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‘America’s Best-Kept Investing Secret’ Is a Savings Bond From Uncle Sam

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Series I savings bonds, aka I bonds, are having a bit of a moment. Long championed by financial wonks as one of the best ways to hedge against inflation, I bonds are finally getting mainstream attention, thanks to interest rates that now far outpace similar safe investments.

The reason these government savings bonds offer such good protection against inflation is by design: the I stands for inflation. As prices for consumers go up, so do I bond interest rates. And as of this week, I bonds are paying out the second highest rate in their history: a tremendous 7.12%. That’s nearly 12 times the rate you could earn from the country’s best savings accounts at the moment.

The current interest rate applies to bonds issued between November 2021 and April 2022. On May 1, 2022, the U.S. Treasury will recalculate a new inflation rate, based on the latest Consumer Price Index.

Zvi Bodie is a long-time proponent of I bonds. Bodie is an economist and author of several investing and finance books. He refers to I bonds as “America’s best-kept investing secret,” due to their relative obscurity.

“The best way to think about [I bonds],” Bodie says, is as “an inflation-protected savings account backed by the full faith and credit of the U.S. government.”

According to Bodie, no investment is safer than I bonds, and they should be utilized by “every person with a Social Security number.”

Of course, no investment is perfectly safe, Bodie says. But he can’t imagine a scenario in which the U.S. government wouldn’t be able to pay. Historically, the U.S. government has never defaulted on bonds, he says. Not even during the Civil War or the American Revolution.

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Caveats to consider before buying I bonds

Even though they’re a safe investment and currently paying out impressive interest, savings bonds may not make sense for every type of saving.

Perhaps the biggest caveat of I bonds is that they typically can’t be cashed out for one year, similar to certificates of deposit (CD). That means they aren’t the best place to stash savings that you might need immediate access to, though the Treasury may make exceptions to that one-year cashout rule based on financial hardship, Bodie says. You’ll have to contact the Treasury directly to explain your situation.

(By the way, the current interest rates for CDs are no comparison to I bonds. Even the best 12-month CD rates are currently less than 1% APY — a far cry from I bonds’ 7.12% annualized rate. And CDs typically have minimum deposit requirements of hundreds, if not thousands, of dollars.)

Similarly, bonds cashed out within a five-year span of their purchase date have a slight drawback: You’ll forgo the last three months of interest. For example, if you cash out an I bond 20 months after purchasing it, you would receive the entire purchase price plus 17 months of interest. After five years, you can cash them out whenever or let them mature for 30 years, the maximum interest-accruing length of an I bond.

Another caveat is the annual purchase limit of $15,000, though that helps limit the benefits of I bonds to lower- and middle-income earners.

“People who benefit from this are disproportionately in the middle class,“ Bodie says. “It’s one of the few government programs that doesn’t favor the wealthy.”

The way interest works for I bonds is also worth noting before you purchase one. There are two different rates, and your bond’s interest is a combination of these two rates. One is called a “fixed rate.” This interest rate does not change over the life of your bond. The Treasury sets new fixed rates each May and November, but those fixed rates only apply to new bonds purchased within that time frame. The fixed rate has sat at zero since May 2020.

The other rate, the aforementioned inflation rate, does change over the life of your bond, with new rates set every six months. For now, the annualized interest rate is 7.12%, and you can lock in that rate for six months so long as you purchase an I bond at any time before May 2022.

Folks who purchased I bonds back when the fixed rate was above zero are particularly benefiting from the new 7.12% inflation rate. For example, on May 1, 2000, the Treasury set the fixed rate at 3.6%. People who still own those bonds are now receiving an interest rate of 10.85% on them.

Finally, keep in mind that series I bonds work differently from the other type of government savings bonds. Those bonds, series EE bonds, have a separate interest rate and will double in face value if you keep it for 20 years, the Treasury says. Both types of savings bonds are different from the bonds in any mutual funds you might own.

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Other perks of I bonds

Aside from being one of the safest investments out there, consider these additional unique perks:

  • No state or local taxes: I bonds aren’t taxable at a state or local level. When you cash them out, you will pay only federal taxes on the interest you’ve earned. You may instead opt to pay the federal taxes as you go each year.
  • Federal tax waived for education purposes: Aside from exemption from state and local taxes on I bond interest, folks who are using the I bond funds to pay for higher education may also be exempt from federal taxes, too, so long as they earn less than the income limits set by the IRS each year, currently $97,350 for single filers.
  • Value can’t deteriorate: The interest rate for I bonds can never go below zero. Because of how inflation rates are factored in, the real value of your I bond will never drop below what you paid for it. No savings account or stock can guarantee that.

How to buy I bonds

Electronic I bonds are available for immediate purchase via Treasury Direct, a government website. You will need to open an account and register the I bonds, which determines who owns them and can cash them. Electronic I bonds are available at any denomination, and you can purchase a total of $10,000 in electronic bonds per year.

Paper I bonds work a little differently. These can only be purchased using your federal income tax refund, the Treasury says. Paper bonds have an annual limit of $5,000 per year, and they can only be purchased in the following five denominations: $50, $100, $200, $500 and $1,000.

The Treasury says these purchasing limits are separate, meaning you can buy a total of $15,000 per year.

To capitalize on the sky-high interest rate, the bonds must be purchased between now and the end of April 2022.

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