Are you looking for an investment that will keep pace with inflation? What if we said it's also relatively low risk? You'd think it was too good to be true, right? There are many advantages to I Bonds, especially in the current market. But there are some drawbacks as well. That's why we put together this guide on I Bonds pros and cons. Let's get started!
I Bonds Explained
There's a good chance you know what a savings bond is. Perhaps you remember getting paper EE bonds as a young kid from an older relative. Or maybe you remember the moment your family finally turned them over to you.
I Bonds are another type of savings bond (though they're not typically issued on paper anymore!). Like the other bonds you might recall, I Bonds are backed by the US Treasury. I Bonds pay interest in two ways:
- A fixed rate that the US Treasury sets
- And an inflation-adjusted rate that is based on the Consumer Price Index (CPI)
They've increased in popularity lately. In fact, in April 2022, over $4 billion in I Bonds were issued. So why are I Bonds so popular now? Many people view them as another way to protect your money from losing its buying power due to the sky-high inflation we are currently experiencing. That's where CPI comes in!
Now that you have a better understanding of what an I Bond is, let's explore I Bond pros and cons to see if these savings bonds are right for you.
Advantages of I Bonds
The US Treasury has sold billions of dollars in I Bonds already this year. For a savings tool to be that popular, there have to be some perks to it, right? There are three considerable benefits to I Bonds, including one lesser-known benefit that families who hope to help their kids pay for college might really love!
One of the biggest advantages of I Bonds is how little risk they pose to investors. We often think of investments that yield high returns as ones that also involve greater risk. That is oftentimes very true, especially when it comes to the stock market.
Yet, I Bonds pose very little risk to the amount you invest. I Bonds are backed by the US government. That means that the government would have to fail for your principal to be at risk. As far as investment options go, I Bonds are virtually risk-free.
Returns Can Help Combat Inflation
People are right to worry about inflation. It can eat away at your money's buying power even when inflation isn't sky-high. Because I Bonds are tied to CPI, that means that they can often help you earn enough to keep pacing with inflation.
The fact that the stock market is in a current slump makes I Bonds particularly appealing. Over the course of a long-term investor's lifetime, the stock market should easily outpace inflation. But in periods of drops, many investors look for other ways to battle inflation.
Tax Perk for Education
Another benefit to I Bonds is that you can use them to pay for higher education. While we typically think of 529 plans or UTMAs as a means to help our kids pay for college, I Bonds are also an option.
If you use I Bonds to pay for tuition, TreasuryDirect says you can exclude some or all of the interest earnings on the bond from your gross income. This can be especially useful to people who don't get any tax benefits from 529 plans.
Disadvantages of I Bonds
There are some major benefits to adding I Bonds to your investing strategy. But like all things in personal finance–and in life!–nothing is perfect. Before you look to load up on I Bonds, make sure you understand some of the disadvantages as well.
The Future is Unknown
Every investor has likely heard that you can't predict what the market will do next. I Bonds are no different. When the rate of I Bonds previously passed 7%, people thought that rate would be as good as it gets. Then in early 2022, the US Treasury announced rates would go even higher–to nearly 10%! Not long after, rates dropped back down to just below 7%.
Now, midway through 2023, the composite rate of I Bonds is 4.30%. This is for bonds issued from May 2023 to October 2023. The Treasury Direct site always has the current rates listed, so you can watch as they ebb and flow.
When you purchase I Bonds, you lock into a set rate. So if rates go higher, you won't get that bump. While it's possible that these rates will go up, they might also go down. Timing the market isn't possible as much as we might wish it were. If you understand I Bond pros and cons, and you think that they fit in with your other financial goals, you likely don't want to worry too much about this drawback!
I Bonds Maturity Time
I Bonds are designed to be long-term investments that mature over the course of 30 years.
You can cash out your I Bonds early, though. You have to hold onto them for at least one year. If you want to dodge a penalty, though, you need to keep them for five years. Otherwise, you forfeit the last three months of interest.
