By Dan Miller, WCI Contributor
The United States government offers two different types of savings bonds—Series EE Bonds and Series I Bonds. One of the main differences between Series EE and Series I Bonds is that Series I Bonds (often just referred to as “I Bonds”) are indexed to inflation. When inflation is low, it doesn't make as much sense to invest in I Bonds, but when inflation rises, putting some of your money in I Bonds with a high rate of return can make a lot of sense.
What Are I Bonds?
Series I Bonds are one of two different types of savings bonds issued by the US federal government. I Bonds have a rate of return that is made up of two different components—a fixed return and a return that varies every six months depending on the current inflation rate. The fixed return is set when you purchase the I Bond, but the inflation-based return varies every six months. You need to combine both the variable and fixed portions of the return to determine the actual return of any given I Bond.
How Do You Buy I Bonds?
The easiest way to buy I Bonds is through the TreasuryDirect website, treasurydirect.gov, but there's a limit. You can only buy $10,000 in I Bonds in one calendar year per Social Security Number (SSN) or Employee Identification Number (EIN). Additionally, you can buy up to $5,000 in paper I Bonds as part of your tax refund.
More information here:
I Bonds and TIPS: Which Inflation-Indexed Bond Should You Buy Now?
How Do I Bonds Work?
Because I Bonds have two different components that make up their actual return, it can be a bit confusing to fully understand how I Bonds work. Here is one example of how interest is calculated to help give you an idea.
The total rate for I Bonds bought between May 2023 to October 2023 is 4.30%.
| Fixed interest rate | 0.90% |
| Semiannual inflation rate | 1.69% |
| Composite rate formula: [Fixed rate + (2 x semiannual inflation rate) + (fixed rate x semiannual inflation rate)] | 0.90% + 2 * 1.69% + 0.90% * 1.69% = 4.295% |
You then round up to get the interest for the I Bond. The fixed component of the interest rate is set when you purchase the I Bond, but the inflation component varies every six months from the date that you purchased your bond. Rate changes are announced every May and November. So, if you bought your I Bond in January, your rate will change every January (based on the rate announced the previous November) and every July (based on the rate announced in May).
How Do You Collect Interest on I Bonds?
One important thing to understand about the interest on I Bonds is that it compounds every six months (semiannually), not continuously. That makes the listed returns slightly lower than the returns you might get from a similarly listed return that is compounded continuously (like investing in the stock market). The difference isn't a huge amount, but it's something to be aware of.
That means that your interest is paid out every six months. You owe federal income tax on the interest that you earn on your I Bonds but not state or local income tax. You can choose to pay income tax as you go or wait until you redeem your bonds—most people just wait until they cash out the bonds to pay tax on any interest they have accrued. You can always check your account at the TreasuryDirect website to see the value of your bonds and how much interest you have earned.
More information here:
When Should You Sell I Bonds?
Deciding when to sell your I Bonds will depend a lot on your overall investing strategy and how I Bonds fit into that strategy. One of our best I Bonds tips is that I Bonds only earn interest for a period of 30 years. So, if you've held an I Bond for that long (perhaps purchased for you as an infant), you'll definitely want to sell, because I Bonds held past the 30-year mark do not continue to earn any interest at all. Additionally, you can't cash out your bonds at all in the first 12 months you own them, and if you cash out in the first five years, you lose the last three months of interest.
Many people became aware of I Bonds in late 2022, when the rate for new I Bond purchases was 9.62% (made up of a fixed rate of 0% and a semiannual inflation rate of 4.81%). In fact, so many people were buying I Bonds at the end of October 2022 that they crashed the TreasuryDirect website. If you bought I Bonds in late 2022, here's a look at when you might consider selling them.
As we mentioned earlier, I Bonds earn interest every six months based on your date of purchase. Here's an example if you purchased your bond in October 2022, though the exact specifics will depend on your actual month of purchase:
- From October 2022-March 2023, your bond earned 9.62%
- From April 2023-September 2023, your bond then earned 6.48%
- From October 2023-March 2024, your bond earns 4.30%
So, one option for an October 2022 I Bond purchaser would be to sell in January 2024 (after 15 months of ownership). You'll get six months of 9.62% interest and six months of 6.48% interest (forfeiting the final 3 months of interest that was at 4.30%). A $10,000 I Bond purchase bought in October 2022 and sold in January 2024 would get $10,820.58 ($10,000 * 1.0481 * 1.0324). Of course, there are many other I Bond strategies that you can use.
The Bottom Line
Because I Bonds are backed by the US government, they generally carry very little risk and can protect your money from inflation. They can be a good spot to park some cash that you don't need in the immediate term, especially during times of market volatility.
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