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SERIES I SAVINGS bonds have garnered a lot of press over the past year. Thanks to higher inflation, these bonds have become a lot more attractive. Although savings bonds have historically been a go-to gift for birthdays, baptisms and bar mitzvahs, they’re more complicated than you might think. I bonds have a number of features that can confuse the average investor, me included.
Series I savings bonds, or I bonds, are designed to protect an investor from losing money to inflation. Each bond’s return has two components: a fixed rate of interest and an inflation rate. The latter is based on the Consumer Price Index CPI-U, it changes every six months and the change affects both newly purchased bonds and those that were bought earlier. Meanwhile, the fixed rate is set when you purchase the bond and it stays the same for the 30-year life of the bond you own. The fixed rate had been at 0% until Nov. 1, 2022, when it was raised to 0.4%. On May 1, the fixed rate increased again, to 0.9%.
The inflation rate that drives I bond returns is revised every six months, on May 1 and Nov. 1. When your bond is credited with that inflation rate depends on when you bought it. For example, if you purchased a bond in January, the inflation rate would be the rate announced the previous Nov. 1. Your January-issued bond’s inflation rate then changes every six months, in July and January, based on the inflation adjustment announced the prior May 1 and Nov. 1. Got that?
The combined rate for bonds bought between May 1 and Oct. 31 is 4.3%. This is the sum of the 0.9% annual fixed rate plus two times the semiannual inflation rate of 1.69%, or 3.38% annually. The actual formula is a bit more complicated, but this is close enough. For comparison, today’s 4.3% is less than half of May 2022’s meaty 9.62%
This is an area of confusion for many people. Each I bond has a six-month interest-rate period that starts on the first day of the month that the bond was bought. That bond’s rate will be the composite rate in effect on the date of purchase, and it will last for six months. When the Treasury resets the inflation adjustment on May 1 and Nov. 1, those changes won’t necessarily apply immediately to your existing bonds.
For example, I purchased several I bonds in mid-April as birthday gifts. My TreasuryDirect account shows that those bonds have an April 1 issue date. They have a composite interest rate of 6.89%—a 0.4% fixed rate plus an annualized 6.49% inflation adjustment, which was announced on Nov. 1. The bonds will continue to earn that 0.4% fixed rate for the next 30 years. The inflation adjustment, however, will change every six months, on Oct. 1 and April 1.
Another confusing aspect of I bonds: how and when interest is earned. New I bonds begin earning interest on the first day of the month you purchase the bond. That means that, even if you purchase a bond at the end of the month, you’ll receive interest for that entire month.
The way that interest is added to your I bond, however, is a bit complicated. The interest earned in any month is credited to your account on the first day of the following month. The implication: It makes sense to wait until the beginning of a month to sell a savings bond to make sure you’ve received the previous month’s interest.
Interest on an I bond compounds, but not like a traditional savings account. With a traditional savings account that compounds daily, each day’s interest is added to the principal, and the following day’s interest is calculated on the principal plus the accumulated interest.
With an I bond, the accumulated interest is compounded semiannually. This means that every six months after the month of issue, the accumulated interest is added to the principal to establish a new principal value. This is also the date when the new composite interest rate is set for your bond. The new, larger principal then earns interest at the new composite rate for the next six months.
To find the current value of your bonds, check your TreasuryDirect account or use the website’s Savings Bond Calculator. To make this even more confusing, the value of any bonds that are less than five years old doesn’t include the latest three months of interest, reflecting the three-month interest penalty for early withdrawal that applies during those first five years. This suggests that, for new bonds, you won’t see any interest show up in your account until the beginning of month No. 5.
A recent article by Harry Sit of The Finance Buff describes a clever strategy for replacing existing I bonds that have a 0% or low fixed rate with newer bonds with the 0.9% fixed rate. This assumes you plan to hold bonds for the long term. Any bonds purchased between May 2020 and October 2022 have a 0% fixed rate.
You can’t sell savings bonds in the first 12 months after you’ve bought them. But once you reach the 12-month mark, you could sell your 0% bonds and use the proceeds to purchase new bonds with today’s 0.9% fixed rate. Sit’s strategy involves waiting until at least three months after May 1, so that the three-month interest penalty you pay would be the three months when your bond is earning today’s lower 3.38% “variable” rate—the annualized inflation adjustment for the current six month period. Three months of interest at that rate is about 0.85%. With the sales proceeds reinvested at today’s new fixed rate of 0.9%, you would break even after a year.
Keep in mind that, depending on which month you bought your savings bond, you might not enter the new, low inflation-adjustment period until much later this year—and thus you shouldn’t necessarily rush to sell your low-rate I bonds this summer. Harry Sit’s article has more details. Also keep in mind that buying a new bond starts a new 12-month “no sell” period, plus the purchase would count toward the $10,000 annual purchase limit. You would also be liable for taxes owed on the interest received from the redeemed bond.
