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I-Bonds Explained

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By Sarah Conwell, Fixed Income Portfolio Manager

In a world of near-zero percent interest rates, it is no wonder the 7.12% annual rate offered on Series I Savings Bonds (I-bonds) is grabbing individual investors’ attention. In this short synopsis, we will:

  • Identify the characteristics of I-bonds
  • Consider the pros and cons of an investment in I-bonds
  • Discuss the “fine print” features of the investment, and how to decide if it is the right fit for your portfolio

Series I Savings Bonds are issued by the US Treasury with an interest rate linked to the level of inflation. The bond’s value will never drop below the initial investment amount, and during inflationary periods the value is likely to increase. Every six months, the annual interest rate on I-bonds is updated. The interest rate is made up of two components: a fixed annual rate and a variable rate indexed to semiannual changes in the Consumer Price Index (CPI) basket of goods.1 When you purchase an I-bond, it accrues interest for six months. In the seventh month, the amount earned is added to the original principal amount, and you will now earn interest on the new principal amount in the following six months. This process will continue until you redeem the bonds or for 30 years, whichever comes first.

One benefit of investing in an I-bond is that it is an incredibly safe investment; its value will not drop below the original investment. Another pro is the current interest rate; the most recently calculated annual composite rate of 7.12% is high compared to investments of similar credit quality and duration. Finally, the income earned on I-bonds may be exempt from federal taxes if the owner uses the proceeds on qualified higher education expenses.

While there are certainly advantages to these securities, they likely won’t be a perfect fit for every portfolio. The primary risk is that investment in I-bonds is a bet that prices will continue to rise. The fixed rate does not change over the life of the bond, so if you purchase today, the fixed rate on your bond will be 0%.2 In the future, if prices decline or simply stagnate, you may find yourself holding an investment with an interest rate far below the initial 7.12% advertised. What’s more, if you wish to sell the bond and swap it for a higher-yielding security, you may be penalized.

This leads us to another risk, the lock-up period. The investor does not have an option to redeem the bond during the first year of investment. If redeemed after the first year but before the fifth, you will be charged a penalty equal to the previous three months of interest. If your financial situation changes, prices do not continue to rise at a steady pace, or interest rates increase in the interim, there is a possibility you may desire to redeem your bond and cannot or will be penalized for it.

Additionally, there is an annual investment limit of $10,000 per social security number3, the investor must create an account with Treasury Direct (www.treasurydirect.gov) to purchase or redeem securities, and I-bonds are not eligible to trade on Schwab, or through other brokers. Also, if you are using similar securities to supplement income, these bonds do not provide cash flow in the traditional sense. At maturity or redemption, you will receive the original investment plus all the interest earned during the time you held the security (assuming you have held it for at least five years). Finally, the interest earned is federally taxable.

If you have a smaller portfolio, need exposure to an inflation-indexed, high-quality instrument, and have an investment horizon greater than five years, I-bonds might make sense for you. However, we suggest talking with your advisor to see how they fit your overall portfolio before making any decisions. If you don’t fit the above description and still find yourself intrigued by this trending investment vehicle, there may be some alternative options that would be a better fit. Contact the Foster & Motley team if you would like to discuss what makes sense for your unique situation today.


1The calculation is = [fixed rate + (2 x semiannual inflation rate) + (fixed rate x semiannual inflation rate)]
2The fixed rate is 0% on all bonds purchased through April 2022
3An additional $5,000 of paper bonds can be purchased using your tax refund
Source: U.S. Department of the Treasury