Are I Bonds Worth the Hype?

I bonds are offering a 6.89% interest rate through April 30, at which point the rate is likely to drop to below 4%. Some people may feel the need to jump on the I bond bandwagon before then. But even with a higher interest rate, are I bonds worth it? Due to how I bond rates are calculated, certain penalties, and a variable rate that’s likely to fall, your return may be lower than the advertised interest rate.

Why I bonds are appealing during high inflation

I bonds can help protect your savings from inflation by paying an interest rate that is designed to keep pace with the current rate of inflation. An I bond’s interest rate is actually a combination of two different rates: a fixed rate and an inflation rate. The fixed interest rate stays the same while the inflation rate changes twice a year.

According to the U.S. Department of the Treasury, the combination of an I bond’s fixed rate and inflation rate creates its composite rate. This is the interest rate an I bond will actually earn. And while that’s technically true, if you buy I bonds now, your take-home pay could be less than 6.89%.

Important things to know about I bonds

According to TreasuryDirect, the government-run website where you can purchase I bonds, I bonds must be held for at least one year. If they are sold before five years, bondholders must pay a penalty equivalent to the last three months’ worth of interest.

Second, there are two types of I bonds: paper and electronic. Paper I bonds are difficult to buy since they can only be purchased by mail when you’re filing a federal income tax return. Paper I bonds have a minimum purchase amount of $50 and a maximum of $5,000 per calendar year. Electronic I bonds can be purchased online. They have a minimum purchase amount of $25 and a maximum of $10,000 each calendar year.

Finally, I bonds, like most investments, are subject to taxes. These taxes can include federal income tax (but not state or local income tax) and any federal estate, gift, and excise taxes plus any state estate or inheritance taxes.

Do you actually earn 6.89% in interest?

If someone purchased $10,000 worth of electronic I bonds in April 2023, they might expect to earn 6.89% of $10,000, or $689, in one year. But I bonds are far more complicated than that.

Because this rate is annualized, $10,000 in I bonds would actually earn a guaranteed $344.50 in interest over the next six months.

But you can’t even cash in your bond until you’ve held it for a year, so the six-month take can feel irrelevant. Since the I bond rate is only guaranteed for six months, we only know half of the equation we’d need in order to figure out how much these bonds could pay in a year.

To quell any curiosity, let’s imagine the 6.89% interest rate drops to 3.79%, as some experts are predicting, for the second six-month period. Add the first six months of interest ($344.50) to your original investment of $10,000 as your new principal. You’ll earn the 3.79% interest rate on that new $10,344.50 total for the next six months. That will result in around an additional $196.50 in interest for your second six-month period, and a total of about $541 in interest for a one-year period.

After one year, you can cash out your bond, but if you do so before you’ve held it for five years, you lose the last three months of interest you earned. That would be about $98, or a $443 net in interest after one year. If you kept your money in the bond for five years, you could keep the total minus any tax owed.

I bonds vs. high-yield savings accounts vs. stocks

Earning what amounts to 4.4% over a year may seem appealing, especially given the relative safety of I bonds. But if it’s a return you’re after, there may be other options to consider. High-yield online savings accounts are paying around 4.5% now. That interest rate is similar to that of I bonds, but with savings accounts, there is no requirement on how long you lock up your money. If you’re willing to take more risk, investing in the stock market through index funds or mutual funds generally earns a higher average return over the long term — historically, the average annual stock market return is around 10%.

For many investors, especially those with many years to go before retirement, I bonds may not be the best choice. If you’re planning on holding an I bond for a long time, it may be more beneficial to put that same money into the stock market. You can use an investment return calculator to estimate what a stock-based return might bring.

Who are I bonds good for?

If you already have an emergency fund and a well-diversified investment portfolio, I bonds could be something to investigate. They may be particularly useful if you have a goal with a specific time horizon, especially one of at least five years. For example, maybe you’re saving for a down payment on a house and you don’t want to risk your funds in the stock market. However, high-yield savings accounts can net you a similar amount in interest without as much hassle, and the stock market can bring higher long-term returns.

Leave a Comment