Series I Bonds: A Small Dollar Investment With Big Returns

March 2022

Barbara O’Neill, Ph.D., CFP®
Distinguished Professor and Extension Financial Management Specialist Emeritus
Rutgers Cooperative Extension

On November 1, 2021, the U.S. Treasury department announced a 7.12% interest rate on new Series I savings bonds. This rate is in effect through April 2022 and is the second highest rate in Series I bond history. I bonds have been called "America's best-kept secret" and pay significantly higher interest rates than most savings accounts and CDs.

Consumers collectively lose billions of dollars annually in interest by not using higher-interest savings alternatives to bank accounts. Below are ten "need to knows" about Series I bonds:

1. Inflation Protection- Series I bonds are designed to protect savings from inflation. They have been available since 1998, are sold at face value (e.g., $50 for a $50 I bond), and provide inflation-protected earnings for up to 30 years.  Twice a year- on the anniversary and semi-annual anniversary of its issue date- the earnings rate of an I bond will change to reflect an adjustment for inflation.
2. Portfolio Diversification- Inflation-indexed bonds are a nice compliment to stocks or growth mutual funds in an investor's portfolio. They reduce portfolio volatility by diversifying investment risk while also providing an inflation hedge. Inflation reached a 31-year high in 2021 and significantly reduced consumer purchasing power.
3. Interest Rate Calculation- I bonds pay a combination of two separate rates: a fixed rate of return (currently 0%) and a semiannual inflation rate. Each May 1 and November 1, the Treasury Department announces a rate of return that applies to all I bonds issued during the six month period that begins on those two dates. Inflation is measured by the "Consumer Price Index for all Urban Consumers" (CPI-U).
4. Interest Earnings- Here is an example of how Series I bond interest is applied. Let's say someone buys an I bond in October. The I bond will grow at the earnings rate announced during the previous May. Six months later, in April, the I bond will pick up the earnings rate announced during the previous November. I bonds are backed by the full faith and credit of the U.S. government and their yield can never be less than zero in the event of deflation.
5. Tax Advantages- Earnings on Series I bonds are exempt from state and local taxes. This increases an investor's return when compared with other cash assets. I bond earnings can be deferred until the bonds are cashed in or they stop earning interest after 30 years. Investors cashing in I bonds before five years are subject to a 3-month penalty. For example, if investors cash in a bond after only 18 months, they would earn interest for only 15 months.
6. Purchase Amounts- Series I bonds are ideally suited for low- and moderate-income investors with small sums to invest. Compared to amounts required to buy many investment products (e.g., thousands of dollars for some mutual funds), Series I bonds can be purchased in denominations as low as $50 for paper bonds and $25 for electronic bonds. Maximum purchase amounts per year are $10,000 for electronic bonds and $5,000 for paper bonds.
7. Long-Term Growth- Over time, the earnings on Series I bonds can be impressive. The U.S. Treasury Department has an online calculator for bond holders to track the value of paper bonds and build an inventory that can be saved and updated periodically. Users enter the denomination amount and serial number for their bonds.
8. One Year Holding Period- Investors must hold I bonds for 12 months before cashing them out. Therefore, they are not a good fit for emergency fund cash that might be needed upon short notice to pay for unexpected expenses such as vet bills and car repairs. The U.S. Treasury can, however, make exceptions for financial hardship.
9. Flexibility- Series I bonds are a useful vehicle for funding mid- and long-term financial goals. After five years, bond holders can cash them out without any interest loss penalty or they can let them mature for up to 30 years, which is the maximum length of time that bonds pay interest.
10. Estate Planning Features- Some older adults may be concerned that they will not live long enough for a 30-year Series I bond to fully mature. Not to worry. I bonds can be jointly owned or they can be registered in a POD (payable-on-death) format for a POD beneficiary to inherit. If the bonds are in the name of one person only, they become part of that person's estate upon death and will pass according to the terms of the owner's will or state intestacy laws.

If you want to hedge inflation and earn a higher-than-average return on a fixed-income asset, consider buying I bonds.