’s what I bonds are, how they work, and why you might consider using them as part of your ongoing savings and investment strategy.

What are Series I bonds? 

I bonds are savings bonds issued by the US Government that are designed to offer protection against inflation. Each bond earns interest based on a combination of a fixed rate that is set when the bond is purchased and an inflation rate that adjusts over time. I bonds are considered low risk because they are backed by the full faith and credit of the US Government.

The history of I bonds

US savings bonds were first introduced during the Great Depression. They were originally offered as a way for everyday Americans to gain access to federally-backed (i.e. safe) securities while also providing financing for government spending. Over the years, the federal government has issued several different types of bonds to meet the changing needs of people looking to save or invest their money.

After an extended period of high inflation in the 1970s and a slight resurgence in the late 80s and early 90s, the US Government started to issue I bonds in 1998 as a means to provide a savings option with inflation protection. Prior to 1998, no other government issued bonds offered inflation protection.

How do Series I bonds work?

When you purchase an I bond, you earn interest on the amount you have invested and when the bond matures or you sell it, you receive the total amount of your original investment back, plus the interest you earned over time.

However, there are two unique features you need to know.

1. How interest is earned

The interest rate on an I bond is made up of two components. The first is a fixed rate that is set when the bond is purchased, and it remains the same throughout the life of the bond. The second is a variable rate that is adjusted every six months and that remains based on the current inflation rate as measured by the Consumer Price Index (CPI). 

An example:

For I bonds issued from November 2021 through May 2022, the interest rates are:

^{Source: TreasuryDirect}

2. How interest is paid

Interest on I bonds is earned over time but not paid directly to the bond owner during the holding period. With more traditional bond investments, the interest can be paid directly to you, the bond owner, as it’s earned (you can spend it, save it elsewhere, or reinvest it). With I bonds, the interest accrues (adds) over time but you can’t collect it until you sell or redeem your bonds.

Can I bonds help reduce the impact of inflation?

For people concerned with the impact of inflation on their savings, I bonds offer good protection because the interest rate is adjusted periodically based on the most recent inflation rate. Since the interest rate isn’t fixed and can be adjusted over time, your savings will always earn an interest rate that is close to, but not always equal to, today’s inflation rate.

It’s important to note that I bonds are designed to protect against inflation and not to beat inflation over the long-term. As a result, they offer great protection for short-term savings needs, but, if you are looking for an investment that will outpace inflation, I bonds are not an appropriate solution.

How to buy Series I bonds

I bonds can be purchased in two ways:

1. You can purchase them online through the Treasury Direct website. Each person can buy up to $10,000 per year with a minimum purchase of $25.
2. You can purchase an additional $5,000 in savings bonds (in paper form) by using your tax refund, but this means you need to make this decision when you file your tax return. You can’t receive your refund and then make the purchase online.

With these limitations, an individual can buy up to $15,000 ($30,000 for a married couple) of I bonds a year so you need to plan well in advance if you want to make them a part of your overall savings strategy.

Can I buy Series I bonds in my child’s name?

The short answer is yes, you can buy I bonds for your children. The more important question is, should you? Here’s what you need to know about buying I bonds for your children and whether or not it could make sense for you.

The same purchase limits as when you buy them for yourself apply so you could buy, each year, $10,000 for them through the Treasury Direct website and an additional $5,000 in paper bonds using your tax refund. Second, these limits include both amounts that you purchase directly for any of your children and any gifts you make to them. So you can’t buy $10,000 in their name and buy $10,000 personally and then gift it to them.

What to consider when purchasing I bonds in your child’s name

1. Once the purchase is made in their name, the money belongs to them. They own it, they control it, and they can do whatever they want with it when they turn 18 (the age of majority in most states). Technically, the account will be linked to you, but it’s their money.
2. While I bonds in the parent’s name can receive favorable tax treatment for college related expenses, I bonds in your child’s name will not receive this preferential tax treatment. They will have to report any interest as taxable income if they sell their bonds and use them for educational purposes.
3. I bonds owned in your child’s name will be treated as their assets when filing for financial aid (through the FAFSA). This means it could adversely affect their eligibility for aid when they attend college.
4. If you purchase the bonds and gift them to your kids, this amount is included in the annual gift tax exclusion amount of $16,000 per child (for 2022). So if you are buying I bonds and gifting them and contributing to an education savings account (a 529 plan), you could end up with a taxable gift that must be reported if you exceed $16,000.

If you are interested in purchasing I bonds for your children, you can do so directly through the TreasuryDirect website. You’ll need to set up what they call a “Minor Linked Account.” It’s an account that is in your kid’s name but linked to, and managed through, your primary account since they cannot open an account directly.

A quick word on taxes

When assets are held in your child’s name, they will be responsible for paying taxes on any interest. It can be advantageous due to what are known as “kiddie tax” rules which makes some unearned income exempt from taxes and some taxable at their tax rate, thereby resulting in a lower tax rate than you would pay if you held the I bonds for them in your name.

How to sell I bonds

If you own an I bond, you cannot sell it to someone else like you could with other stock or bond investments. They can only be redeemed (sold back to) the US Treasury Department after you’ve held them for at least 12 months or a full calendar year. Note: This means you will not be able to access the money before that 12 months is up. 

After 12 months, you can redeem your bonds directly with the federal government. However, if you have held your bond for less than 5 years, you will forfeit the last 3 months of interest. You can hold your series I bonds for up to 30 years from the date of your initial investment, at which point they mature and must be redeemed.

How are Series I bonds taxed?

Series I bonds, like other U.S savings bonds, offer unique tax benefits and planning opportunities. They are exempt from state and local income taxes, but you still have to pay federal income taxes. You also get to decide when you pay taxes on the interest. Most investments require that you report and pay taxes on any interest payments for the year in which it is earned. With I bonds, you get to choose whether you want to pay taxes in the year the interest is earned or wait to report it and pay taxes when you redeem them.

I bonds also offer tax benefits for education planning. The interest on I bonds may not be subject to federal income taxes if they are used to cover higher education expenses. Income limits and other requirements apply so you need to plan in advance to maximize any tax benefits.

Are I bonds a good investment?

With inflation at a 40-year high and uncertainty on the horizon, I bonds should be considered to protect your cash in the short-term. The interest you receive on I bonds, especially in a low interest rate environment, will most likely keep pace with, but rarely beat, inflation. I bonds can be a good solution if you have a savings goal over the next 2 to 5 years and want to protect the value of your savings.

As for a longer-term investment, there are a few items to consider:

1. With limits on how much you can buy each year, it can be a challenge to purchase enough I bonds to gain significant exposure and to properly diversify your investment portfolio.
2. You cannot purchase I bonds in your retirement accounts like your 401(k) or IRA so you have to use other savings.
3. For longer time horizons there may be better wealth building investments like stocks, that despite their higher risk, can provide returns above inflation.