What are Series I Savings Bonds?

Last week I noted that Series I Savings Bonds are now paying 3.36% (current as of 11/09). Given current CD rates, this makes them a rather attractive alternative to bank CDs. That being said, a lot of people aren’t familiar with them, and are thus unlikely to use them.

What is a Series I Savings Bond?

Series I Savings Bonds (also referred to as “I Bonds”) are a low-risk, inflation-indexed savings instrument issued by the Federal government. Unlike CDs, which have a fixed interest rate, I Bond rates are adjust semi-annually based on the prevailing inflation rate, in May and November.

The I Bond rates is actually made up of two components, a fixed rate that sticks with the bond over its lifetime and a variable rate that changes every six months based on the Consumer Price Index (CPI).

How to Purchase I Bonds

You can purchase I Bonds in one of two forms: electronic or paper. Electronic purchases are done via TreasuryDirect, whereas paper bonds can be purchased (with no fee) from most banks.

The primary limitation with I Bonds is that you can only purchase $5k worth of them (per format, so $10k total) per calendar year per social security number. The good news is that you can convert your paper bonds into electronic format following the purchase.

Electronic I Bonds can actually be purchased in any amount between $25-$5k, whereas paper bonds are issued in denominations of $50, $75, $100, $200, $500, $1000, and $5000.

Advantages of I Bonds

Aside from providing inflation protection, I Bonds offer some tax advantages, as well. For starters, the interest accrues within the bond itself, so you are not taxed on the proceeds until you choose to redeem the bond (more below).

A second tax advantage is that I Bonds are not subject to state income tax, such that the tax equivalent yield is actually higher than that of an equivalent, fully taxable investment.

Note: Jim also made the excellent point in the comments that interest on I Bonds (as well as EE Bonds) is tax-free if used for college tuition (with some restrictions; details).

Redeeming I Bonds

I Bonds have to be held for a minimum of one year before they can be redeemed, and they cannot be transferred through market sales. In other words, once you buy one, your money is locked in for 12 months. Period.

You can redeem your I Bonds between 1-5 years after purchase for a three month interest penalty. After five years, you can redeem your I Bonds without a penalty. If left untouched, your I Bonds will continue to earn interest for up to 30 years.

Are I Bonds right for you?

The answer to this question will depend on your circumstances, but I’m of the opinion that I Bonds can be a great alternative to CDs. The reason for this is that they provide inflation protection and they also offer a few tax advantages (noted above) as compared to CDs.

Look at it this way… If you buy one today and have to break it in a year, you’ll have earned a little better than 2.5% after paying the three month penalty (assuming rates remain the same). In the mean time, if inflation kicks up, so will your interest rate.

14 Responses to “What are Series I Savings Bonds?”

  1. Anonymous

    Hi. At 37,which bonds do you recommend for myself? Long term Short term.. Can you also tell me which bonds are better for my 10yr old daughter? Thank you much….

  2. Anonymous

    Nickel, this is a terrific post with lots of clear information on something I’m going to start adding into my portfolio. I’ve had it on my “should I do this?” list since turning 35 (I’m 37 now). You answered almost all of my questions (I did follow up research on I bonds vs TIPS). I love that they have a 30 year maturity and that the interest accrues tax-free. Thank you for the information! This has spurred me into action!

  3. Connie: Correct, the fixed rate was 0.1% for bonds purchased from May-Nov 2009, and the inflation rate was negative enough to wipe that out (and then some). The variable portion has since adjusted (as of November 1) and those bonds are now paying 3.16% (0.1% plus the variable rate).

    All I Bonds are subject to the same variable rate, they only differ in the fixed rate, which is set at purchase. As such, I Bonds bought earlier this year are slightly behind the curve, as the fixed rate was 0.1% vs. 0.3%.

    As an aside, if you’ve owned your I Bonds for 1-5 years and the rate falls to zero again, you can simply hold for three more months at 0% and then cash them in (if that fits with your plan) and there won’t be a penalty (three months worth of 0% interest is $0).

  4. Anonymous

    What you haven’t mentioned in this article is the fact that any I bonds that were purchased before 5/01/2008 are at this time paying 0% interest rate. Does anyone know why this is when new purchases are paying 3.36% interest.

  5. Anonymous

    Arthur Levernier – I bonds aren’t the only bonds the government sells to borrow money (from China, US funds, anybody really). In fact, if you want to lend money the the US government on the same terms that China gets, you can buy the same bonds at auctions directly from the government or at secondary market through your broker – as many as you want. Here are the rates from the last auction: http://finance.yahoo.com/bonds As you can see over 3% is for regular 10 year bonds. These rates are NOT adjusted for inflation, so if there is high inflation you’ll still be getting 3.47%. Or if you need to sell them on secondary market before maturity they may be worth less; will worth less if there is inflation. Or if you want inflation protection, you can buy as many TIPs as you want.

    I bonds are different – they are bought and sold directly from treasury and they aren’t traded at secondary market.

    I bonds purchase’ limits are for everyone, including Chinese. Not sure why they introduced limits, but some bloggers wondered if the government is no longer interested in selling I bonds as they turned out more expensive for the government. Before 0% during last 6 months there was a period of around 6% if I remember correctly. But who knows what the real reason for the limit is.

  6. Anonymous

    Why are U.S. Citizens only allowed to purchase I Bonds $5,000.00 per S.S. number when our country needs money. Is it true that China borrows money from the U.S. and they receive 3% interest? Wouldn’t it be better for our citizens to be able to buy all the I bonds they want?

  7. Anonymous

    Not that it is a major threat, but it should be noted that if we experience deflation, these bonds can actually return 0%. I suppose 0% is better than losing money, but it is worse than even liquid savings. All Series I bonds ever issued paid 0% from May to November this year.

  8. Anonymous

    That does make them a pretty good alternative to CD rates, most 12 month rates aren’t 2.5%, so even with the penalty, a good option. Plus, with inflation indexing…hmmm, may have to look more closely at these!

  9. Anonymous

    I just recently signed up with Treasury Direct and look forward to getting a few bonds to start with. Having the money locked away with penalties if I touch it is a good incentive to keep it saved.

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