What are I Bonds? Should I Buy Them?
What are I Bonds?
I Bonds are inflation-protected bonds offered directly by the U.S. Treasury. These bonds mature in 30 years and compound every six months with interest.
Two components determine the rate for I Bonds:
- Fixed Rate: This rate is set at the time of purchase and never changes. The current rate is 0% as of October 2022.
- Inflation Rate: This rate adjusts every six months based on the previous six months of inflation as determined by the CPI-U (Consumer Price Index for all Urban Consumers). Currently, 9.62% as of October 2022.
To determine the total interest rate, add up both components above and factor in the semi-annual compounding. For example, say I buy $10,000 of I Bonds on October 13, 2022. The combined annualized rate was 9.62% (0% + 9.62% + 0% x (4.81%)). Over the next six months, from October 1 (the beginning of the month) to March 1, I will get an annualized 9.62%, or an effective 4.81%. In dollar amounts, the I Bonds will grow by $481 by March 1.
There are a few limitations with I Bonds. You cannot redeem them until one year has passed. If you redeem the bonds between one and five years, you will owe a 3-month interest penalty based on the most recent three months of interest paid. After five years, you are free to redeem without penalties. You can buy up to $10,000 per person per calendar year with a minimum of $25.
I Bonds are not taxed until you redeem them, so you do not have to worry about phantom income. Additionally, the interest generated from I Bonds is not subject to state and local taxes.
Should I Buy I Bonds?
The estimated annualized rate for the next 6 months from November – April is calculated to be 6.47% based on the CPI-U. If you buy them before the end of October, that means you’ll get 6 months of the current annualized rate of 9.62% followed by 6.47% annualized for the next 6 months, giving you an effective 8.20% return for a year.
With the current high inflationary environment, I Bonds are a great way to maintain purchasing power for short-term liquidity. Effectively, I Bonds are liquid after one year of holding, so they are appropriate for shorter-term goals, as long as you can wait at least one year. You can even slowly transfer your emergency fund into I Bonds, as long as you recognize the risk you take for one year of being unable to access it.
However, they maintain purchasing power in the long run, and that’s it. You will not get a real return from I Bonds (due to the current fixed rate being 0%).
Where Can I Buy I Bonds?
You may only buy them directly from the U.S. Government through the Treasury Direct website. You must make an online account and link your bank account first. They will be listed as “Series I Bonds.”