What Are I-Bonds and Why You Should Buy Them in 2023

There has been quite of lot of discussion in previous months over Series I Bonds, or I-Bonds.

I-Bonds are U.S. Treasury issued savings bonds created in 1998 to give the average American a way to save that would be guaranteed to hold its buying power.

Let’s see how we can maintain the purchasing power of our hard earned assets using I-Bonds.

This entire article contains information publicly available on the TreasuryDirect website.

How are I-Bonds a hedge against inflation?

An increase in inflation is a decrease in the value of the dollar.

Inflation increases the price of goods and services, which effectively decreases the amount of goods and services we can buy with a dollar in the future.

I-Bonds protect us against inflation and deflation. I-Bond interest rates are guaranteed to follow the current inflation rate (as measured by the Consumer Price Index, or CPI), but it will never go below 0% (even if CPI is negative).

The value of our I-Bonds is guaranteed to increase. It will either grow with inflation or remain the same in the case of deflation.

What are the limitations of I-Bonds?

There are a few restrictions when handling I-Bonds:

  • I-Bonds can only be cashed out after year 1
  • I-Bonds cashed out before year 5 will lose the last 3 months of interest
  • We are limited to contributions of $10,000 per year plus up to $5,000 in paper I-Bonds if we elect to receive our tax-refund back as I-Bonds

A little trick for cashing out before 5 years: if we cash out our I-Bond during a time when the interest rates for previous 3 months of interest are 0%, we won’t lose any interest.

How are I-Bond interest rates calculated?

The actual interest rate, or composite rate, is dependent on two components: the fixed rate and variable rate, also known as the inflation rate.

Fixed rates. The fixed rate is fixed for the life of the bond, which has a maturity of 30 years. The fixed rate may change every 6 months. It will apply to any bonds bought in the next 6 months. While the fixed rate may change over time, it will not affect any bonds we currently own (only new bonds we purchase).

Variable rates. The variable rate, or inflation rate, will reset every 6 months based on the current inflation rate, as measured by the CPI. It will apply to any bonds we currently own as well as any new bonds we may purchase.

Given the following variables:

  • CR: composite rate
  • FR: fixed rate
  • VR: variable rate, or inflation rate

The composite rate can be calculated from the following formula:

When is interest accrued on I-Bonds?

Interest is earned monthly and compounded semi-annually.

Our account balance reflects what we have earned minus the 3 month penalty (until year 5).

Additionally, interest is earned for the entire month we own the bond. As long as the purchase clears before the end of the month, I-Bonds bought on the 28th will earn interest as if bought on the 1st.

How are we taxed on I-Bonds?

Taxed when cashed. We will owe tax on all interest earned. However, we only owe them when the bonds are cashed in, meaning we are in control of when these taxes are paid.

Tax-exempt? All interest earned is local and state tax-exempt. Interest earned can be federally tax-free if used for qualifying educational purposes while under certain income limitations.

What are the benefits of being government-subsidized?

No risk for us. I-Bonds are guaranteed by the U.S. Treasury. The government is willing to pay us money and assume all of the risk. The only way for us to lose is if the government defaults on us. But at that point, we’ve got bigger problems at hand.

No tricks. Because I-Bonds are sold directly by the government, there are no expenses, commissions, or fees. No big institution profits when we buy individual government bonds.

Additionally, we don’t have to worry about banks changing interest rates.

Why buy I-Bonds now?

High interest rates. Because of the current inflation rates, I-Bonds are paying high variable rates.

The current fixed rate is 0%, and until May 2023, the variable rate is 6.89%, which means we are getting a 6.89% annualized return for 6 months.

A small reminder. However, this rate only applies to the first 6 months we own the bond. The composite rate could drop to 0% or continue increasing, which would be great for the bond but terrible for the U.S. economy and our own finances.

What should I use I-Bonds for?

Emergency funds. Many suggest to use I-Bonds for your emergency fund, but some argue that the withdrawal restrictions make it a poor choice for an emergency fund.

Some suggest to slowly contribute every year while having an actual emergency fund. Once you have the same amount in I-Bonds out of the one-year lock up period as you do in your emergency fund, you can use your original emergency fund for whatever you’d like and mentally switch your emergency fund over to your I-Bonds.

Future payments. I-Bonds can also be a good vehicle for investing in an unknown timeline, or something that we know is at least a year out. This could be a down payment for a home or car.

How do I buy I-Bonds?

You can buy I-Bonds through TreasuryDirect.

To be eligible, you must have a SSN and meet one of the criteria below:

  • U.S. Citizen (living in the U.S. or abroad)
  • U.S Resident
  • Civilian employee of the U.S., regardless of where you lived

If you have an EIN for a trust/corporation, you may purchase I-Bonds under those entities as well.

Is TreasuryDirect a scam?

Fortunately, it is not, which is quite surprising.

There’s an onscreen keyboard, and no one understands why.

Luckily, you can bypass the on-screen keyboard for the password.

  1. Right click on the password box and select Inspect
  2. Delete where it says readonly=true
  3. Type in your password

You can of course do the same with the email input.