If you're looking to purchase I Bonds, you want to be mindful of the fact that your money isn't very liquid. That means that it's harder to access. And that's no problem for a long-term investor. But if you are wanting to put your emergency fund into I Bonds, you might want to think again!
Limits on I Bond Amounts
I know what you're thinking! If the rate of return on I Bonds is a guaranteed 4.30% right now, I'll move over a good slice of money right now. Not so fast. There are limits on how much each individual can purchase every year.
The I Bond limits are currently:
- $10,000 per person (electronic bonds)
- $5,000 with your tax return (paper bonds)
There are also regulations around gifting and other details you might want to review. That doesn't mean you shouldn't purchase I Bonds. It simply means that I Bonds can't suddenly become your entire investing strategy.
I Bonds Purchasing Platform
Another disadvantage of I Bonds has to do with how you buy them. The platform you use to buy I Bonds (more on that later!) leaves a lot to be desired in terms of its interface. But there's not much by way of technology that savvy investors won't tolerate (we're looking at you, Vanguard).
Some users claim it's difficult to navigate. Others report that getting in touch with an actual person for live support is time-consuming. But since the Treasury is churning out billions of dollars of I Bonds each month, we can cut them some slack here.
While it's true that Treasury Direct feels dated and clunky, what it lacks in user experience, it may more than make up for with its guaranteed high return rate.
I Bonds Paperwork
Are you spoiled with a finance platform that makes it easy to grab at-a-glance summaries of your transaction history or send notifications about your money situation? You could be in for a rude awakening with I Bonds.
As an I Bonds investor, you have to keep track of your own paperwork. You want to keep a record of what you purchase and when. If you purchase more than the $10,000 annual limit, Treasury Direct will issue you a refund.
How to Buy I Bonds
Ready to purchase I Bonds? Great! You'll need to head over to the US Treasury's website at Treasury Direct. Then, you can follow these steps to buy I Bonds:
- Visit TreasuryDirect.gov.
- Create an account by clicking Open an Account,
- Check your email for your account information.
- Log in with your account number and a passcode that will also be emailed to you.
- Choose the BuyDirect option and select Series I.
- Indicate the amount you want to purchase. Note that there is a $25 minimum.
- Enter your bank account number that the money will come from.
- Decide if you want to set up recurring transactions.
- Review and complete your purchase.
- Revisit TreasuryDirect to purchase more bonds or to review your current balances.
You also want to note that you can't buy I Bonds with the money you keep in your IRA, Roth IRA, or any other retirement account. Instead, you have to purchase I Bonds with separate money. If you are someone who gets a tax refund, you might be pleased to know that you can use your tax refund to purchase up to $5,000 in paper I Bonds.
I Bonds Pros and Cons Frequently Asked Questions
Now that you know some of the main I Bonds pros and cons, it's time to get into the nitty gritty details of I Bonds. Specifically, we rounded up the most common questions we've heard people ask about I Bonds and did our best to dish on all the details.
Check out our I Bonds FAQ!
Can you lose money with I Bonds?
No, you don't lose money with I Bonds. But there are limits on how much you can purchase each year and when you can withdraw your money. If you're interested in I Bonds, you want to make note of their maturity period. I Bonds mature after 30 years.
Are you looking to get your money out sooner? I Bonds have to be held for at least one year. If you cash them out within five years, you lose the last three months of interest. So while you aren't losing your money, you are giving up some earning potential if you touch them before five years is up.
What is the difference between EE bonds and I Bonds?
If you remember our walk down memory lane from earlier, you might recall savings bonds from your childhood. Those were likely EE bonds. So what's the difference between EE bonds and I Bonds?
EE Bonds are designed to double in value over the life of the bond. After 20 years, you can decide if you want to redeem the value of the bond or let it earn interest for up to 10 more years.
