Investment Management

Bonds, Part III

Series I Savings Bonds: ‘Inflation-proof' security offering 9.62% gross return


Series I savings bonds, also known as I bonds, are treasury securities issued by the federal government, and they have been getting a lot of attention lately due to soaring inflation rates. Treasuries, in general, are considered to be among the safest investments you can make because they are backed by the “full faith and credit”[1] of the U.S. government – meaning the U.S. government is always going to take care of its bondholders. The bonds were originally introduced in 1998 to encourage Americans to save for the future while protecting their savings from inflation, yet with inflation at 1.56% at that time, holding onto purchasing power likely wasn’t top of mind for many. The bonds are non-marketable, meaning they cannot be bought or sold on the secondary market; they earn monthly interest based on combining a fixed rate and an inflation rate that is compounded semi-annually; and they can eventually be redeemed at their full purchase price, plus interest. They are considered particularly attractive investments during high inflationary periods by design. Because they are backed by the U.S. Treasury and based on the Consumer Price Index, I bonds are one of the safest ways to hedge against inflation—and now through October 2022, I bonds can be purchased at the current rate of 9.62%. Wall Street Journal journalists Andrea Fuller and Jason Zweig interviewed the Treasury and reported: “through mid-June, $14.4 billion in I bonds have been sold, which is roughly 40 times as many sold in all of 2020 combined – more than 1.5 million accounts have been opened since November 2021, and less than a million existed prior!”[2]

In Bonds, Part I, I explained that bond prices and interest rates are negatively correlated – when interest rates go up, bond prices go down, and when interest rates go down, bond prices go up. With three aggressive rate hikes year-to-date and more projected by year-end, the Fed may be offering investors the best of all worlds with I bonds, a stable bond investment that also offers a high yield, considering the 30-year treasury rate is currently 3.3%!

How do I Bonds earn interest?

I bonds begin to earn interest monthly from the first day of the month of the issue date, regardless of the date of purchase. Unlike traditional bonds where the interest is paid semi-annually to the bondholder, the interest is added to the bond – and every six months from the bond’s issue date, interest earned from the previous 6-month period is added to the principal value, creating a new principal value. Interest is then earned on the new principal.

  • The interest on I bonds is a combination of a fixed rate and a variable semi-annual inflation rate.
    • Fixed rate of return remains constant throughout the life of the I bond. This rate is set by the U.S. Treasury Secretary every six months – on the first business day of May and November.
    • Variable semi-annual 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 rate announced in May is the percent change between the CPI-U figures over a six-month period ending prior to May 1 and November 1 of each year. For example, the earnings rate announced on May 1 reflects an inflation rate from the previous October through March. The change is applied to a bond every six months from the bond’s issue date.
  • To get the actual rate of interest, referred to as the composite rate, the fixed rate and inflation rate are combined as follows:

Composite rate = [fixed rate + (2 x semi-annual inflation rate) + (fixed rate x semi-annual inflation rate)]

The composite rate will never be less than zero, however, it is possible for it to be lower than the fixed rate. If the inflation rate is negative (because we have deflation at times, not inflation), it can offset some of the fixed rate, though the composite has a bottom of zero. To date, there have been two six-month periods that have had a composite rate of 0.00% – May 2009 and May 2015 – but I’ll take 0.00% for a six-month period of an investment over a negative return any day!

Rising inflation is considered to be bad news for traditional bonds due to the negative correlation bond prices have with interest rates, however skyrocketing inflation is considered to be good news for I bonds and helps preserve the value of the bonds. The fixed portion of the composite rate has been 0.00% since May 2020, which coincides perfectly with Covid, but with inflation rates spiking as high as they have been, the composite rate of the bonds is presently the highest it has ever been!

Figure 1 provides a look at the historical fixed rates, semi-annual inflation rates, and composite rates of I bonds since their inception in 1998 — not too shabby, in our view!

Figure 1. Historical I Bond Rate Chart

SOURCE: TreasuryDirect


How long must I keep an I bond?

I bonds have a 30-year life span unless you redeem them first. You can redeem them as early as one year after purchase, but if it’s before five years, you give up three months of interest as a penalty.

When comparing national deposit rates provided by the Federal Deposit Insurance Corporation as of June 21, 2022, even after factoring in the three-month interest penalty, I bonds are considerably more lucrative than other deposit alternatives.

Figure 2. National Average Deposit Rates as of June 21, 2022

Source: FDIC

*I Bonds current rate of 9.62% is for bonds purchased now through October 2022. Rate will be adjusted based on CPI-U at that time.

How do I purchase I bonds?

  • Electronic Form

Open an online account with the U.S. Treasury at Then, electronic I bonds can be purchased in any amount, to the penny, for $25 or more through your online account.

  • Paper Form

Purchasing paper I bonds is completed through your tax return, by including IRS Form 8888 and completing part 2 to tell the IRS you want to use part (or all) of your refund to purchase paper I bonds. Purchase amounts must be in $50 multiples. Once your tax refund has been processed by the IRS, your paper savings bonds will be mailed to you. Also – this may go without saying, but if you don’t receive a tax refund, you cannot purchase paper I bonds.

