If safety is a top priority for your investments, you should consider Series I bonds. They are bonds issued by the U.S. government that carries a zero-coupon interest rate and are annually adjusted for inflation. The return on these bonds, which are typically considered variable interest bonds, are generally low. However, this reflects the high security they enjoy because of being backed by the federal government. Here’s what you need to know about these unique securities.
What Is a Series I Bond?
A Series I bond (or an “I Series” bond) is a savings bond issued by the U.S. Treasury. It pays a fixed interest rate determined at time of purchase. The bonds are also inflation adjusted, meaning that the Treasury pays an additional interest rate applied twice per year (in May and November) based on an estimated rate of inflation. Unlike some U.S. securities, Series I bonds are sold at face value. A $50 bond is sold for $50.
The duration of these bonds differs from that of other bonds. They can range from one year to 30 years, but if they are sold before five years has elapsed from the time of purchase the owner forfeits the last three months of interest.
The interest on a Series I bond tends to be quite low. For example, at time of writing bonds issued between May 2020 and October 2020 paid a fixed rate of 0.00%. The 0.00% rate is the one given on the Treasury’s Series I Savings Bonds Rates & Terms sheet. This low interest rate is why it is essential for the government to adjust Series I bonds for inflation. Without this correction many bonds would grow more slowly than inflation, meaning that bondholders would lose money compared to simply keeping their money in the bank.
Series I bonds are nonmarketable. This means that they cannot be legally bought or sold to third parties. There is no secondary market for these bonds. They can only be redeemed by the original owner.
How Series I Bond Interest Works
A Series I bond pays interest on a monthly basis and compounds every six months. The primary interest for any given bond is fixed for the lifetime of the instrument. So, for example, say you bought a $100 bond at a 1% interest rate. Each month it would pay $1 in interest. After six months the interest would compound and you would then gain 1% interest on $106.
Most investors consider the inflation adjustment on a Series I bond to be an additional form of interest on this asset. As a result, this is typically considered a variable interest bond. Together the interest rate and the inflation adjustment on a Series I bond are called the “composite rate.” The composite rate on a Series I bond can never fall below zero, even in the rare event that deflation would otherwise drag a bond’s composite rate into negative numbers.
For example, as noted above, at time of writing Series I bonds sell with a 0.00% fixed interest rate. If inflation goes negative the composite rate will be set at the 0% floor.
Series I bonds have these deadlines:
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Within one year of purchase: You cannot cash the bond.
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Within one year and five years of purchase: You can cash the bond, but forfeit the previous three months’ interest payments. This is known as “early redemption.”
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After five years of purchase: You can cash the bond with no penalty.
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After 30 years of purchase: The bond ceases to pay interest.
You do not have to cash these bonds after 30 years. This is a debt instrument and remains good indefinitely. However, after this point it will begin to lose value against inflation. The interest on a Series I bond is subject to federal income tax, but not state or local income taxes. The principal on a Series I bond is typically not subject to any taxation. Interest on a Series I bond is not paid during the lifetime of the bond. Rather, as noted above, it is compounded and paid upon redemption. This is known as a “zero coupon” bond.
Buying Series I Bonds
Series I bonds have different limits based on whether you purchase them electronically or in paper form.
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Electronic Bonds
This comes with no hard copy and is available via the Treasury’s website Treasury Direct. The minimum purchase is $25, and you cannot buy more than $10,000 per calendar year. You may buy them in any denomination you choose.
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Paper Bonds
This is issued in a paper certificate via the U.S. mail. The minimum purchase is $50, and you cannot buy more than $5,000 per calendar year. You may buy them in denominations of $50, $100, $200, $500 and $1,000.
The purchase limits apply separately, capping an individual’s purchase at $15,000 per year. This limit targets this bond at individuals and makes it less useful to institutional investors.
Only U.S. citizens, legal residents or civilian employees of the U.S. government (regardless of citizenship or residency) may buy Series I bonds.
You can buy Series I bonds electronically through Treasury Direct. Paper bonds can only be purchased as part of your annual tax return. When filing your taxes, you can include an additional form to direct the IRS to issue all or part of your tax refund in the form of a Series I savings bond.
You may purchase Series I bonds as a gift by registering the bond in their name at the time of purchase. This would make them eligible to redeem the bond upon maturity.
The Bottom Line
Series I bonds are a low-risk savings bond issued by the U.S. government. They pay low interest rates but make up for this with their high security and biannual inflation adjustment. You may purchase these either electronic via TreasuryDirect or you can use your IRS tax refund to buy paper I bonds. Keep in mind that there is no secondary market for these securities.
Tips on Investing
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If you are looking for low-risk options to balance out your investment portfolio, Treasury inflation protected securities (TIPS) are another great option. Before you buy either TIPS or I Series bonds learn about the wide range of U.S. Treasury securities for both individual and institutional investors.
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