When inflation threatens your portfolio, as it has been during 2021 and 2022, safety becomes a priority for your investments. By March 2022 the year-over-year inflation rate had soared to 8.5% - a 40-year high. Naturally investors were searching for protection. If you're in that position, consider Series I bonds. These are bonds issued by the U.S. government that carry a zero-coupon interest rate and are annually adjusted for inflation. The variable return on these bonds was 9.62% through October 2022. Here's what you need to know about these unique securities.
Consider working with a financial advisor as you look to increase your portfolio's protection from inflation.
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What Is a Series I Bond?
A Series I bond (or an “I Series” bond) is a savings bond issued by the U.S. Treasury. It pays a fixed interest rate determined at time of purchase. The bonds are also inflation adjusted, meaning that the Treasury pays an additional interest rate applied twice per year (in May and November) based on an estimated rate of inflation. Unlike some U.S. securities, Series I bonds are sold at face value. A $50 bond is sold for $50.
The duration of these bonds differs from that of other bonds. They can range from one year to 30 years, but if they are sold before five years has elapsed from the time of purchase the owner forfeits the last three months of interest.
The interest rate of the bond is a combination of a fixed rate that stays the same for the life of the bond and an inflation rate that is set twice a year. At time of writing, the interest on a Series I bond issued from May 2022 through October 2022 was 9.62%.
Series I bonds are nonmarketable. This means that they cannot be legally bought or sold to third parties. There is no secondary market for these bonds. They can only be redeemed by the original owner.
How Series I Bond Interest Works
A Series I bond pays interest on a monthly basis and compounds every six months. The primary interest for any given bond is fixed for the lifetime of the instrument. So, for example, say you bought a $100 bond at a 1% interest rate. Each month it would pay $1 in interest. After six months the interest would compound and you would then gain 1% interest on $106.
Most investors consider the inflation adjustment on a Series I bond to be an additional form of interest on this asset. As a result, this is typically considered a variable interest bond. Together the interest rate and the inflation adjustment on a Series I bond are called the “composite rate.” The composite rate on a Series I bond can never fall below zero, even in the rare event that deflation would otherwise drag a bond’s composite rate into negative numbers.
For example, as noted above, at time of writing Series I bonds sell with a 0.00% fixed interest rate. If inflation goes negative the composite rate will be set at the 0% floor.
Series I bonds have these deadlines:
Within one year of purchase: You cannot cash the bond.
Within one year and five years of purchase: You can cash the bond, but forfeit the previous three months’ interest payments. This is known as “early redemption.”
After five years of purchase: You can cash the bond with no penalty.
After 30 years of purchase: The bond ceases to pay interest.
You do not have to cash these bonds after 30 years. This is a debt instrument and remains good indefinitely. However, after this point it will begin to lose value against inflation. The interest on a Series I bond is subject to federal income tax, but not state or local income taxes. The principal on a Series I bond is typically not subject to any taxation. Interest on a Series I bond is not paid during the lifetime of the bond. Rather, as noted above, it is compounded and paid upon redemption. This is known as a “zero coupon” bond.
Buying Series I Bonds
Series I bonds have different limits based on whether you purchase them electronically or in paper form.
This comes with no hard copy and is available via the Treasury’s website Treasury Direct. The minimum purchase is $25, and you can buy up to $10,000 per calendar year in electronic I bonds. Further, you may buy up to another $5,000 in paper I bonds using your federal income tax refund, meaning you can purchase up to $15,000 of I bonds each year. You may buy them in any denomination you choose.
This is issued in a paper certificate via the U.S. mail. The minimum purchase is $50, and you cannot buy more than $5,000 per calendar year. You may buy them in denominations of $50, $100, $200, $500 and $1,000.
The purchase limits apply separately, capping an individual’s purchase at $15,000 per year. This limit targets this bond at individuals and makes it less useful to institutional investors.
Only U.S. citizens, legal residents or civilian employees of the U.S. government (regardless of citizenship or residency) may buy Series I bonds.
You can buy Series I bonds electronically through Treasury Direct. Paper bonds can only be purchased as part of your annual tax return. When filing your taxes, you can include an additional form to direct the IRS to issue all or part of your tax refund in the form of a Series I savings bond.
You may purchase Series I bonds as a gift by registering the bond in their name at the time of purchase. This would make them eligible to redeem the bond upon maturity.
A Series I bond is a powerful anchor to windward, financially speaking. They are low-risk savings bonds issued by the U.S. government that pay low interest rates but make up for this with their high security and biannual inflation adjustment. Through October 2022 they were paying a lofty 9.62%. You may purchase these either electronically via TreasuryDirect (up to $10,000) or you can use your IRS tax refund to buy paper Series I bonds (up to $5,000). By combining electronic and paper purchases, you can buy up to $15,000 of Series I bonds each year. Keep in mind that there is no secondary market for them.
Tips on Investing
Balancing risk and reward in your investment portfolio is a challenge. A financial advisor can give you excellent guidance on the best way to do that. Finding a financial advisor doesn't have to be hard. SmartAsset’s matching tool can help you find a financial professional in your area, in minutes, to help you do just that. If you're ready, get started now.
If you are looking for low-risk options to balance out your investment portfolio, Treasury inflation protected securities (TIPS) are another great option. Before you buy either TIPS or I Series bonds learn about the wide range of U.S. Treasury securities for both individual and institutional investors.
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