There’s a final bit of timing involving I bonds. Earnings from I bonds are subject to federal income taxes, but not state or local taxes. You have a choice of recognizing the bond’s income for federal tax purposes in the year you earn it or, alternatively, you could wait until you sell the bond to report the income. Most folks opt for the latter, so they benefit from the tax-deferral.
Richard Connor is a semi-retired aerospace engineer with a keen interest in finance. He enjoys a wide variety of other interests, including chasing grandkids, space, sports, travel, winemaking and reading. Follow Rick on Twitter @RConnor609 and check out his earlier articles.
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BTW TreasuryDirect has removed the password typewriter so it’s easy to log in using a stored password.
The keyboard is gone, but TD has also implemented two-factor identification. You will now receive a one-time passcode to enter before you get to your password. The first time it happened to me I was not able to access my email at the moment and had to come back later to make important changes. I am prepared now, of course.
That’s great news for TD users with password managers.I hope they’ve made the change to prep for supporting industry standard (FIDO2) passkeys. That typewriter approach was a means of defeating keyloggers which today seem to be a relatively rare avenue of attack.
Passwords at TreasuryDirect are now case sensitive.
Rick, this might be the best and most comprehensive article I’ve ever read on I bonds. I was fortunate to have purchased the ones I have way back in 2001 when the fixed rate was 3.00%.
Rick, this is so helpful. Thank you. I Bonds have some real advantages but their complexities (and the Treasury Direct website) are truly migraine inducing.
Like William, I jumped in a few years ago, and likewise it was John Lim’s excellent article that motivated me. The new lower rates have me thinking of cashing them in and thus simplifying a bit our financial life. I will keep your article handy as a great reference.
Thanks Andrew
Thanks Rick, another good summary. I was one of the many who jumped into I-bonds when the rates jumped a couple of years back. It was John Lim’s articles on Humble Dollar that started me thinking about I-bonds.
Besides Harry Sit you referenced in your article I also enjoy and recommend reading about TIPS and I-bonds at TIPS Watch written by David Enna. https://tipswatch.com/
For me, I like the default of being able to control the recognition of the taxable interest income on my I-bonds until I redeem them. I am in the process of converting traditional deferred retirement money to a Roth and prefer that interest income in later tax years and I can’t do with a taxable fund. I also plan to use my I-bonds in future tax years to fine tune my overall taxable income by redemption of an appropriate portion of my I-bonds near year end to hit my taxable income target.
I am past the twelve month holding period on most of my I-bond holdings so I am also thinking of my I-bonds holdings as a no market risk, inflation protected savings account combination emergency account and savings for my next car purchase.
Once you get past the initial 12 month holding period, I think I-bonds are perhaps the very best option for holding emergency funds. Your emergency funds are 100% protected against 4 types of risk: default, inflation, deflation, and liquidity. You also get tangible tax benefits. It is not too hard to build up a large emergency fund over the course of a few years (especially if you have a spouse and one or more trusts).
Thanks William for reading and commenting.
Rick, I am floored by your mastery of the I bond maze. I have several friends in I bonds and they need to pour over this article.
Thanks for the kind words Steve
thanks for the clear explanation of I bond features. super useful for anyone in the process of deciding whether to continue to hold or redeem.
As pointed out, Treasury Direct’s way of reporting I Bond value is one of the quirky, nonintuitive aspects:
And does that also suggest the interest credited at the beginning of month 5 actually pertains to month 1?
Thanks for reading and commenting
Thanks for tackling this, as it helps reinforce the plans I’d made for I bonds I’d purchased in May of last year, holding them for the next three months and then cashing them in to realize a lower three-month interest penalty.
Thanks for reading and commenting
As a retired person looking to simplify my financial life, dealing with Treasury Direct, and the low $10,000 annual limit for I-bonds makes them less appealing as a part of my portfolio. You can add inflation protection easily by buying an ETF that invests in Treasury Inflation Protected securities. ETFs such as TIP or SCHP are easy to buy or sell without limits, and since you already have a broker, you can avoid Treasury Direct. Alternatively, you can buy the TIPs themselves from your broker.
From January 2021 through last month, TIP and SCHP have had a compound annual return of -1.69% and -1.94%, respectively. That seems significantly less appealing than logging into Treasury Direct. The two financial instruments are completely different, and if the broker tried to claim otherwise, I’d be looking for a new broker that is fee only and a fiduciary.
Thanks for reading and commenting.
Rick, my hat’s off to you for tackling this topic and patiently presenting the information.
Edmund, thanks for reading and the kind words.
Very informative, thanks Rick. I knew I-bonds were kind of complicated, but not to this degree. These complications seem to me to be around the edges though, not in the category of owning something one doesn’t understand. I’ll keep holding them.
Michael, thanks for reading and commenting. I thin if you hold them for the long term the complications are not too important. I think it’s good to know a few of the rules so you don’t sell at a disadvantageous time.
Yes I agree