U.S. savings bonds

What You Should Know About This Popular Investment

Series I Savings Bonds, or simply “I-Bonds”, have been in the news quite a bit lately with eye-catching rates. Consumers have been earning absolutely paltry rates on savings products like high-yield savings accounts, money market accounts, and certificates of deposit (CDs) for years, yet things are starting to look up.

Thanks to the Fed’s moves to hike interest rates to help with rising inflation, it’s not uncommon to see savings accounts earning northward of 4% right now, and the same is true for other no-risk or low-risk financial products.

That said, there’s another type of savings vehicle that has been growing in popularity over the last few years. With Series I Savings Bonds, you could be earning well over double the top rate you would be earning with a savings account. Not surprisingly though, there’s a catch.

How Do I-Bonds Work?

Series I Savings Bonds are government-backed bonds that help consumers fight against inflation. While rates for these bonds adjust every six months, the current rate of 6.89% applies from November 1, 2022 to April 30, 2023.

Series I Savings Bonds can be purchased on TreasuryDirect, and they earn interest for up to 30 years depending on how long you wait to cash them out. You have to wait at least 12 months to cash out an I bond, meaning these bonds aren’t that great for emergency funds that might need to be accessed with short notice.

You can cash out your I bond any time after that, but you’ll pay a penalty of three months of interest if you cash out your Series I Savings Bond before five years are up. If you keep an I bond open for 24 months before accessing your money, for example, you would ultimately earn the first 21 months of interest.

Another benefit of Series I Savings bonds is the fact that they’re not taxable on the state and local level. Plus, they’re backed by the federal government, so there’s no chance you could lose the principal of your investment and the rate is guaranteed.

The Biggest Problems With I-Bonds

Other than the fact you have to keep I-bonds in place for a minimum of 12 months and you’ll pay a penalty if you cash them out in the first 5 years, there are a few other downsides and “gotchas” to be aware of.

The first one is the fact that consumers can only buy $10,000 in electronic Series I Savings Bonds per year. A couple can buy $20,000 in I bonds, and families can invest in I bonds for their kids. However, this cap is very limiting and it dramatically lowers the number of purposes you can use I bonds for.

Second is the fact that Series I Savings Bonds don’t always earn exceptional rates. The 6.89% rate they are offering is very good right now, but that’s only because inflation is high. In other years when inflation has been on the low end, Series I Savings Bonds weren’t nearly as valuable as a wealth-building tool.

The fact is, I bonds are actually made up of two different rates:

  • A base rate good for the life of the bond
  • A variable rate that fluctuates based on market conditions

With that in mind, rates on I bonds are bound to change dramatically over time. And if the Fed manages to get inflation under control, the rate for I bonds will almost certainly plummet in a hurry.

Should You Buy Series I Savings Bonds In 2023?

Because Series I Savings Bonds are entirely illiquid for the first 12 months, they aren’t a good option for storing your emergency fund. That said, these bonds can be incredibly useful if you are trying to maximize interest earned on money you won’t necessarily need in the next year, such as part of the down payment on a home.

If you have several tiers of savings, including emergency funds, mid-tier savings and long-term savings, then it could also make sense to buy the maximum amount in I bonds with cash you won’t need in the short-term.

That said, it’s important to remember that the good times may not last forever since rates for I bonds do go up and down. In fact, the last rate on I bonds that was good through October 31, 2022 was at 9.62%, which is almost 50% higher than rates beginning November 1st of this year.

The Bottom Line

With the stock market down and inflation eating away at any income gains people have made the last few years, finding a safe and secure way to earn an exceptional rate is an incredibly smart move. Series I Savings Bonds can definitely help in this realm, although fluctuating rates and caps on bonds amounts ultimately limit their potential.

Either way, it definitely makes sense to invest in Series I Savings bonds if you have $10,000 (or less) earning a lower rate and you know you won’t need it in the next 12 months. After all, I bonds don’t have any hidden fees and their rate is guaranteed, which makes them similar to high-yield savings accounts or certificates of deposit (CDs).

And if the rate on I bonds manages to go down after 12 months, you can always cash in your bond and move your savings to an account with a better rate and terms.

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