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What Are I Bonds? 9 Things to Know Before Investing

By Rick Orford · November 01, 2022 · 7 minute read

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What Are I Bonds? 9 Things to Know Before Investing

Series I Savings Bond rates have been rising in recent months. This is good news for investors, as Series I Bonds currently offer highly competitive interest payments with near-zero risk. For Series I Bonds issued from May through October 2022, the yield (composite rate) was 9.60% for six months after the issue date. So, is now a good time to buy I bonds?

Investors looking for a safe investment with a generally higher interest rate may want to have a look at investing in Series I Savings Bonds, commonly known as I Bonds. I Bonds are similar to most bonds in that they are essentially a loan to an entity (in this case the U.S. government), with the promise to return your money with interest. I Bonds are different in that they may offer competitive returns over time, and some tax breaks as well. Here are nine important things to know before you invest in I Bonds.

9 Important Things to Know Before You Invest in I Bonds

1. I Bonds May Offer a Higher Rate, But Not a Fixed Rate

For those looking for stability and low-risk investment returns, I Bonds may be a good option, but they are not traditional fixed-income securities. I Bonds are a type of savings bond offered by the U.S. Treasury and backed by the full faith and credit of the U.S. government. They are unique in that they offer two types of interest payments: a fixed rate and a variable rate, which together provide the bond’s composite rate.

The fixed-rate portion is determined when the bond is purchased, and remains the same for the life of the bond. The variable rate gets adjusted twice a year (i.e., May and November), based on inflation rates. Investors may hold I Bonds for up to 30 years.

As of November 2022 and through April 2023, the current fixed rate on I Bonds is 0.40%. However, the inflation rate is 6.48% — making for a composite rate of 6.89%. (The formula for the composite rate is a little more complicated than just adding the fixed and inflation rates.)

💡 Recommended: Guide to the Consumer Price Index (CPI): The Inflation Indicator

2. Your I Bond Principal Is Guaranteed

Because I Bonds are backed by the U.S. government they have a low risk of default and offer tax-advantaged interest income. Furthermore, the principal is guaranteed. This means (unlike traditional, non-government bonds) that the redemption value will never decrease. This is one of the advantages of savings bonds as a whole. As a result, I Bonds are considered low-risk investments.

3. I Bonds Offer Some Tax Breaks

Tax-efficient investors may want to consider certain I Bond features. Because I Bonds are exempt from municipal or state taxes, this can be a boon for some investors. That said, while federal taxes usually apply, they could be deferred until the bond is ultimately sold, or matures; whichever happens first.

Additionally, I Bond investors may use the interest payments for qualified higher education expenses, and receive a 100% deduction (this is called the education exclusion). Some restrictions apply, including:

•   You must cash out your I Bonds the year that you want to claim the education exclusion.

•   You must use the interest paid to cover qualified higher education expenses for you, your spouse, or your dependent children the same year.

•   You cannot be married, filing separately.

4. I Bonds Are Similar to E Bonds & EE Bonds

Investors who are familiar with the Series E Bond may also find I Bonds appealing. While Series E Bonds are no longer available from the Treasury, they can still be purchased from other investors who currently hold them. Historically, Series E bonds were also known as defense or war bonds.

Series E bonds were replaced by Series EE bonds (aka “Patriot Bonds”) in 1980. Today, like Series I Bonds, investors can buy EE Savings Bonds from TreasuryDirect .

An interesting feature of Series EE Savings Bonds is that, over a 20-year period, these bonds are guaranteed to double in value. And should the interest not be enough to double the value, the U.S. Treasury will top it up, giving the bond an effective interest rate of 3.5%.

While I Bonds don’t offer the same guarantee, because they are basically variable rate bonds, your principal is guaranteed and is likely to see a competitive rate of return since these bonds are designed to keep pace with inflation.

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5. I Bonds Are Easy to Purchase

Investors can purchase I Bonds online through TreasuryDirect in denominations over $25. The maximum amount of I Bonds someone can purchase is $10,000 per calendar year.

In paper format, investors may use their tax refund to purchase up to $5,000 a year.

6. I Bonds Are a Long-Term Investment

In general, the primary risks in buying bonds revolve around redemption. What if you need your money before maturity?

I Bonds are generally a long-term investment. To start with, investors must understand that they have their money locked up for one year. After that, investors who redeem their I Bonds before they’ve held the bond for five years will forfeit the last three months of interest. (You can redeem an I Bond after five years with no penalty.)

As a result, those looking for a shorter-term investment may want to consider investing in treasury bills.

7. Other Investments Might Offer Better Returns

One advantage of investing in stocks, mutual funds, and ETFs is that investors can potentially make a lot more money if the stock or fund does well. Similarly, you could lose money if the investment performs poorly. Since I Bonds are principal protected, you can never lose the initial investment, but it’s possible your money won’t grow as much as it could if you invested in other options, like equities.

Honorable mention: TIPS, or Treasury Inflation-Protected Securities, are also a type of government bond designed to protect investors from inflation. The principal amount of a TIPS bond will increase with inflation, while the interest payments remain fixed. I Bonds are similar to TIPS but offer additional protection against deflation.

8. It’s Hard to Predict an I Bond’s Return Over Time

To maximize your return on investment when purchasing I Bonds, it is essential to understand the differences between the two interest rate components of the bond, and how they can play out over time.

I Bonds offer a fixed interest rate, which remains the same for the life of the bond, and the inflation-protection component, which adjusts with changes in inflation rates twice per year.

As of November 2022, the fixed rate is 0.40%. It will remain that rate for I Bonds bought from November 2022 through April 2023. The current inflation rate, which adjusts twice a year, is 6.48%. The composite rate of return or earnings rate is 6.89% for six months after the issue date.

That means if you bought a $10,000 I Bond this month, you would get roughly $345 in interest for the first six months. After that, your rate would adjust. If inflation goes up, so would the rate of return. If inflation goes down, the bond’s inflation rate would likewise decrease.

While you might hazard a guess that your $10,000 could see a 6.89% return after one year, or $689 on your $10,000 investment, there are no guarantees.

And if you hold onto your I Bond for 10, 20, or 30 years, you would see some years with higher inflation rates and some years with lower inflation rates.

9. You Must Meet Certain Criteria to Buy an I Bond

To be eligible to buy I Bonds you must be:

•   A United States citizen, no matter where you live,

•   A United States resident, or

•   A civilian employee of the United States, no matter where you live.

Also, investors can only purchase I Bonds with U.S. funds. You cannot buy them with foreign currency.

The Takeaway

If you’re looking for a safe and reliable investment option, I Bonds are worth considering. They offer tax breaks and other benefits that can make them a near risk-free choice for your long-term savings goals. That said, because I Bonds come with a composite rate of return, it’s hard to predict how much your money will actually earn over time.

Fortunately, with I Bonds (as with most government bonds), your principal is guaranteed. If you buy a $1,000 I Bond, no matter what happens, you will get your $1,000 back.

If you’re interested in getting that steady rate of return, there are alternatives to government bonds, including the new Checking and Savings all-in-one bank account with SoFi. With SoFi, you can earn a competitive annual percentage yield, and you don’t pay account fees.

Better banking is here with up to 4.60% APY on SoFi Checking and Savings.


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