What it means
An I Bond is a loan you make to the US government, and in return the government promises to pay you back with interest that keeps pace with inflation. The "I" stands for inflation, and the whole design exists because ordinary savings accounts often pay less than the rate at which prices are rising, quietly shrinking what your money can buy.
The rate is rebuilt twice a year, in May and November, from the change in the consumer price index over the preceding six months. Your fixed rate is locked in on the day you buy and never changes, so two people holding the same bond series can earn different totals depending on when they bought.
The combined figure is called the composite rate. For a business or a household, the appeal is that the downside is unusually limited.
The composite rate can never fall below zero, so the bond will not lose nominal value, and interest is exempt from state and local income tax while federal tax can be deferred until you cash out. That combination makes it a sensible home for reserve cash that is not needed for day-to-day operations.
The constraints matter just as much as the benefits. You cannot cash an I Bond at all in the first twelve months, and if you redeem it before five years you forfeit the last three months of interest, so it is not a substitute for a current account.
Annual purchase limits also apply per person, which caps how much of a large reserve you can realistically hold this way. The most common misreading is treating the headline rate as a fixed annual yield.
It is an annualised figure that applies only to the next six months, after which it will be recalculated, so a bond advertised at a high rate may pay far less over the following period if inflation cools.
In practice
Real-world examples.
Example
A dental practice owner keeps $60,000 of surplus cash in a business current account earning almost nothing. Over three years she moves personal savings of $10,000 per year into I Bonds instead, accepting the twelve-month lock-up in exchange for a rate that tracks inflation rather than the bank's discretion.
Example
A couple saving for a house deposit they expect to need in about four years split their savings between a high-interest account for the portion they might need quickly and I Bonds for the rest. They accept the three-month interest penalty on early redemption because they are unlikely to buy before year three.
Example
A small charity's treasurer holds a reserve fund that must not lose real value between grant cycles. The board approves an allocation to I Bonds specifically because the composite rate cannot go negative, which suits a reserve whose main job is to still be worth something in five years.
Think of it
“I Bond is an inflation-protected savings bond-rate adjusts with inflation.
Formula
Calculation
Composite rate = fixed rate + (2 x semiannual inflation rate) + (fixed rate x semiannual inflation rate)
Suppose the fixed rate on your bond is 1.30% and the semiannual inflation rate announced for the coming period is 1.50%. The calculation is 0.0130 + (2 x 0.0150) + (0.0130 x 0.0150) = 0.0130 + 0.0300 + 0.000195 = 0.043195, which the Treasury rounds to a composite rate of 4.32%.
If you hold $10,000 of these bonds for the full six-month period, the interest credited is $10,000 x 4.32% / 2 = $216, taking the balance to $10,216. Note that the 4.32% is an annualised rate covering only those six months; the next period starts from a freshly announced inflation figure and the same $10,216 balance.Case study
Seen in the real world.
In this illustrative example, Harbourline Ceramics is a fictional twelve-person studio whose owner, Priya, had built up roughly $45,000 of cash she thought of as her personal emergency fund. Sitting in a savings account paying 0.4% while prices rose around 4%, the fund was losing real value every year even though the balance on the statement never fell.
Priya moved $10,000 into I Bonds in one calendar year and another $10,000 the next, keeping $25,000 liquid for genuine emergencies. Over the following eighteen months the composite rate on the first purchase averaged a little over 4%, and while she could not have touched the money in the first twelve months anyway, she had not planned to.
The lesson from this fictional case is not that I Bonds are the best investment available. It is that Priya matched the money to its job: cash she genuinely might need overnight stayed liquid, and cash that only needed to hold its value went somewhere designed to do exactly that.
Watch out
Common mistakes.
- Treating the advertised composite rate as a guaranteed annual return, when it is an annualised rate that applies only to the next six months before being reset.
- Buying I Bonds with money that might be needed within a year, forgetting that redemption is blocked entirely for the first twelve months.
- Assuming the fixed portion changes with the rest of the rate, when the fixed rate you receive at purchase is locked in for as long as you hold that bond.
Questions
People also ask.
Can I lose money on an I Bond?
Not in nominal terms, because the composite rate is floored at zero, though you can lose three months of interest by redeeming before the five-year mark.
How is the interest taxed?
Interest is exempt from state and local income tax and federal tax can usually be deferred until you cash the bond in or it matures.
Are I Bonds suitable for a company's operating cash?
Generally no, because the twelve-month lock-up and per-person purchase limits make them a poor fit for money that funds payroll or suppliers.
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