I Bonds don't have a double value guarantee. Instead, they come with a fixed interest rate, plus a rate tied to the Consumer Price Index. When the fixed interest rate is high, I Bonds are an appealing option since that rate is locked in for the life of the bond.
What is the difference between I Bonds and Bond Funds?
A bond fund is made up of hundreds or even thousands of different bonds. You still earn income from interest payments (just like an I Bond!), and because it's made up of many bonds, your portfolio is subject to less risk.
Can a married couple purchase I Bonds separately?
Good news if you're married and interested in I Bonds! I Bond limits are set per person, so that means a married couple can double up on I Bonds. With a $10,000 limit on I Bonds each, you've now got the opportunity to purchase up to $20,000 in I Bonds each year if you're married.
Can I buy I Bonds for my kids?
Yes! You can buy I Bonds for your kids! The maximum amount of I Bonds that any individual can purchase a year is $10,000. That cap applies to adults as well as minors. That means that you can purchase $10,000 for each child.
The catch to this is that you need to help your child create an account with Treasury Direct (or set one up for them). You'll need basic information including full name and Social Security number. Then, you can buy the bond with your account and select the gift option, connecting it to your child's Treasury Direct account.
You also want to note that your child will take ownership of their Treasury Direct account at the age of 18. Similar to a UTMA or UGMA, your child is now in charge of that money and can do with it what they see fit.
Can my business buy I Bonds?
Sure thing! Your business can absolutely buy I Bonds. The same $10,000 yearly limit applies. In order to qualify, your business has to be a Schedule C business. I Bonds can also be purchased through living trusts.
Does the I Bond interest rate change?
Yes and no.
I Bonds contain two rates: a variable rate and a fixed rate. So when we discuss the interest on an I Bond, we are talking about a composite rate–a rate that combines the fixed and variable rates!
The variable rate is a semiannual inflation rate that is based on–you guessed it!–inflation. CPI, or the consumer price index, determines the variable rate. That part of the interest rate isn't something that you can really predict, and it does change over the life of a bond.
The fixed-rate portion of the composite rate, though, is set for the life of the bond.
And if the idea that the rate might vary makes you nervous, know that Treasury Direct says your interest rate can't drop below 0% and the redemption value can't decline.
What is the risk with I Bonds?
I Bonds are low risk. What makes them low-risk? They are backed by the US government. That means that their redemption value cannot drop.
However, just because I Bonds are low risk doesn't mean you should move all of your money into I Bonds. Generally, investors want a balance of risk. Low-risk investments tend to have a lower return. That's why you want to make sure your investment portfolio is diversified and aligns with your risk tolerance.
And while it isn't risk per se, investors also need to be aware that there are penalties with I Bonds. If you cash in an I Bond early (before the first five years it was issued), you will have to give up the last three months of interest.
Do I pay taxes on I Bonds?
Yes! You will pay taxes on I Bonds. However, the way I Bonds are structured means that you won't typically pay taxes immediately. Instead, you generally only pay taxes when I Bonds mature. You will also pay taxes if you sell your I Bonds early.
In both those instances, that is because you typically don't pay taxes until the interest from the I Bonds shows up. Then, you report the I Bond interest the same way you report other interest income on your tax return.
Additionally, there is another strategy some people may want to use when it comes to paying taxes on I Bonds. Instead of waiting for the year that you earn the interest, you can report the interest each year. This strategy might make more sense in a year when you're out of work or for a minor who has little to no taxable income to report.
To stay up-to-date on I Bond tax information, you can check the Treasury Direct website.
Final Thoughts on I Bonds Pros and Cons
I Bonds are an exciting concept right now. Many people see them as a way to battle record-setting inflation with little investment risk. Of course, there are some drawbacks, like the long maturity period and the fact that your money remains illiquid for so long.
Still, understanding I Bonds pros and cons can help you decide if purchasing I Bonds is the right money move for you.
What do you think of these I Bonds Pros and Cons? Are I Bonds worth it for you right now?
Please us know in the comments below.