What am I ? How do they work?

Part of the interest on I bonds is linked to the consumer price index.

What are I bonds in simple terms?

I’m reading, or Series I bonds, are US Treasury savings bonds. It is a relatively new Treasury security that was introduced in 1998 by the US government to “encourage Americans to save for the future while protecting their savings from inflation”.

These bonds can be purchased for as little as $50. The artwork on the bonds honors distinguished Americans like Dr. Martin Luther King, Jr., Chief Joseph, and Marian Anderson.

According to former Treasury Secretary Robert Rubin, I bonds are particularly attractive investments during periods of high inflation, as they guarantee a “real rate of return above inflation”. This is because part of the interest they offer is tied to the consumer price index, so when consumer prices rise, the interest rate on these bonds also mounted.

Generally, in the bond market, prices move inversely to interest rates: when interest rates rise, most bond prices fall, and vice versa.

Creating a high-yield treasury like this could be a way for the federal government to try to encourage Americans to keep investing in treasuries, even during periods of volatility, bear markets and recessions. Historically, the Fed countered inflation by raising interest rates. So with I bonds, the Fed is perhaps offering investors the best of all worlds: a stable bond investment that also offers a high return.

How do bonds work?

I bonds are unique in that investors get a combination of two interest rates: fixed and floating.

  1. The links I fixed rate yield is fixed at the time of purchase and remains the same throughout the life of the bond.
  2. His floating rate is adjusted every six months by the Bureau of Labor Statistics to reflect changes in the consumer price index (CPI).

Interest is compounded semi-annually and added to the principal of the bond and paid when an investor cashes in the bond or it matures.

I bonds have a maturity period of 20 years plus an extended period of 10 years for a total of 30 years. Investors face penalties for cashing in too early, which we’ll discuss below.

How much is an I Bond worth?

Currently, the interest rate for I bonds purchased between October 2021 and April 2022 is 7.12%. Compare that with the I bonds purchased between May 2021 and November 2021. The interest they offered was only 3.54% because the six-monthly inflation rate was much lower. When inflation is low, the interest rate on I bonds falls.

I Example of bond interest rate

To calculate the total interest rate of an I bond, or composite rate, use this formula:

Compound formula

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TheStreet Dictionary Terms

Here is an example of an interest rate for an I bond issued between November 2021 and April 2022:

Fixed rate: 0.0%

Floating inflation rate: 3.56%

Compound rate:[00%+(2×356)+(00%x356)=712%[00%+(2×356)+(00%x356)=712%[00%+(2×356)+(00%x356)=712%[00%+(2×356)+(00%x356)=712%

The composite rate is 7.12% and applies to the first six months of holding the bond.

What is the schedule for I Bond rate changes?

Source: TreasuryDirect.gov

Issue month New rates come into effect

January

January 1 and July 1

February

February 1 and August 1

March

March 1 and September 1

April

April 1 and October 1

May

May 1 and November 1

June

June 1 and December 1

July

July 1 and January 1

August

August 1 and February 1

September

September 1 and March 1

October

October 1 and April 1

November

November 1 and May 1

December

December 1 and June 1

How are bonds similar to TIPS? How are they different?

Another category of Treasury bonds that offers an element of inflation protection is Treasury Inflation Protected Securities (TIPS). I bonds and TIPS come from the US government and both have the highest credit rating, AAA. However, TIPS differ from I bonds in that their principal is indexed to inflation, as measured by the consumer price index (CPI), whereas with I bonds, their full payment reflects a fixed rate plus inflation adjustment.

Another difference between TIPS and I bonds relates to where they can be bought and sold. TIPS can be sold on the open market, and since older bonds often have higher yields than newer bonds, this makes them more valuable.

I bonds cannot be bought or sold on the secondary markets; when you sell them, you buy them back at face value, so there’s not much potential for price appreciation, just interest.

Why are I bonds safe investments?

Investors find I bonds attractive because they make semi-annual interest payments and are backed by the “full confidence and credit” of the US government, which means their risk of default is almost zero. They have the highest credit rating (AAA) of all debt securities, which means they are low risk. Moreover, they are considered liquid, which means that they can be easily converted into cash.

How can I buy bonds?

Investors can purchase I bonds through the Treasury Department’s website, TreasuryDirect.gov. They can be purchased in electronic or paper format. Investors can purchase up to $10,000 of I Bonds on an annual basis. They can also purchase up to $5,000 of I Bonds with their tax refund using Form 8888. The minimum investment is $50.

How are bonds imposed?

I bonds are taxes at the federal level but not at the state. Investors can choose to pay their taxes in cash or on the accrual basis. I bonds can also be held in a tax-deferred retirement account like an IRA or 401k.

Are there penalties for early redemption of I bonds? What are other important considerations?

I bonds can be held for as little as one year and as long as 30 years, but they carry early withdrawal penalties. If an I bond is sold before 5 years, a penalty of 3 months interest is applied.

Additionally, investors who buy I bonds to pay for college are actually exempt from paying federal taxes on their I bond income.

Are I bonds a good investment?

Dan Weil of TheStreet thinks I Bond’s 7.12% yield isn’t too shabby given that 30-year Treasuries yield just 2.28%. And if inflation falls, there is an easy solution.

Maria D. Ervin