Many people are eager to learn about I bond pros and cons. The Honeybee and I bought $20,000 worth of United States’ Series I savings bonds in May 2022 – known colloquially as “I bonds” – in order to take advantage of their current “risk free” interest rate of 9.62%. That’s right; nine point six two percent. The latest composite rate announced by the US Treasury for the period from November through April 2023 is 6.89%.
Now I’ve bought – and sold – the ubiquitous fixed-rate Series EE savings bonds in the past. But until recently I was completely unfamiliar with the Series I bonds.
With that in mind, let’s take a closer look at how I bonds work, and how to buy them. We’ll also cover I bond pros and cons:
What is an I bond?
I-bonds are 30-year US Treasury bonds that adjust for inflation semi-annually. Simply put: I-bonds earn a variable rate of interest that’s tied to inflation. So if price inflation increases over time, then the value of the I bond goes up.
How is the I bond interest rate calculated?
The interest rate on an I bond is a composite rate that combines two separate rates. According to Treasury Direct, which is the US Treasury’s financial services website responsible for selling US Treasury bonds to the public, those two rates are:
- A fixed rate of return, which remains the same throughout the life of the I bond.
- A variable semiannual inflation rate based on changes in the Consumer Price Index for all Urban Consumers (CPI-U). The Bureau of the Fiscal Service announces the rates each May and November. The semiannual inflation rate announced in May is the change between the CPI-U figures from the preceding September and March; the inflation rate announced in November is the change between the CPI-U figures from the preceding March and September.
Yes; I realize that the CPI understates the actual inflation rate by close to a factor of two. If that’s enough to make you want to pass on these bonds, I won’t ask you to reconsider.
When it comes to I bond pros and cons, you should know that the interest rate readjusts every six months. The current 6.89% composite rate (consisting of a 0.4% fixed rate, plus the variable fixed rate of 6.49%) started on November 1. The next adjustment is May 1, 2023. So if inflation continues to climb, the interest payout will continue to increase too.
A big I bond pro is that the redemption value of your I bonds will never decline. And the interest rate can also never go below zero.
Another enticing characteristic of I bonds is that they’re tax free at the state and local level. As an added bonus, parents and students who use I bond proceeds to pay for college expenses can avoid paying federal tax too, as long as they meet the specified IRS criteria.
One final point on taxes: There’s no need to pay federal taxes on any accrued interest until you sell them. This can be especially attractive if you intend to buy and hold your I bonds for many years.
Of course, I bonds have a few cons too. These are in the form of rules that some may find to be unacceptable. Here are the primary ones:
- After you buy them, your money is inaccessible for the first 12 months
- Any withdrawals before five years will result in a penalty of three months interest (which really isn’t much of a penalty at all)
- I-bonds don’t provide any income while you hold the bond; rather, the interest accrues and is only paid when you sell, or the bond matures
- Because I bonds already come with an element of tax deferral, you can’t hold them inside an IRA
- There is a purchase limit of $10,000 per person per year; however, you can also buy an additional $5000 annually with your federal income tax refund
Are I bonds right for you?
Of course, when it comes to storing and insuring your wealth, there is nothing better than holding physical gold.
That being said, after evaluating these I bond pros and cons – and if you have a chunk of cash you can afford to tie up in a bond for at least one year – where else are you going to find a “secure” bond or certificate of deposit (CD) that is currently paying that kind of interest for your greenbacks? Especially when that debt instrument is with a “bank” – the “Bank of Uncle Sam” – that, at least in theory, can’t go bankrupt.
And, yes, I am fully aware that with the financial and monetary systems currently in severe distress right now, any bond is an”iffy” investment.
Then again, cash really isn’t any safer than US Treasuries – especially when you realize that those Federal Reserve Notes in your wallet are essentially just bonds that pay 0% interest.
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