Why the US Treasury Series I Bond Is an Attractive Investment During Periods of High Inflation (2024)

UPDATE: The current interest rate for Series I Bonds can be found here on the US Treasury web site.

Most federal employees are familiar with US Treasury Savings Bonds, particularly Series E and Series EE savings bonds. Series E bonds (also known as the “war bonds”) were issued between May 1941 and July 1980. Series EE bonds started in January 1980 and are still available today for purchase.

All US Treasury savings bonds have the full backing and faith of the US government and are considered as “AAA” rated. They are not sold by brokerage/securities and insurance firms and no salespeople earn commission recommending the purchase of savings bonds.

With respect to Series EE savings bonds, the one investment downside with respect to owning a Series EE savings bond is that the bond offers a fixed rate of return. No adjustments are made to the bond interest in times of high inflation. A bond investment in general can be severely affected during a prolonged period of inflation.

But starting in 1998, the US Treasury offered a different type of savings bond investment called the Series I savings bond. The Series I savings bond interest structure is complicated. It is a combination of a fixed rate that does not vary over the life of the bond and an inflation rate that is readjusted twice a year.

For example, for Series I bonds issued between May 1, 2022 and Oct. 31, 2022, the interest rate is 9.62 percent, an increase from the 7.12 percent interest rate during the period Nov. 1,2021 through Apr. 30, 2022. Given the recent surge in interest rates, a Series I savings bond can be an attractive and safe investment.

Important Facts About Series I Savings Bonds

A Series I savings bond is a security that earns interest calculated based on a fixed rate and a rate that is reset twice a year based on current inflation rates. The bond earns interest until it reaches a maturity of 30 years or if the I bond owner cashes it, whichever comes first.

A Series I savings bond may be cashed at any time after 12 months. The bond owner will receive the original purchase price plus the interest earned. Since Series I bonds are meant to be long-term investments, if the I savings bond owner redeems the bond within the first five years of ownership, he or she will lose the previous three months interest.

For example, if the I bond owner redeems the bond after 21 months of ownership, then he or she will receive the first 18 months of interest income. Interest rates on I bonds are adjusted each six-month period, the interest rate cannot fall below zero, and the bond redemption value cannot decline.

A Series I savings bond is not taxed at the state or local levels. For those individuals who live in a state with state and local taxes and in particular those states with high income tax rates, Series I savings bonds can be particularly appealing. I bond interest is taxed at the federal level at ordinary income tax rates. Taxes on the interest paid can be deferred until the Series I savings bond is cashed.

Buying Series I Savings Bonds

There are two ways to purchase series I bonds, namely:

(1) In electronic form by going to the web site https://www.treasurydirect.gov; or

(2) In paper form by using a portion or all of one’s federal income tax refund to purchase one via IRS Form 8888 when filing one’s tax return. A sample Form 8888 is shown here:

I savings bonds are purchased at their face value. For example, an investor pays $500 for a $500 Series I bond. The bond increases in value as it earns interest.

I savings bonds purchased electronically come in any amount to the penny for $25 or more. For example, an investor could buy a $200.57 bond electronically. Paper Series I bonds are sold in $50, $100, $200, $500 and $1,000 denominations.

In any calendar year, an investor may purchase up to $10,000 in electronic I bonds at www.treasurydirect.gov and add up to $5,000 in paper I bonds by applying one’s federal income tax refund. I bonds that one buys for him or herself and I bonds received as gifts or transfers count towards the limit. But if a bond is transferred to an individual upon the death of the original owner, then the amount is not included in the individual’s $10,000 annual limit.

Individuals may buy I savings bonds as gifts by any TreasuryDirect.gov account holder, including to children. The dollar amount of the gifts counts towards the $10,000 annual limit of the recipient, not the giver.

Understanding Series Bond Interest Rates

UPDATE: The current interest rate for Series I Bonds can be found here on the US Treasury web site.

The interest on a Series I savings bond is a combination of: (1) Fixed rate and (2) Inflation rate.

Fixed rate

Known at the time of purchase and never changes. The US Treasury announces the fixed rate for I bonds every six months on the first business day of May and on the first business day in November. The fixed rate is an annual rate and applies to all I bonds issued during the next six months.

Inflation rate

The inflation rate can and usually changes every six months, on the first business day in May and on the first business day in November. This is based on changes in the non-seasonable adjusted Consumer Price Index for all Urban Consumers (CPI-U), for all items including food and energy. However, the change that is applied to an investor’s I bond is applied every six months from the bond’s issue date. Table 1 illustrates when a Series I bond composite interest rate changes depending on the initial issue date.

To compute the composite rate, the fixed rate of interest and the inflation rate are combined using the following equation:

[Fixed rate + (2 times semi-annual inflation rate)] + (fixed rate times semi-annual inflation rate).

The following illustrates the computation of the composite rate for I bonds issued from May 1,2022 through October 31, 2022:

Note the following facts:

1. The composite rate can be less than 0%
2. The composite can be less than the fixed rate if there is deflation that will offset some of the fixed rate, and
3. If there is severe deflation that it completely takes more away from the fixed rate, the composite rate is capped at zero. This happened in May 2015.

Which Investors Should be Attracted to Series I Savings Bonds?

It is apparent from the above discussion detailing how Series I savings bonds work that they are not as easy to understand as a simple market account or a certificate of deposit (CD). With a Series I savings bond, a decision has to be made every 6 months on whether to cash in the I savings bond in favor of a better alternative or to buy more of I bonds to lock into another favorable six-month interest rate.

Over the past 6 to 9 months, Series I savings bonds have appealed as a place to invest cash on a short-term basis for at least 12 months and longer as inflation has accelerated over the last year. This comes at a time when interest rates paid by banks and money markets continue to be minimal in spite of the Federal Reserve raising short-term interest rates.

No matter how much the Series I savings bond inflation-adjusted interest rate will be revised in November 2022, it is unlikely that investors will find a better interest rate on CDs and money market account. This means that for the short term, Series I savings bonds can be safe and above average yielding investment.

UPDATE: The current interest rate for Series I Bonds can be found here on the US Treasury web site.