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Do I-Bonds really deserve the brilliant spotlight?

Series I bonds hold a unique position within one’s portfolio. With restrictions on where and how much can be purchased, I-bonds are important to help you fight inflation and market volatility. They are a mainstay of low-risk bond investments while providing a return that will fluctuate with inflation.


Series I-bonds, usually referred to as just I-Bonds, are a savings bond issued by the United States Treasury. I-bonds are drawing attention because of their current interest rate and low risk. You buy and redeem your I-bonds directly with the government. You cannot purchase them through advisors, mutual funds, or ETFs; you must use the Treasury Direct website. 




The current interest rate for i-bonds is historically high. As of May 2022, the rate is 9.62% (annualized). The interest rate is called the composite rate. The composite rate is based on two components, a fixed rate, and an inflation rate. The fixed-rate is just that, fixed. The Treasury Direct website will inform you of the fixed-rate; it will not change over the lifetime of your bond. The fixed-rate has been zero since May 2020. 


The inflation rate does change. The Treasury will announce the inflation rate every six months, based on the Consumer Price Index. The inflation rate can go negative; it has been negative twice since 1998. The inflation rate is announced on the first business day of May and November. Although the inflation rate can become negative, your composite interest rate cannot go below zero. In other words, you won’t get less than you paid for your bond!


To break down how these components impact today’s rate of 9.62%, the fixed rate is 0%; therefore, the unusually high inflation rate is causing the historically high composite rate. 

The composite rate is adjusted every May and November; it could go up or down. In November, the next inflation rate will change the composite rate. If inflation is lower in November, the composite yield will likely still be more attractive than a Certificate of Deposit or other low-risk equivalents. 


How long are we talking?


Once you purchase your I-bond, you begin to accrue interest. That interest builds; you will see it added to your bond in May and November. The interest that is added helps you to compound your earnings over time as a mid to long-term investment. I-bonds are not appropriate for a short-term investment. You cannot redeem within twelve months of the purchase. You must hold the bond for at least five years to receive the entire interest. If you redeem the bond between one year and five years, you will lose the last three months of interest. Not a terrible penalty but enough to encourage holders to hold i-bonds for at least five years. 




The amount you may invest in I-bonds has changed over the years. Currently, you are limited to $10,000 per investor each year. Another way to invest a little more in I-bonds is by using your tax return. You can buy a paper I-bond by completing Form 8888 with your tax return. The limit is lower when using your tax return; you can only buy up to $5,000 of I-bonds. The IRS has compiled a frequently asked question page dedicated to the process available here


Uncle Sam


There are two ways you can declare your interest payments for tax purposes. You can report the interest as you earn it every year. Alternatively, you can wait to report the interest until you redeem the bond or the bond reaches maturity (whichever happens first). The best approach for you depends on your tax bracket today and your anticipated tax bracket. If you are in a low tax bracket now and expect to be in a higher bracket when you redeem the bond, it likely makes sense for you to report the interest every year so that you are not lumping the interest together in a future higher tax bracket year. The interest you earn is subject to federal income tax but not state or local income tax. 


If you are going to be using your I-bonds for education, you might be happy when it comes to tax time. If you fit the criteria, you may not be subject to Federal income tax. The requirements to exclude your interest from Federal tax include an income limit; your modified adjusted gross income (AGI) must be less than $98,200 if single, head of household, or qualifying widow(er); $154,800 if married filing jointly. You must be using the bond to pay for qualified educational expenses for someone in your family, yourself, your spouse, or a dependent. In order to exclude the interest from Federal tax, you will complete IRS Form 8815


End of the road


If you do nothing, your I-bond will reach maturity in thirty years. If you’d like to redeem your bond before the thirty-year maturity date, remember the penalty you will face if you redeem before the fifth anniversary. The electronic version of I-bonds is easy to redeem. You log into the Treasury Direct website, select ‘Redeem’, and you can direct the proceeds to your bank account. You have some flexibility with redemption; you can either cash in the entire bond or just a portion. Redeeming paper bonds is a little more tedious; you will have to follow specific instructions from the Treasury. Regardless of how you cash in your bond, you will receive a tax form to help you report your interest on your tax return. 


I-bonds may not always be as attractive as an option as they are today. Ultimately your investment decision will depend on your risk tolerance and the limits unique to I-bond rules. For now, I-bonds are an intriguing possibility for investors looking for a low-risk investment with a return that will fluctuate with inflation.


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