This article is part of Money's January 2022 digital cover, which features 22 ways to make 2022 the best money year of your life. Browse all 22 articles here.
Since their inception in 1998, Series I Savings Bonds — I bonds for short — never really got their day in the sun. That all changed in November, when the six-month yield on I bonds shot up to 7.12% — a sky-high interest rate that dominated headlines.
Experts say the savings bonds, which are issued by the U.S. Treasury, are a safe hedge against inflation, and that’s by design. The interest rate on I bonds is based on the Consumer Price Index (CPI), which tracks the cost of everyday consumer goods. The Treasury Department also uses the CPI to calculate inflation rates, so the two are interconnected: When inflation goes up, so do the interest rates on I bonds.
David Enna, the founder of the financial website TIPS Watch (short for Treasury Inflation-Protected Securities), says I bonds have gone unnoticed for so long, in part, because financial advisors don’t make commissions on them like they do on other assets, so there’s often no incentive to recommend them.
I bonds are “straight up very safe investments” that are “pretty boring,” he says. “Now, suddenly, inflation is high, and there's a lot more interest.”
Concerns around inflation seem to be here to stay. According to a survey from the New York Fed, consumers are expecting inflation rates to linger around 6% throughout 2022 and stay as high as 4% over the next three years.
“The beauty is that there is something that we can invest in that protects us against inflation,” says Zvi Bodie, an economist, financial textbook author, finance professor emeritus of Boston University and longtime proponent of I bonds.
Why I bonds should be your savings account in 2022
Inflation is “devastating” people’s savings right now, Enna says. According to the Federal Deposit Insurance Corporation (FDIC), the national average interest rate for savings accounts is 0.06%, while inflation grew 6.8% from November 2020 to November 2021 alone.
What that means is if your savings account doesn’t have an interest rate of at least 6.8%, you’re actually losing out by keeping your money there. Even the best high-yield savings accounts have interest rates well below 1% — a far cry from the 7.12% rate of I bonds.
As an example, let’s say you have $5,000 in a savings account with a 0.5% interest rate over the course of a year marred by 5% inflation. At the end of the year, you would have $5,025 in your savings account because of the interest it earned. However, if your money grew at the rate of inflation, it would’ve been $5,250. In other words, inflation ate away $225 of value from your savings.
And with inflation so high (and savings account rates so low) that's sort of the best-case scenario.
“To add insult to injury, the little bit of interest [on savings accounts] is subject to income tax,” Bodie says, noting that I bonds aren’t taxed at a state or local level and only incur federal taxes when they’re cashed out.
That’s why experts are saying I bonds are so useful, particularly right now.
Until the last business day of April 2022, you can lock in I bonds’ 7.12% interest rate for six months. On the first business day of May (May 2 this year), the I bond rate will change again, based on inflation. It could go up or down.
So long as you purchased the bonds before then, you are guaranteed that 7.12% rate for six months. Once your bond turns six months old, the interest will compound and then the rate will change to the new one set on May 2, whatever it may be. You can’t just cash out your bonds after six months, however. There are withdrawal limitations similar to certificates of deposit (CDs) at banks (more on that below).
As Enna explains, any I bonds you purchase now are guaranteed an annual interest rate of at least 3.56%. That’s assuming the worst: the interest rate on May 2 drops to 0%, “which is highly unlikely,” he says. (Here’s a deeper look at exactly how I bonds work and how to buy them.)
Even in this worst-case scenario, the 3.56% I bonds interest rate would still be roughly 60 times higher than that of the average savings account.
I bonds caveats and savings strategies
While I bonds are one of the safest investments out there, there are a few caveats you should be aware of:
I bonds have a $10,000 annual electronic purchase limit per individual.
They also have a $5,000 annual paper purchase limit (which can only be made through your tax returns). The paper limit applies to individuals and couples.
After you buy an I bond, you can’t cash it out for at least one year, similar to certificates of deposit (CDs).
If you cash out an I bond before five years, it loses the last three months of interest.
Because I bonds can’t be cashed out for 12 months (unless under special circumstances), experts say you shouldn’t put your entire emergency fund into them all at once. Instead, consider laddering your savings over time, similar to the strategies used for CDs.
“Do it gradually … so that you are still maintaining some funds that are [immediately] available,” Bodie says. “Just in case.”