  • Purchase Limits

One of the pesky things about I bonds that can be a turnoff for investors is the annual purchase limits. The limits apply per social security number, meaning individuals may purchase additional bonds through separate tax IDs for minors as gifts or for entities including trusts, estates, corporations, partnerships, etc. in some cases. The annual limits are $10,000 for electronic form and $5,000 for paper form bonds — the paper limit applies to individuals and couples.

Tax Perks & Planning

Income tax applies at the federal level, but not at the state and local levels. There are also certain tax benefits that may be available when the bond is cashed if the money is used for higher education. Also, investors have the discretion of reporting the phantom interest (phantom since it’s accrued, but not paid out until maturity or redemption) on their federal return either every year or for the year when the bond matures or is redeemed. Deciding whether to claim the interest each year or defer it until redemption should be made on a case-by-case basis by each individual investor — your financial advisor can help determine what is most appropriate for your situation. In the event you choose to defer the interest, remember to pull your own 1099 form each year from your TreasuryDirect® online account, by clicking ManageDirect®, and then under Manage My Taxes, you will see the document for download.

In the event you receive an I bond as a gift, something to keep in mind is that the owner of the bond is liable for the taxes due, regardless of who purchased the bond.

How to redeem an I bond

Electronic I bonds can be redeemed on the TreasuryDirect® website application and paper I bonds can be redeemed at some local financial institutions or by mail. Additionally, you do not have to cash out the entire bond all at once. For example, if you purchase a $10,000 bond, you can redeem $2,000 at any point after the 12-month mandatory holding period, keeping in mind the 3-month interest penalty if you’re redeeming it prior to five years. If you’ve deferred the tax reporting on the interest, the pro-rata amount would be reportable at redemption.

Estate Planning Considerations

When purchasing I bonds, the registration information is an important decision regarding estate planning. The choices given on TreasuryDirect® are Sole Owner, Primary Owner, and Beneficiary; and when purchasing bonds through your tax return, there is also a choice of Co-Owner.

  • Sole Owner: If you purchase the bond under the registration of sole owner, you are the only one who can make transactions, and, if you die, the bond will become a part of your estate and must go through probate. This may be a suitable choice when purchasing a bond under the name of a trust or company, but when purchasing as an individual, you should always select a beneficiary. There is not an option to name more than one beneficiary on a bond, so if you wish to do so, you must purchase multiple bonds to divide the investment and designate a separate beneficiary for each.
  • Primary Owner: This registration uses “WITH”, for example JOHN DOE WITH JANE DOE. The first-named owner is the primary owner, John Doe in my example, and would have primary ownership of the account. The second-named could view the account but could only make transactions on the account in the event of the primary owner’s death.
  • Beneficiary: Only the owner may make transactions. If they die, the beneficiary becomes the only owner. The beneficiary cannot be an entity.
  • Co-Owner: When purchasing paper I bonds, you have the option of selecting co-ownership as a registration. This registration uses “OR,” for example: JOHN DOE OR JANE DOE. Either owner may cash without knowledge or approval of the other; but for most other transactions, both owners must sign. If one owner dies, the other owner becomes the sole owner.

Do bonds make sense for me?

I bonds should not be a substitute for an emergency savings fund since they have a one-year minimum holding period and your emergency fund should be fully liquid, in cash, ready to deploy. However, laddering a series of I bonds overtime (similar to the bond laddering strategy discussed in Bonds, Part II), would make it possible to have an I bond reaching that one-year minimum holding period every 12-months – creating liquidity in the event it is needed.

Alternatively, if you have more than enough cash tucked away for emergencies in a high-yield savings account to fund your near-term needs and are seeking a guaranteed investment to protect your cash from inflation, I bonds are worth considering as an alternative to stash some of your surplus cash, but they should not be used as a replacement for an emergency fund. If you have additional questions about I bonds, or any details related to your personal finance situation, reach out to your relationship manager to address your needs.

Since the inception of I bonds in 1998, there have been 49 inflation rate adjustments. Only two of those have been negative – and remember the investment is virtually risk-free since the composite rate can never be less than zero! While the Fed will ultimately succeed in weakening inflation, the question is how long it will take and whether it will send the economy into a recession. As we see inflation begin to subside in the coming months/years, the inflation rate portion of the I bond’s composite rate will also go down, but in the event inflation continues to rise, there’s a good chance we’ll see double-digit returns from I bonds when the November composite return is released. Generally speaking, when something seems too good to be true it usually is, but occasionally something checks out — and that is the case with I bonds!


Previous in Series:

Bonds, Part I: How Interest Rate Increases Affect the Bonds in Your Portfolio

Bonds, Part II: How can laddering bonds help to de-risk a portfolio?


[1] Investopedia, Full Faith and Credit
[2] WSJ, If Inflation hasn’t made you crazy, try buying an I bond

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