In This Article
What are I Bonds?
Inflation linked Bonds (I Bonds) are 30 year bonds which pay interest semiannually. They are a popular investment right now because they are currently yielding 9.62% risk free. Though popular, there are some quirks that you should know prior to investing:
- The interest rate is determined by the Consumer Price Index (inflation rate) biannually. This means your rate can (and will) change. Generally, their return is 1% higher than the current inflation rate.
- The current rate is based off the 8.62% inflation rate and is good until October 2022.
How Do I Bonds Work?
Unlike other bond types, the interest earned is not paid out. Instead, it gets added to the value of the bond. The interest is paid out biannually and is added to the total value of the bond. Then, the rate is re-adjusted to what the CPI is at that time- plus 1%. This cycle repeats and compounds. The next interest rate applied will be applied to the new total value of your bond, which includes interest from earlier payments.
Is the Interest Taxable?
The interest on an I Bond is taxable on your federal income only. Per the treasury, you have a few options to handle that:
You can elect to report the interest earned for a given year on your tax return.
Defer payment on interest earned until one of the following:
- You cash out
- You give up ownership and the bond is reissued (selling the bond on the market).
- The bond stops earning interest because it has reached maturity (30 years).
There is one exception. If you use an I bond to pay for education you can be exempt from taxes on the interest. If interested, the details can be found here.
How To Buy an I Bond
You will need to make a treasurydirect account which you can do here. Once you have an account you can buy them anytime. The minimum is $25. You can buy any amount greater than $25 and up to $10,000.
If you are so inclined, you can buy physical I Bonds. They are available in the following denominations:
The only way to buy physical I Bonds is buy them when you file your tax return. Basically, you can have all or some of your tax returns in I Bonds up to the limit of $5,000.
Bonus: How To Gift an I Bond
You can also gift someone an I Bond. In order to do so, you need to know their social security number and they also need to have a treasury direct account. Hopefully they will streamline this process a bit to be more like a 529 contribution.
I’m sure in todays day and age people will appreciate a text from you asking for their social security number so you can give them free money.
You can also gift those physical I bonds from your tax return. Little does he know it, but AJ will be receiving one in the mail this year.
Where Do I Bonds fit into your finances?
I Bonds are useful if you want to protect your savings from inflation and earn a small return. That being said, you will still need to determine the amount of savings that you have on hand for emergencies. Our calculator can help you quickly determine (or double check) this number.
In todays inflationary environment, an emergency cost more than it used to. What's your savings number?
Whatever you determine to be your savings number, you should not invest that in I Bonds. That’s because you will not have access to it for 12 months after investing-which defeats the point. Rainy day savings are dollars that you intentionally sideline from investing to give you the peace of mind when unexpected things happen.
That being said, I Bonds are perfect for targeted savings.
Targeted savings is money you are saving for a specific expense (think downpayment) that is more than 12 months but less than 5 years away.
One popular alternative to I bonds for your savings is high yield savings accounts. Some quick back of the envelope math shows how much better $10k does in an I Bond compared to a high yield savings account.
Lending Club High Yield Savings
Current Interest Rate: 9.62%
Current Interest Rate: 1.25%
I bonds are a savings tool that help your savings keep up with inflation. Although everyone is talking about the 9.62% return, keep in mind that this is driven by the consumer price index and that rate it adjusted every 6 months.
Due to their initial lock up period of 12 months you should avoid putting your rainy day savings in them. However, they are an excellent investment for savings you will need in the mid term horizon (12 months- 5 years).
For long term investments, the stock market will likey offer a much better return. If you are looking for some ideas for long term investments, check out our article: The Best Investments for Passive Income
Did you know?
1. Income in a combat zone is tax free. Where are they located?
2. You can pocket up to $500,000 in profit on a home sale tax free?
3. Reservist can deduct travel expenses from there taxes?