I bonds: The inflation-protected asset you should know about

With inflation rates hitting levels not seen in decades, an investment product known as an I bond – which coincidentally, has also been around for decades – is suddenly getting a lot of attention. We recently discussed “What are I bonds” on our weekly podcast, Everyday Wealth™.

Series I savings bonds, or I bonds, were first introduced by the U.S. Treasury in 1998 and have a unique trait; the rate the bonds pay is a combination of both a fixed rate and an inflation rate based on the consumer price index levels over the previous six months.

The fixed-rate portion is set for the lifetime of the bond when purchased, while the inflation rate portion is variable and will change every six months. The inflation rate for each individual bondholder will vary based on when the bond is purchased, and interest will accrue at different rates during each six-month period that it is held.

Then, every six months after the bond is issued, the interest earned in the previous six months is added to the principal, creating a new principal value, upon which interest is calculated over the next six months. The full principal plus interest is paid out when you redeem the bond.

As you can see, one of the compelling reasons for owning I bonds is that as inflation rates rise, so can the interest you earn.

There are only two ways in which you can buy I bonds. The electronic version is available directly from the U.S. Treasury and you will need to create a TreasuryDirect account in order to purchase them. However, paper I bonds can be bought using your federal income tax refund.

You can buy up to $10,000 in electronic I bonds annually and up to $5,000 in paper bonds for a yearly maximum of $15,000 per person per year. Those are individual limits and there are no household limits, so for example, a husband and wife could buy a combined $30,000 in I bonds per year.

I bonds earn interest for 30 years, though there are some restrictions to be aware of.

First off, I bonds cannot be redeemed within the first 12 months of issuance. And if you need to redeem the bonds after the initial 12 months but before you’ve held them for five years, you will forfeit the last three months of interest that you would have earned.

For example, if you redeem an I bond after holding it for 18 months, you will receive only the first 15 months of interest. After holding for five years, there are no longer any penalties for redemption.

Another unique trait of I bonds is that they are nonmarketable, meaning they can’t be bought or sold in the secondary market. They can only be bought from or redeemed by the U.S. Treasury, which means that unlike other bonds, such as Treasury inflation-protected securities or TIPS, you are guaranteed to get your full principal back, even if you redeem them before the 30-year maturity.

Due to the individual purchase limits, restrictions on short-term redemption and the unpredictable nature of inflation rates, I bonds are not designed to be a core component of your overall integrated wealth plan.

Instead, they can be used to supplement other financial products, such as certificates of deposit, money market and savings accounts as a way to diversify and help increase the returns on your cash reserves.

If you want to learn more about I bonds and the role they can play as part of your overall financial plan, contact an Edelman Financial Engines planner today.