How to buy an I bond to protect your portfolio from inflation

I bonds are designed to help protect against inflation.

Brian Acton

By

Brian Acton

Brian Acton

Contributing Reporter

Brian Acton is a contributing reporter at Policygenius, where he covers personal finance and insurance news. His work has also appeared in The Wall Street Journal, TIME, USA Today, MarketWatch, Inc. Magazine, and HuffPost. 

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As inflation rates rise, consumers are struggling to find room in the budget for rising costs. But inflation has been good for the performance of Series I savings bonds, government-backed securities that are currently paying 9.62% interest per year. 

“The major advantage of buying I bonds is that they currently have a high yield and are designed to help protect against inflation, which is something that many have worried about through the first half of 2022,” says Drew Feutz, certified financial planner and co-founder of Migration Wealth Management. The rate they’re paying “is much higher than what you will find on the rate of other high-quality bonds.”

I bonds offer low risk and pay out big when inflation soars. Here’s how they work and how you can buy them. 

How I bonds work

You might be more familiar with Series EE savings bonds, which earn a fixed interest rate for the bondholder for the lifetime of the savings bond. I bonds are similar in that they are fully backed by the U.S. government and mature in 30 years. 

Unlike traditional savings bonds, a Series I savings bond earns a composite rate made up of two factors. The first is a fixed rate, set when you buy the bond, that remains the same forever. The second is a variable inflation rate that is readjusted every six months based on the Consumer Price Index for all Urban Consumers. Those rates are added together to arrive at the current rate on the bond. 

Currently the fixed rate is set at 0%, but the annual inflation rate on the bonds is 9.62%. This means that bonds issued from May through October this year pay 9.62% for six months from the time of purchase, when they readjust based on the latest inflation rate. 

I bonds earn interest monthly for thirty years or until you cash out the bond, whichever happens first. You can cash out the bond after twelve months, but you’ll lose the final three months of interest if you cash out before the bond is five years old. After five years, there is no penalty for cashing out early.

When inflation is high, the return on I bonds improves. Every six months, the interest your bond earned for the previous six months is added to the bond’s principal value, and the ensuing interest the bond earns is based on the new principal amount. I bonds are best used as long-term investments with reliable returns that keep up with inflation

But I bonds aren’t a good fit if you need quick access to your funds, because you’ll lose out on earnings if you cash out in less than five years. And the 9.62% earnings rate isn’t guaranteed beyond six months. If inflation decreases, so will your earnings rate. When inflation drops, the return will drop too. 

“I bonds should be considered a cash holding in your portfolio that you don’t need to access within 12 months. It’s important to note that I bonds do not pay out interest payments like many fixed income assets do,” Feutz says. 

Earnings on I bonds are subject to federal income tax, but you can defer paying for up to 30 years, once the bond matures. Earnings may be tax exempt if you use them to pay for qualified higher education expenses. They are not subject to state or local tax. 

“You can choose to report I bond interest and pay taxes every year or defer until you cash the bond or it matures,” Feutz says. 

How to buy I bonds

To buy I bonds, you must have a Social Security number and be a U.S. citizen, a U.S. resident, or a civilian employee of the U.S. government. 

You can buy up to $10,000 in electronic I bonds in a single year by creating a TreasuryDirect account, which allows you to buy bonds and complete most transactions online for free. To open an account you will need a Tax ID number (social security number or employer identification number), U.S. address, email address, and a bank account and routing number. You can buy electronic I bonds in any amount, down to the penny, when you purchase $25 or more. 

You can also purchase up to $5,000 in paper I bonds per calendar year using your federal income tax return. You have to submit IRS Form 8888 with your tax return, completing part two to instruct the IRS to use your refund to buy paper I bonds. Paper bonds are available in denominations of $50, $100, $200, $500, and $1,000. The bonds will be issued and mailed to you when the IRS processes your tax return. Any remaining funds left from your tax refund will be sent to you by direct deposit or check. 

“Be sure to only buy I bonds through Treasury Direct or your tax return, as anything else you might find may be a scam,” Feutz says. 

Between electronic I bonds and paper I bonds, you can buy up to $15,000 in I bonds in a single year. Any bonds you receive as a gift count toward your annual limit, unless you receive them due to the death of the original owner or you convert a paper bond issued before 2008 to an electronic bond. 

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