What is an I-Bond?
US Treasury Series I-Bonds (I-Bonds) are inflation-adjusted savings bonds. Interest compounds every six months (May and November), and the rates are also reassessed at that time. The annual interest rate for I-Bonds purchased from November 2022 through April 2023 will be 6.89%. The stated rate applies for the first 6 months that you own the bond.
With the annual Consumer Price Index (CPI) rate exceeding 7% for the ninth consecutive month, I-Bonds are an attractive alternative to consider for emergency reserves and cash balances. They are guaranteed by the Federal government.
Taxes on the interest earned can either be paid in the year earned or deferred until the bond is redeemed.
How does an I-Bond’s interest work?
Two components dictate how an I-Bond earns interest. There is a fixed rate and an inflation rate. The fixed rate is the amount of interest you will receive which is established whenever you purchase the bond. This amount will never change as long as you hold the bond. To provide some perspective, for I-Bonds purchased between 11/2022-4/2023, the fixed rate is 0.4%. For bonds purchased between 5/2022-10/22, the fixed rate was 0%.
The inflation rate will fluctuate and is reassessed every 6 months. The inflation rate is based on the Consumer Price Index for all Urban Consumers (CPI-U), which is published by the U.S. Bureau of Labor Statistics. As this index fluctuates, so will the interest rate of an I-Bond.
The interest that an I-Bond earns is on the first day of the month that the I-Bond is purchased and is credited twice a year to the value of the bond, thereby resulting in the bond benefiting from semi-annual compounding.
I-Bonds will continue to earn interest until either the bond is cashed in/redeemed or the bond matures after 30 years.
There are some limitations to I-Bonds to be aware of:
- I-Bonds can only be purchased through the Treasury Department’s website, treasurydirect.gov. They cannot be purchased by investment advisors on behalf of their clients.
- An I-Bond CAN NOT be redeemed for at least one year from the date of purchase and must be redeemed within 30 years.
- If an I-Bond is redeemed within 5 years from purchase, the owner will be forced to forgo the last three months of earned interest.
- The current annual cap on I-Bond purchases is $10,000 per person per year, although an additional $5,000 can be purchased with funds owed from a tax refund, and $10,000 can be purchased with a Trust.
Bottom Line: I-Bonds have received a lot of attention over the last year due to their high-interest rate. While these rates will not last forever, I-Bonds will continue to be a useful tool for investors – either as a component of a cash reserve or as a secondary source of inflation-protected income in retirement.