I Bonds Explained: Inflation-Protected Savings With Government Backing

In 2022, inflation hit 8-9% and I bonds suddenly became household names — millions of Americans rushed to buy them when their yields hit 9.62% with zero risk of principal loss. The frenzy has calmed, but I bonds remain a useful tool for specific savings goals. Here's everything you need to know.

What Are I Bonds?

Series I Savings Bonds (I bonds) are inflation-protected savings bonds issued by the US Treasury. Unlike regular savings accounts or CDs, I bonds don't pay a fixed interest rate — they pay a variable rate tied to inflation.

The yield formula: I bond rates consist of two components:

1. Fixed rate: Set at purchase and never changes. This has ranged from 0% to 3.6% historically. Recent rates have been higher as the Fed has tightened monetary policy.
2. Inflation component: Changes every 6 months based on the Consumer Price Index (CPI-U). When inflation is high, this component is high.

The composite rate is calculated by the Treasury using both components. You can check current I bond rates at TreasuryDirect.gov.

Safety: I bonds are backed by the full faith and credit of the US government. The principal will never decrease — you cannot lose money in I bonds.

Key Features and Rules

Purchase limits: You can buy up to $10,000 in I bonds per year per Social Security number through TreasuryDirect.gov. There's one exception: you can buy an additional $5,000 per year using your federal tax refund (by overpaying your taxes and choosing I bonds for the refund).

Minimum holding period: You must hold I bonds for at least 12 months. They can't be redeemed before that — this is not negotiable.

Early redemption penalty: If you redeem within the first 5 years, you lose 3 months of interest. After 5 years, you can redeem with no penalty. After 30 years, the bonds stop earning interest.

Tax treatment:

• Federal income tax: interest is taxable when you redeem (not annually, unless you choose to report annually)
• State and local tax: EXEMPT — I bond interest is not taxed by states
• Education exclusion: interest may be tax-free if used for qualified education expenses (income limits apply)

How to buy: Only through TreasuryDirect.gov (a US government website). You cannot buy I bonds through brokerage accounts or banks. Set up an account, link your bank account, and buy electronically.

When I Bonds Make Sense

Emergency fund reserves (the top 2 tiers): Your immediate emergency fund (1-3 months expenses) should be in a high-yield savings account for instant access. But the next tier — money you hope to never touch for 1-5 years — can earn competitive rates in I bonds while being completely safe.

Predictable multi-year savings goals: Saving for a home purchase in 3-5 years, a car, college expenses in 5 years — goals where you need to preserve purchasing power without taking stock market risk.

Risk-averse investors: For people who can't sleep knowing their money might drop in value, I bonds offer safety without the interest rate risk of bond funds (I bond principal never goes down).

Conservative retirees: For money you can't afford to lose, I bonds beat most alternatives.

When I Bonds Don't Make Sense

If you might need the money in under a year: I bonds are locked for 12 months. Keep immediate emergency funds in a high-yield savings account or money market account.

As your only investment: The $10,000/year limit and fixed-income nature of I bonds means they're not a growth vehicle. Long-term wealth building requires equity exposure through stock index funds.

When your time horizon is 7+ years: Over long time horizons, stock index funds historically return 7-10%/year real (inflation-adjusted), vastly outperforming I bond returns. I bonds are about safety, not growth.

I Bonds vs High-Yield Savings Accounts

Both are safe and liquid (after I bond's 12-month lockup), but there are differences:

When I bond rates are above current HYSA rates (which happens during high inflation), I bonds are better for money you won't need for 1+ years. When HYSA rates are competitive or when you might need the money sooner, HYSA wins.

I Bonds vs TIPS

Treasury Inflation-Protected Securities (TIPS) also protect against inflation and are often compared to I bonds:

• TIPS can be bought in any amount, are tradeable on the secondary market, and can lose market value if interest rates rise (even though principal is inflation-adjusted). They're more complex and better for larger portfolios.
• I bonds are simpler, capped at $10,000/year, can't lose principal, but aren't tradeable.

For most individual investors, I bonds are simpler and more appropriate than TIPS.

Step-by-Step: How to Buy I Bonds

1. Go to TreasuryDirect.gov — the only place to buy electronic I bonds
2. Open an account — you'll need a Social Security number, bank account information, and a US address
3. The site looks old — this is normal. TreasuryDirect uses older technology but is completely secure
4. Buy I bonds — under "BuyDirect," select "Series I" and enter the amount (minimum $25, maximum $10,000/year)
5. Link your bank account if you haven't already
6. Track your bonds — they appear in your TreasuryDirect portfolio with current value and interest earned

One catch: TreasuryDirect has a somewhat clunky interface. If you lock yourself out of the account, the customer service process is notoriously slow. Write down your account number and keep it somewhere safe.

Paper I Bonds via Tax Refund

If you'd like to buy beyond the $10,000 electronic limit (up to $5,000 more), overpay your federal taxes and designate the refund as I bond purchases on Form 8888 with your tax return.

This requires planning ahead — you need to overpay your estimated taxes or withholding to trigger a refund. Most financial advisors don't recommend overpaying taxes just for this, but if you're getting a large refund anyway, I bonds are a better destination than a checking account.

Bottom Line

I bonds are one of the safest, most underappreciated savings instruments available to ordinary Americans. They're not going to make you wealthy — the $10,000 annual limit and variable returns mean they're a tool for safety, not growth. But for emergency fund reserves, medium-term savings goals, and money you genuinely cannot afford to lose, they're hard to beat when inflation-adjusted returns compare favorably to alternatives.

Check TreasuryDirect.gov for current rates before purchasing — when rates are competitive with high-yield savings, I bonds are a strong choice for the 12+ month portion of your savings.