Inflation is often referred to as a “silent thief.” And for good reason. If inflation is running at 3% per year and a person has $10,000 in savings, then after one year their savings will be worth $9,700 in terms of purchasing power. In other words, inflation has reduced the real value of their savings by 3%. This can be a particular problem for people who are retired and relying on their savings to support themselves. I bonds are an effective way to help investors mitigate the negative impact of inflation over time.
What are I bonds?
I bonds are a type of savings bond that are issued by the United States Department of the Treasury. I bonds are unique in that they offer both a fixed rate of interest and an adjustable rate of interest. The fixed rate portion of the I bond is set at the time of purchase and remains fixed for the life of the bond. The adjustable rate portion is based on inflation, as measured by the Consumer Price Index (CPI), and is updated every six months.
What are the benefits of I bonds?
The fixed rate remains constant for the life of the bond, while the adjustable rate fluctuates in response to changes in inflation as measured by the CPI. So, if inflation ticks up, an I bond will pay a higher interest payment. As a result, I bonds provide a relatively safe way to protect savings from inflation. In addition, I bonds are exempt from state and local taxes, making them an attractive investment for many people.
How do interest payments work?
Interest accrues monthly and is compounded semiannually. However, investors do not receive interest payments until the bond is redeemed, and you must own an I bond for one year before it can be redeemed. In addition, if you redeem the bond within the first five years after purchase, you will incur a penalty that is equivalent to the last three months of interest on the I bond.
Are I bonds taxed at the federal level?
I bonds are exempt from state and local taxes. In most cases, investors owe federal taxes on the interest earned from I bonds. However, interest earned on I bonds can be excluded from federal taxes if it is used for qualified education expenses, a feature that makes I bonds a good tool for college savings.
Because interest payments are not made until the bond is redeemed, investors have the option to defer reporting the interest for tax purposes until the year in which interest payments are distributed.
How do you purchase I bonds?
I-bonds can be purchased in denominations of $50, $75, $100, $200, $500, $1,000, and $5,000. I-bonds have a maximum maturity of 30 years and can be redeemed after one year. Generally, you can purchase up to $10,000 of I-bonds in a calendar year. However, this limit applies to entities, not individuals. If you own different trusts and limited liability companies, each of these entities can purchase $10,000 of I bonds per calendar year. I-bonds can be purchased online, through a bank or broker, or by mail.
Originally published by VanEck on November 22, 2022.
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