When inflation is on people's minds, one savings option tends to come up again and again: the I bond. It is one of the few places where the government effectively promises that your savings will keep pace with rising prices. Here is how it works, and where its limits are.
What an I bond is
A Series I savings bond is a savings bond issued by the US Treasury, available directly to the public through TreasuryDirect. When you buy one, you are lending money to the federal government, which pays you interest in return. The "I" is for inflation: unlike an ordinary fixed-rate bond, an I bond is specifically designed so that its return rises and falls with the cost of living.
How the interest rate works
The I bond's rate is a combination of two pieces, as the Treasury explains. The first is a fixed rate, set when you buy and locked in for the entire life of that bond. The second is an inflation rate, tied to the Consumer Price Index, which the Treasury resets every six months, in May and November. Add the two together and you get the bond's overall "composite" rate.
When inflation climbs, the inflation portion rises and your total rate goes up; when inflation eases, it falls. Crucially, the composite rate cannot go below zero, so an I bond will not lose value in dollar terms. Interest is added to the bond twice a year, so you earn interest on your interest over time. Because the rate changes, I bonds are not the place to lock in a guaranteed fixed yield; they are a hedge against inflation.
The rules on cashing out
I bonds are meant to be held, not traded. You must keep one for at least one year before you can redeem it at all. If you cash out before you have held it for five years, you give up the last three months of interest as a penalty. After five years, you can redeem with no penalty. A bond keeps earning interest for up to 30 years, after which it stops.
How much you can buy
There is an annual limit. In general, you can buy up to 10,000 dollars in electronic I bonds per person each calendar year through TreasuryDirect. Because the cap is per person, a couple can buy more between them, and separate purchases can be made for children through custodial accounts. Historically there has also been a way to buy an additional amount in paper I bonds using a federal tax refund, though rules on this can change, so it is worth checking the current terms on TreasuryDirect.
The tax angle
I bonds come with useful tax features. The interest is exempt from state and local income taxes, a real benefit in high-tax states. Federal income tax does apply, but you can choose to defer it until you cash the bond in or it matures, rather than paying each year. There is also a potential education tax break: if you use the proceeds for qualifying higher-education costs and meet income limits, some or all of the interest may be federally tax-free. The details and income thresholds change, so confirm them before counting on that.
Where I bonds fit
I bonds suit a particular job. They are best for money you will not need for at least a year, that you want kept safe and shielded from inflation, rather than for chasing the highest possible return or for an emergency fund you might need instantly. Their strengths are safety, the government stands behind them, automatic inflation protection, and tax advantages. Their drawbacks are the yearly purchase cap, the one-year lockup, the early-withdrawal penalty before five years, and a return that moves with inflation instead of being fixed.
For a saver worried mainly about their cash quietly losing purchasing power, an I bond can be a sensible, low-risk piece of the puzzle. This article is informational and general in nature, not financial advice; check current rates and rules on TreasuryDirect or with a financial professional.
