Are I-Bonds Right for You?

Brett Roper, CFP®, AIF® |

Lately, I’ve had quite a few clients contact me with questions on the I-Bond.  What exactly is an I-Bond and why is it gaining such popularity?  The current inflationary period has given rise to a renewed interest in this US government savings bond, but investors should explore the pros and cons before purchasing.  

What is an I-Bond?

U.S. Government Series I-Savings Bonds pay a fixed interest rate (which is set at the time of purchase) and an additional interest rate indexed to inflation (which adjusts to reflect the past six months’ level of inflation as measured by the Consumer Price Index).  Interest accrues monthly for up to 30 years if you hold the bond to maturity.

I-Bonds carry some important caveats.  They cannot be sold for one year and if they are redeemed before five years you must forfeit three months of interest.  After five years, I-Bonds are fully liquid, risk-free securities.

Also, investors are limited to purchase a maximum of $10,000 per calendar year online, and up to $5,000 of paper bonds through your tax refund. 

Since I-Bonds are offered by the Federal Government, they are seen as an extremely safe investment.

What is the current Interest Rate on I-Bonds?

If you purchase an I-Bond before November 1st you will receive an annualized 9.62% interest rate the first six months you own the bond, and then a new rate based off the inflation rate from April to September.  The worst case scenario is inflation plunges to 0%, and you only receive a 4.81% return for the year.

So if prices rise 3% from April-September, you will receive 4.81% yield the first six months on your I-Bonds, and 3% for the next 6 months.  For the year that totals 7.85% when compounding after the first six months. 

If you decide to withdraw after one year, you would have to forego three months of interest, lowering your return on investment to 6.28%.

How Do I buy an I-Bond?

I-Bonds have to be purchased directly through

Tax Considerations of I-Bonds?

The interest that your savings bonds earn is subject to federal income tax but not to state or local income tax.  Also, interest is subject to federal estate, gift, and excise taxes as well as any state estate or inheritance taxes. 

You can report the interest every year or defer reporting the interest until you file a federal income tax return for the year in which the first of these events occur:  cash the bond and receive what the bond is worth including interest, give up ownership of the bond and the bond is reissued, or the bond stops earning interest because it has reached final maturity.

Who Should Use an I-Bond?

I-Bonds are ideally suited as a way for an investor to progressively build up your emergency/opportunity cash fund.  An individual who wants to maintain a $50,000 cash reserve could buy $10,000 worth of I-Bonds per year for 5 years.  After the first year, the $10,000 allotment purchased from the prior year would become liquid and available for emergency use if needed.  The only impediment to the early withdrawal of that money after the first year and before the fifth is the three month forfeiture of interest.

After each allotment passes the five year mark, there would be no penalty for taking the money out.  If a new series of I-Bonds later offers a more attractive rate than one currently held, the investor can always sell the older bond and buy the new one.

For investors needing a source of steady income or as a substitute for other fixed income options, the I-Bonds may not be a good fit.  I-Bonds don’t make regular interest payments but instead pay income when you sell.  Therefore, they are not a good option for those looking to fund any part of their living expenses with the current interest earnings from the bonds.

However, I-Bonds could be a smart move for another group… parents or grandparents saving for a child’s education.  As mentioned above, I-Bond earnings are not taxable on the state or local level.  In addition, you can avoid paying federal taxes if you use I-Bonds for higher education expenses.  An investor can use them as another way to save for college, with the flexibility of simply paying federal taxes on the interest earned in the event you do not use the funds for higher education costs.

In the end, the enticing current interest rate or the desire for flexible tax-free college savings may overcome the limitations of the I-Bond.  We always begin investment planning by focusing on risk tolerance, time frame, and intention of our clients’ funds - feel free to reach out if you are interested in learning more.



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