I Bonds - Learn You How

Series I Savings Bonds (I Bonds)

It’s been less than 1 year since I’ve discovered Series I Savings Bonds but they’ve been around quite a while (composite rates go back to 1998 on the Treasury Direct website). This short post will get you going with the basics of I Bonds.

What are I Bonds?

Series I Savings Bonds a.k.a I Bonds are savings bonds offered by the US Treasury. I Bonds are some of safest savings and investment vehicles available because they are backed by the full faith and security of the United States. The “I” in I Bonds refers to inflation because the interest rate of the bond adjusts for inflation 2x a year. Currently the annual rate of I Bonds is a whopping 7.12% which for a safe investment is outstanding.

Wait what did you say 7.12%? (Update - now 9.62% thru Oct 2022)

Yes, may have heard something about inflation this year I presume? That’s why the annual rate is so high on I bonds right now because the real inflation we are all experiencing is so high. The annual rate on I Bonds is set 2x a year in both May and November. Once you purchase some I bonds you get to keep the 7.12% annual rate for 6 months guaranteed. After those 6 months the annual rate could be higher or lower but whatever the rate is at time of purchase you lock it in for 6 months from the time of purchase. 7.12% is a fantastic risk-adjusted rate of return and even if the rate drops I Bonds are still worth keeping as part of your broader asset class allocation.

Purchasing I Bonds

Purchasing I bonds is very simple and can only be done through the TreasuryDirect website at https://treasurydirect.gov. The website is a bit dated and signing in can be a bit of pain but that’s fine because you probably aren’t going to be logging in a lot anyways. Bottom line is it works and you’ll know exactly how your I Bonds are performing because they won’t be going up and down like stocks or bonds on the open market. The minimum purchase of I Bonds is quite low at only $25 so anyone should be able to save and invest throughout the year to build up your account. If you want to make bigger purchases that is fine too and the maximum yearly limit for electronic I Bonds is $10,000 per person which is quite high.

The only other way to get I Bonds is through your tax refund and you are allowed to purchase up to an additional $5,000 in paper I Bonds but only with your tax refund. Note that if you are married you and your partner can both purchase $10,000 in I Bonds for a total of $20,000 in I Bonds each calendar year.

Risks of I Bonds

The main risk with I Bonds is the minimum holding period of 1 year. Effectively this means there is a 1 year lockup period on any money you invest in I Bonds. Once you purchase I Bonds you cannot for any reason get your money back before 1 year so keep this in mind. I Bonds can make great places to keep your cash and build up an emergency but investing all at once would be a concern with the 1 year holding period. An easy way to deal with this is to slowly build up your I Bonds account by making monthly purchases to spread out this risk over time versus a single lump sum purchase.

The other main risk with I Bonds is that after 1 year but before 5 years if you cash in your I Bonds you will lose the last 3 months of interest. I don’t view this as a big of risk as the 1 year holding period but it’s still important to be aware of. You can hold I Bonds for as long as you want but they will only earn interest for 30 years.

Tax Implications of I Bonds

The interest on I Bonds is usually deferred but there is an option to pay it annually if desired. Most people would just prefer to let the interest grow tax deferred and then you pay taxes when you decide to cash in the I Bond. In other words one way or another you will pay federal taxes on the gains from I Bonds. The good news is you don’t have to pay state and local income taxes on gains from I Bonds.

Strategies with I Bonds

I Bonds can be used in a variety of ways from everyday savings, emergency fund, retirement, or even a big ticket items like a wedding or vacation. One of the more popular strategies is to use them as part of your retirement income by helping to establish a “floor” of safe and reliable income. You can effectively build a nice and safe annuity-like product for yourself with either I Bonds or a combination of I Bonds and other Bonds such as Series EE Savings Bonds. You would start building up your account at 25-30 years out and then when retirement comes along you have guaranteed income from your savings bonds.

This is also known as a type of bond ladder but essentially you are spreading out some very safe bond investments over time (yearly maximum purchases) and then you will guarantee your income by making withdrawals once you are in retirement. This is a very important concept because we are talking about creating an annuity-like product to draw from in retirement. We don’t want to rely entirely on the stock market for retirement but we also want to take advantage of the potential gains of the stock market over time. We want to create a very safe and stable income floor and then everything else is upside risk.

Key Thoughts and Observations

One of the triggers I’ve come to realize with savings and investment vehicles are the limits. When the United States government has limits on the amount you can purchase or take advantage of that is my signal to pay attention. Some examples of this are:

401(k) Contribution Maximums
IRA Contribution Maximums
Savings Bonds maximums and eligibility

Regarding I Bonds and other savings bonds we should take advantage of these limits – especially in conjunction with our spouses. We can establish our own safe and reliable income stream in retirement and help provide ourselves with an income floor to weather the markets volatility.