“By a continuing process of inflation, government can confiscate, secretly and unobserved, an important part of the wealth of their citizens.”
John Maynard Keynes
The above quote notwithstanding, there is one government program that can significantly help the individual investor during a period of high inflation. It is the lowly savings bond, specifically the Series I savings bond. First, I’ll discuss a brief history of the savings bond program, and then give an overview of I Bonds specifically including how they may benefit you as an investor.
A Brief History of I Bonds
The first savings bond was introduced in 1935 during the depths of the great depression and was the brainchild of treasury secretary Henry Morgenthau, Jr. The idea of these first “baby bonds” as they were popularly known was to be an interest bearing security for the small individual saver with a predictable rate of interest and without the fluctuation of marketable government bonds. The original baby bond had a fixed interest rate of 2.9% and a 30 year maturity. By 1941 the program was updated with the series E bond. Known as “war bonds” during WWII this became the most popular savings program in American history. This program continues today with the series EE bonds. These bonds were sold by volunteers and included some excellent propaganda during the war years.
While these savings bonds were a popular way to save, one drawback was their fixed rate of interest. In times of high inflation the purchasing power of these bonds is significantly and permanently reduced, making this a potentially risky bet for a long term retirement saver.
In 1998 a new type of savings bond was introduced, the I Bond. With an I Bond the interest rate is comprised of two components, a fixed rate that lasts the life of the bond, and a variable rate that increases with inflation. Currently the fixed component of the I Bond is zero. Due to the recent high inflation the inflation component is 9.62%! This 9.62% rate is good for the next 6 months and will then be re-calculated based on the Consumer Price Index for all Urban Consumers (CPI-U). If inflation remains high the rate will remain high also. (Update: On November 1, 2022 the new 6 month rate will be announced and is expected to be around 6.5%. This is still high compared to other options.)
How Does it work?
| Minimum Investment | $25 |
| Maximum Investment | $10,000 Electronic; Up to $5,000 additional paper bond with tax refund. |
| Holding Period | Minimum 1 year, max 30 years. Three month loss of interest penalty if cashed out within first five years. |
| Taxes | Interest subject to Federal Income tax. State tax exempt. |
| Fixed Interest | 0% |
| Variable Interest | 9.62% (annualized) as of 10/2022. Adjusted every six months based on CPI(U). |
Each person can invest up to $10,000 annually ($25 minimum). The maximum holding period is 30 years, with a minimum holding period of one year. The security can be cashed out anytime after one year, however if cashed out within the first five years you will lose 3 months worth of interest. Even if cashed out early, this could still be favorable to other low risk savings options. For example, one year Treasury rates are recently around 4%. So, if you held for one year before cashing out, even with the loss of 3 months interest you may come out ahead, especially if inflation stays high during the second 6 month period you hold the I Bond.
There are also some tax advantages to I Bonds. The interest is subject to Federal income taxes at your marginal rate, but is not subject to state income taxes. Notably, you can choose to defer the taxes until you cash out the bond, meaning you could potentially defer the taxes on all of the interest for up to 30 years! If you prefer (such as perhaps with a bond held in a child’s name with a low or zero tax bracket) you can choose to declare the interest to the IRS and pay tax each year. Importantly, once you choose a method you need to stick with it until you cash out the bond.
Who can Buy?
US Citizens and residents with a social security number can purchase up to $10,000 of I Bonds annually. This includes children (under a parent’s or guardian’s account.) Each can purchase up to $10,000 worth of I Bonds. In addition, your tax refund can be used to purchase up to $5,000 of paper bonds. This is in addition to the $10,000 limit.
Interestingly, trusts can also purchase up to $10,000. By using multiple trusts this is a potential way to control and earn the interest well above the intended $10,000 per person. Each trust must be its own entity with its own tax ID. This is an advanced strategy and should not be attempted without consulting with a qualified tax and legal advisor.
How to Buy
I Bonds (along with other savings bonds and treasury securities) can be purchased directly from the US government at treasurydirect.gov.
I Bonds are one of the few low risk securities that can do well in an inflationary environment. While the amount you can purchase is relatively small this security should be a consideration in most individual investor’s portfolios during this new inflationary era.
