I Bonds: Inflation-Matched Fixed Income

February 16, 2023

Estimated Reading Time: 4 Minutes 

What are I Bonds?

Series I Savings Bonds (I Bonds) are a type of savings bond issued by the U.S. Treasury. The “I” stands for inflation, as these bonds are designed to protect investors from the effects of inflation on their savings.

How Do I Bonds Work?

I Bonds have a fixed interest rate, which is set at the time the bond is issued and remains the same throughout the life of the bond. In addition to the fixed interest rate, I Bonds also have a variable interest rate that is adjusted every six months (in May and November) to reflect changes in the Consumer Price Index (CPI), a measure of inflation.

The combined interest rate of an I Bond is calculated by adding the fixed interest rate and the variable interest rate. The variable interest rate is based on the CPI, which means that it will increase if inflation rises and decrease if inflation falls. This helps to protect investors from the eroding effects of inflation on their savings.

I Bonds can be purchased online through the Treasury Direct website, in denominations as small as $25 and up to a maximum of $10,000 per Social Security Number per calendar year.

What are the Benefits of I Bonds?

I Bonds can be a useful addition to a diversified investment portfolio, especially for those who are looking for a safe and secure way to protect their savings from inflation.

Protection from Inflation

The variable component of I Bonds’ interest rates is adjusted twice a year to keep pace with inflation, or the CPI. This means that the interest rates on Series I Bonds will increase if inflation rises, providing investors with a hedge against the effects of inflation on the value of their savings.

Tax Advantages

Series I Bonds offer some tax advantages to investors. The interest earned on these bonds is exempt from state and local income taxes, and federal income tax on the interest can be deferred until the bond is redeemed. Additionally, if you use the bond to pay for qualified education expenses, you may be able to exclude all or part of the interest from your income.

Low Risk

I Bonds are backed by the full faith and credit of the U.S. government, which means they are considered to be a low-risk investment. Because they are backed by the U.S. government, there is significantly lower risk compared to corporate or other tax-advantaged bonds, which may make them an attractive option for conservative investors who are looking for a safe haven for their money.

Flexible Terms

Series I Bonds have a minimum holding period of one year, but they can be held for up to 30 years. This gives investors the flexibility to choose how long they want to hold the bond, and the longer they hold the bond, the more interest they will earn.

What's the Catch?- The Risks of I Bonds

If you redeem an I Bond after one to five years of ownership, you will forfeit the last three months of interest. This means that if you need to access your money before the five-year mark, you will pay a penalty for doing so.

There are limits on how much you can invest in Series I Bonds each year. The maximum annual purchase amount is $10,000 per person. If you have a large amount of money to invest, you may not be able to put it all into I Bonds.

There is also a limited liquidity to I Bonds. While they can be redeemed at any time after the one-year holding period, there are limits on how much you can redeem in any given year. If you need access to a large amount of your money quickly, you may not be able to get it all out of your Series I Bonds at once.

Though inflation is currently very high, the Federal Reserve is doing whatever it can to reduce it. If successful, the variable interest rate on Series I Bonds will decrease as the CPI decreases. The combined interest rate for I Bonds will not fall below zero. While the variable interest rate on the I Bonds may decrease, the variable portion is unlikely to ever turn negative unless we enter into an extended deflationary period (negative inflation, or prices decreasing), which is not the same as a period of decreasing inflation (inflation increasing at slower rates). Even in this unlikely scenario, the fixed interest rate portion of the I Bonds’ total yield would act as a bellwether, protecting the total yield and value of the investment.

Though I Bonds are available for purchase online, the Treasury Direct website is somewhat antiquated and difficult to navigate. It has a tendency to crash if too many people attempt to purchase I Bonds at once.

Additional Important Information

Series I Bonds can be a good option for smaller investors in the short term. Though the rate of return is somewhat low, they are a safe option to store savings with an inflation protection. As with any other investment, it is important to check with a financial professional to see if I Bonds are the best choice for your goals and objectives. Contact Chicago Partners for a free consultation on your portfolio if you have any questions about I Bonds or other investment management strategies.

Important Disclosure Information

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