I Savings Bonds
From Bogleheads
Series I Savings Bonds (often called I bonds) are government savings bonds issued by the U.S. Treasury. They offer inflation protection.
Note: Treasury Inflation Protected Securities (TIPS) also provide inflation protection. TIPS are considered alternatives to I Bonds. See I Bonds vs TIPS for similarities and differences between the two instruments.
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History
I bonds were first issued in September, 1998. Historical interest rates, along with computation metrics, for I bond issues can be found at I Savings Bonds Rates & Terms.
Features
- I Bonds have two components that make up their total return -- a fixed rate and an inflation rate.
- The fixed rate is fixed for the entire life of a given I Bond. The fixed rate for newly issued I Bonds is updated every six months on May 1 and November 1.
- The inflation component is based on the Consumer Price Index and is updated every six months for both existing I bonds and newly-issued ones.
- Paper and electronic versions of I Bonds are available. Each version is limited to $5,000 per year per person. (Investors can also purchase an additional $5,000 in paper bonds for their trust.)
- I Bonds are not marketable securities, meaning that, unlike other bonds and stocks, you cannot trade I Bonds in the secondary market.
- I Bonds offer tax-deferral for up to 30 years.
- I Bonds cannot be redeemed during the first year, and if you redeem them within the first five years after purchase, you lose the most recent three months' interest.
- When you redeem your I Bonds, you can never get back less than you invested, even if there was a long period of negative inflation (deflation).
- I Bonds are free from state and local taxation. (See below.)
Where to Purchase
You can buy electronic I Bonds at Treasury Direct.
You can buy paper I Bonds at any bank that's an agent for the Federal Reserve (most are).
You can mail your completed I Bond purchase paperwork directly to the Federal Reserve Bank.
Tax Benefits
Tax-Deferred Growth
Interest from I Bonds accumulates tax-deferred for up to 30 years. (I Bonds do not distribute interest like CDs and other bonds do.) After 30 years, the I Bonds no longer earn any additional interest. When I Bonds are redeemed, the interest is taxable income for federal income tax purposes, but is free from state and local taxation. However, if the proceeds of the I Bond redemption are used for qualifying educational expenses, the interest is also tax-free at the federal level (see below).
Tax-Free Growth for Qualified Education Expenses
If I Bonds are redeemed for qualifying education expenses, the interest is completely tax free, provided certain conditions are met. According to Publication 970 (2007), Tax Benefits for Education, the tax-free redemption requires the following conditions to be met:
- You pay qualified educational expenses for yourself, your spouse, or a dependent for whom you claim an exemption on your return.
- Your modified adjusted gross income (MAGI) is less than $80,600 ($128,400 if married filing jointly or qualifying widow(er)). (This MAGI number is adjusted annually.)
- Your filing status is not married filing separately.
- The owner of the Savings Bonds must be at least 24 years old before the bond's issue date. (The issue date is printed on the front of the Savings Bond.)
- The full proceeds of the savings bond redemption (both interest and principal) must be used for qualifying educational expenses.
Note that redeeming I Bonds to contribute to a 529 plan or a Coverdell education savings account is also considered a qualified educational expense. See Publication 970 (2007), Tax Benefits for Education for more details.
Role in a portfolio
- If your tax-advantaged accounts are filled up with bond funds, you can "extend" your tax-advantaged accounts by purchasing I Bonds. This process is somewhat similar, but not identical, to placing Treasury Inflation Protected Securities in Non-deductible Traditional IRA. This technique is particularly useful if your tax bracket is too low to justify tax-exempt bonds in your taxable account.
- If you are desperately looking for tax-advantaged space to place tax-inefficient assets like REIT, you can free up some of your tax-advantaged space by purchasing I Bonds. Meanwhile, you can exchange a part of the bond allocation in your tax-advantaged account to a REIT fund, for example.
- If you have a tax-free growth account like a Roth IRA, but no tax-deferred account like a Traditional IRA, you may want to place stocks in a Roth IRA while buying I Bonds in your taxable account to make the maximum use of the tax-free growth in the Roth IRA.
Caveats
Redemption while in a high tax bracket
I Bonds redeemed when the investor is in a high tax bracket may provide little or no positive after-tax, after-inflation return, especially if they are held for shorter periods of time. For this reason, if you expect to be in a high tax bracket when you'd redeem your I Bonds, they may not be a suitable investment for you. Specifically, if you are in your 20's, in 30 years you may well be in your peak earning years, which means you'd probably be in a high tax bracket when the bonds mature.
To illustrate the point, here is the after-tax, after-inflation value of $1 invested I bonds compounded for 30 years with 3% inflation and 1% fixed rate and then redeemed in the 35% federal income tax bracket:
(1+(1.04015^30-1)*(1-0.35)) / (1.03^30) = $1.0165153416
which is equivalent to an after-tax return of 0.05%/year.
Tips for buying I Bonds
Since I Bonds earn the full month's interest if you own them on the last day of that month, it is generally a good idea to buy I Bonds at the end of a month after earning some bank interest during the month. Conversely, you'd want to redeem your I Bonds at the beginning of any month, since holding them 'til later in the month won't earn any additional interest, unless you own them on the last day of the month.
Links
Further Reading
- Larry E. Swedroe, Joseph H. Hempen (2005). The Only Guide to a Winning Bond Strategy You'll Ever Need.
| Bonds | ||
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| Bonds | Treasury Inflation Protected Securities • I Savings Bonds • EE Savings Bonds • Corporate Bonds • Mortgage Backed Securities • Municipal Bonds• Convertible Bonds • High Yield Bonds • Emerging Market Bonds | |
| Bond Topics | Bond Basics • Bonds: Advanced Topics • Laddering Bonds or CDs • Individual Bonds vs a Bond Fund • I Bonds vs TIPS | |
| Vanguard Bond Funds | Vanguard Total Bond Market Index Fund • Vanguard Inflation-Protected Securities Fund • Vanguard High-Yield Corporate Fund | |
| Research Resources | Vanguard SEC Filings: Taxable Fixed Income Funds • Vanguard SEC Filings: Tax-Exempt Fixed Income Funds | |
