SERIES I SAVINGS bonds have lately garnered a lot of investor interest because—if you buy during the current six-month purchase period—your initial annualized interest rate will be 3.54%. You’ll only earn that for the first six months. Thereafter, your yield will match the inflation rate. For bonds purchased between May and October, there’s no additional interest paid, over and above the inflation rate.
Still, the higher inflation climbs, the more interest your I bonds will earn. But that doesn’t mean you should cheer for higher inflation. Why not? Whatever the inflation rate, the money you have in Series I savings bonds will leave you with pretty much the same purchasing power because their value rises with inflation. But that, alas, is before federal income taxes. After taxes, the higher the inflation rate, the more you’ll pay in income taxes—and hence the further behind inflation you’ll fall.
In fact, the ideal scenario would be zero inflation. That way, you’d owe zero taxes when you cash in your bonds and thus your after-tax return would match the inflation rate. But with every tick higher in inflation, the value of your I bonds will also tick higher—and you’ll owe more in taxes when you eventually cash them in.