How to Invest in I Bonds: Easy Investment With Potential Tax Benefits

A little-known savings vehicle for Americans is the I bond, or Series I Savings Bond. The U.S. Treasury introduced the I bond in 1998 as a means of protecting one’s savings. Although not everyone recommends investing in bonds, some financial experts say I bonds provide a better option for a portion of your savings than a regular savings account.

According to Forbes, I bonds are “designed to provide middle and lower income Americans with a safe inflation-protected account to use for retirement, education, and emergencies.” I-bonds aren’t ideal for stashing money you need readily accessible, like your emergency fund, but they can be a useful part of a longer-term savings plan, according to Kiplinger.

To buy I bonds, go to the Treasury website and set up an account. Since paper bonds aren't available for purchase at financial institutions anymore, you can purchase electronic I bonds at TreasuryDirect.gov.

The New York Times also explained that people can buy up to $5,000 in paper I bonds at tax time using their federal tax refund.

You need your Social Security number in order to buy I bonds, and if purchasing as a gift, you should have the recipient’s Social Security number. However, you can list your own Social Security number when buying gift I bonds without counting towards your annual limit.

The current interest rate on I bonds is 7.12 percent, which will apply for bonds issued from November 2021 through April 2022. Account holders must keep I bonds for one year and can continue earning interest for up to 30 years.

For those who cash out I bonds in less than five years, the interest from the last three months is forfeited. However, if you hold an I bond for longer than five years, there isn't an interest penalty.

As Kiplinger points out, the three-month early withdrawal penalty is less severe than those on most five-year CDs. Financial planner Matt Hylland of Cedar Rapids noted that even after paying the penalty, “you will still likely be far ahead of where you’d be if you just earned the standard interest rate on your bank savings account.”

The annual purchase limit for I bonds (per Social Security number) is $10,000 for electronic bonds with a minimum purchase of $25. In addition, there's the option to buy paper bonds with your tax refund of up to $5,000.

For I bonds, the interest rate is a composite of both a fixed rate that remains the same for the life of the bond and a variable semiannual inflation rate. CPI (consumer price index) changes impact the variable rate on bonds.

Consumer price increases of 6.2 percent from October 2020 to October 2021 caused an increase in I bond rates. The current six-month rate of 7.12 percent will likely drop in accordance with inflation when the rates reset in May 2022, Kiplinger predicted.

Longtime Boston University professor and economist Zvi Bodie is a proponent of I bonds. He told Forbes, “If you have an emergency fund that is currently sitting in a bank account or low-risk mutual fund, there is an arbitrage opportunity waiting for you.”

There are tax benefits to investing in I bonds, which are exempt from state and local taxes. The interest is tax-deferred until the bond matures or the bondholder cashes out and withdraws the money. In comparison, the interest on a savings account or mutual fund is taxed at the federal and state level in the same year it's earned.

If you use the proceeds of an I bond to pay for qualified higher education expenses in the same calendar year as the withdrawal, the interest will be exempt from federal income tax, which is another benefit of I bonds.

I bonds are considered to be a “safe” investment because the interest rate can't go below zero and the redemption value of the bonds can't decrease (you'll get your initial investment back, at least). However, remember to also use other means of hedging against inflation for the long term, such as investing in the stock market.