How Do I Bonds Work?

Freaking out over growing prices at the store paired with a sinking stock market? I bonds may be a good haven for you.

The U.S. government issues I bonds as a way to raise money. Think of them as a loan on which the government will pay you interest every month, in this case, linked to inflation.

We have detailed below how I bonds work and how you can buy and sell them.

I bonds are issued by the U.S. government. Bonds are loans upon which the issuer (in this case the U.S.) pays interest and also gives back the original investment when the bond matures. Let’s say you buy $100 in I bonds. You can expect to receive monthly interest that includes a fixed rate, at 0% now, and an inflation-linked rate, currently at 9.62%.[1]

I bonds mature in 30 years, which means you can earn interest on that investment for 30 years, after which you get your original $100 back. However, you can get out of your investment after 12 months, though you will be penalized three months’ worth of interest. After holding the bond for five years, you won’t be penalized for withdrawal.

Back to the interest rate that the government pays you. The inflation-linked portion changes every May and November, based upon a consumer price index, which measures the cost of several items, including food and energy.

The rate change goes into effect in May and November. You can buy the bonds at any time, and the rate that is in effect the day you buy it will last for six months and then be updated based upon the most recent change, be it in May or November.

You can purchase up to $10,000 of I bonds on the Treasury’s web site each calendar year, with a minimum of $25.

You can buy them only on the TreasuryDirect website, where you will be asked to sign up for an account. The interest is added to the bond until it reaches 30 years or you cash it in, whichever comes first.

You can only purchase paper I bonds using your federal tax refund. And you can buy up to $5,000 of paper I bonds per year. This can be in addition to I bonds you purchase on the Treasury website.

So you could get up to $10,000 in I bonds online and $5,000 of paper I bonds with your tax refund for a total of $15,000 in any given year.

For paper bonds, you can buy them in increments of $50, $100, $200, $500 and $1,000.

Any individual can buy I bonds, including children, who can also be gifted the bonds.

“I bonds can be purchased by individuals and by trusts,” says Akeiva Ellis, a Certified Financial Planner who writes for young adults at The Bemused. “This includes children under 18 if the minor has their adult custodian create a minor linked account. I bonds cannot be purchased by businesses.”

I bonds are considered a safe bet as they are backed by the U.S. government.

The interest rate can’t go below zero and the redemption value of your I bonds can’t decline.

Ellis points out that the I bonds being issued right now have the highest inflation-linked rate to date. So you could capitalize on these rates as long as you’re OK with not cashing them in for a while.

That said, the risk of investing in I bonds is that you might be missing out on a more lucrative investment. It all depends on your individual situation and appetite for risk.

I bonds are taxed at the federal level but you might be able to avoid the taxes if you use the funds to pay for higher education, Ellis says. If you do have to pay taxes, only the interest you’ve earned would be taxed, not your original investment. I bonds aren’t taxed at the state or local levels.

“When it comes to reporting interest, you have options,” she says. “You can either report the accrued interest each year or defer until you either cash in the bond, surrender ownership of or gift the bond, or the bond reaches its maturity year and stops accruing interest, whichever happens first.”

If you report your interest every year, Ellis says you need to continue to do so on that basis, and for any you buy in the future.

I bonds can help you mix up your investments.

“I bonds are a great choice for long-term investors looking to diversify their portfolio or someone looking for a place to park their excess cash for a couple of years,” Ellis says.

That means if you want to invest in the short term, I bonds might not work for you. Take this route for your long-term investments as a way to slowly build wealth, and as a haven from market volatility.