I Bonds: A Safe Short-Term Investment with Some Yield

There’s been increased interest in I Bonds lately, due to a combination of low interest rates on savings and CDs and a recent increase in inflation. Physician on Fire has an excellent article on the ins-and-outs of I Bonds, including great step-by-step instructions on how to purchase them. Since he’s done such a nice job, I won’t try to recreate what he’s done here, so please go read his article and then I’ll add a few more thoughts below.

I just want to reiterate some of the disadvantage that he points out, just because a fair number of folks overlook them. First, you have to lock up your money for 12 months. The only way to get your money before that would be in the case of a natural disaster. Once you hit 12 months, you can redeem any time, but if you redeem before five years you lose the last three months worth of interest. Neither of these are particularly bad, just something to be aware of. You wouldn’t want to put all of your emergency fund in I Bonds due to the 12-month lockup (although once you pass the 12 months it could then become part of your emergency fund), and if you are anticipating using the money sooner than five years, just be sure to factor in that 3-month interest penalty.

It’s also important to remember that your interest rate resets every 6 months. Lots of folks are attracted to them right now because they are paying 7.12%, but realize that six months after you buy them they will reset to the current interest rate, which could be higher or lower than 7.12% (and likely to be much lower if the current inflation surge turns out to be temporary). Again, not a reason to not get them, but some people seem to think they are locking in 7.12% forever. As the article points out, however, if you purchase the maximum $10,000 per person now, and then make your 2022 purchase of $10,000 before May, both will get the 7.12% rate for 6 months from the date of issue.

As PoF points out, if you end up using the proceeds from the I Bonds for qualified education expenses and your income doesn’t exceed the limits (phase-outs currently start at a MAGI of $83,200 for single, $124,800 if married filing jointly), the interest is then tax free at the federal level (it’s already tax free at the state level). An interesting variation on this would be to cash in the I Bonds and then invest the proceeds into your state 529 program if it has a tax break. So, for example, if you’re in Colorado you could invest in I Bonds now and, assuming you have a 529 plan that you’re funding, take the money when you redeem it and invest it in your Colorado 529 plan. This would not only make the interest from the I Bonds tax free, but then you’d get the 4.55% return from the Colorado state tax deduction for your contribution.

So, are I Bonds a good place to put money that you might want to spend in the next one to five years? As always, it depends on individual circumstances, but it is a good, safe option for a lot of folks. Just don’t expect that you’ll be earning 7.12% for the full one to five years if you purchase I Bonds now. (For a more speculative option currently paying 9%, check out this post, but note that BlockFi is not backed by the full faith-and-credit of the U.S. Government.)

Update April 2022: While we won’t know for sure until the Treasury Department announces the rate in May, folks are projecting that the rate starting May 1, 2022 will be around 9.62%. If I Bonds fit into your portfolio somewhere, I would recommend considering purchasing them before the end of April. That will lock in the 7.12% for six months, and then the (possibly) 9.62% for six months after that. That will get you to the 12 month mark (when you are allowed to cash them in with that 3-month penalty) earning over 8%. If inflation stays high, you can leave it there longer. If it drops precipitously, you can withdraw it and invest somewhere else. Even with the 3-month interest penalty, it will earn much, much more than in a typical savings account.