What Are I Bonds and Can They Protect Your Retirement Savings from Inflation?

If you’re currently retired or approaching retirement, you’d probably prefer to protect your savings from risky investments. However, investments considered “safe” also tend to offer dismal returns. When inflation kicks into high gear, it can quickly eat away at the value of your retirement savings. Is there any way you can get the best of both worlds? A safe way to invest your retirement savings that will also give you enough returns to hold up against inflation? The answer could be I bonds. What are I bonds and can they really shield your retirement savings from inflation?

Let’s find out. But first, remember, the information on this website is for general educational purposes only and is not intended to provide specific advice or recommendations. Please discuss your particular circumstances with an appropriate professional before taking action.

Inflation – One of the Biggest Dangers to Your Retirement

No one wants a stock market crash to cut their 401k or Roth retirement accounts in half a year before retirement. That’s why financial advisors recommend that you shift your retirement savings into safer investments as you get closer to retirement. There’s only one problem with this advice. Safer investments usually mean low growth. Savings accounts and bank CDs typically yield only 1 to 2% returns. That might be okay if your everyday costs stay the same during your retirement years, but what happens when inflation begins creeping up?

Inflation can be a retirement savings killer. Imagine you’ve put $500,000 into a “high-yield” savings account that earns 1.5% interest. Now, imagine that inflation reaches 8.5% for the year. That means the value of your money would shrink by 7%., a loss of $35,000 in value over the year.


Women Need Their Retirement Savings to Last Longer

The danger of inflation is even greater for women nearing retirement. Women tend to have less saved for retirement compared to men and need to make their money last longer.  Women 65 and older must make do with 83% of the median household income that men enjoy at the same age. A woman who was 65 years old in 2019 can also expect to live, on average 20.8 additional years.

And that’s the average, meaning many women will live even longer. You may need your retirement savings to last for decades, but high inflation could dramatically erode your money. (Here’s how to check your retirement progress.)

What’s the solution? I bonds could offer the perfect hedge against inflation while keeping your retirement savings safe.

What Are I Bonds?

I bonds, also known as Series I savings bonds, are sold and backed by the U.S. government. What makes I bonds so unique is that their return is tied to the US inflation rate. In the six-month period between May 2022 and October 2022, I bonds offered a stunning 9.62% rate of return. Compare that to the 1.5% return you might get with most savings accounts.

When inflation is high, so is the return of I bonds.

How Do I Bonds Work?

I bonds offer returns in two ways. The first is a fixed return through the 30-year life of the bond. At the time of this writing, that return was 0%. Bummer, right? But I bonds also earn a variable interest rate pegged to inflation. (Specifically, this return is based on the Consumer Price Index for all Urban Consumers, or the CPI-U).

The interest rate on I bonds is adjusted twice a year in May and November. If the inflation rate goes up, the return of the I bond will also go up at the next readjustment period and vice versa. Earned interest is compounded semiannually, meaning interest will be added to your principal investment twice a year.

The bottom line is that I bonds can be a very, very good investment when the inflation rate is high.

How Long Do I Need to Hold I Bonds?

Government savings bonds usually require buyers to hold the bond for a certain amount of time before the bond “matures.”

You must hold your I bonds for at least a full year before you can cash them in. If you cash in your I bond before five years, you’ll be penalized and lose the last three months of interest accrual.

If you’re afraid of locking your money away for five years, take heart. This penalty isn’t actually so bad. Imagine you put your money into I bonds for 3 years (36 months) and then decide to cash out. You’ll get all your initial investment back along with all the interest you earned for 33 of the 36 months. If inflation was high during those three years, you should still walk away with plenty of earnings.

I-bonds have a 30-year lifespan, over which time will continue to earn interest unless you cash them out.

I Bond Purchase Limit – $10,000/$15,000 Annually

Ready to shovel your full retirement account into I bonds? Unfortunately, you could run headlong into a yearly purchase limit.

An individual can only purchase $10,000 worth of electronic I bonds a year. You can boost this limit to $15,000 by purchasing $5,000 in paper bonds with your federal tax refund. Yes, this is weird, but, hey, it’s an option.

Want to buy more I bonds? The $10,000 I bond limit applies to each individual. If you are married or living with a partner, they can purchase $10,000 in I bonds as well, bringing your household total to $20,000.

If inflation rates remain high, you may want to continue investing $10,000 or $15,000 into I bonds each year.

What Are the Benefits of I Bonds?

The primary benefit of I bonds is their ability to protect your savings from inflation. When inflation is high, I bonds returns let your money keep pace.  That’s not all the good news about I bonds.

Here are a few other perks you’ll get:

High Level of Safety

I bonds are backed by the United States government, which has never defaulted on a loan. That’s as close to a guarantee for your money as you can get. After all, if the US government fails, we’ve all got bigger problems than our retirement savings.

No State Income Tax

The interest you earn on your I bonds is not taxable by your state. This can be a big help to savers who live in high-tax states, like New York or California.

I Bonds Are Giftable

Do you want to give your kids, grandkids, or other family members a financial gift? You can purchase up to $10,000 in I bonds for each person on your gift lift every year. This is in addition to the $10,000 (or $15,000) of I bonds you can purchase for yourself. Just remember that the one-year no-cash-out rule still applies to your giftee as does the three-month interest penalty if the bond is cashed before five years. (You can also always give your family the gift of financial knowledge.)

No Federal Income Tax if Used for Education

Are you thinking of going back to school, or do you want to help fund your child’s or grandchild’s education? If you use your I bonds to pay for a qualified education expense, you won’t have to pay federal income tax on your I bond earnings. That would make your I bond earnings completely tax free!

What Are the Drawbacks of I Bonds?

We’ve already discussed the fact that you can’t cash out your I bonds for the first year you own them and that you’ll lose three months of interest accrual if you cash them out before five years. Here are two other challenges to take into consideration.

Variable Earnings Rate

Just as I bonds can provide big returns during periods of high inflation, they can also readjust to much lower returns if inflation recedes. The United States has seen long periods of very low inflation growth in the recent past. This could happen again. If you are more focused on getting a good return on your investments rather than putting your money in a low-risk investment, you’ll need to keep your eye on your bonds. It can be easy to park your money in I bonds while the returns are good, forget about them, and come back years later to find that your bonds savings bonds didn’t earn as much as you expected.

Forgetting Your Account Exists

Buying I bonds means you’ll have another investment account to remember. If you choose to purchase paper bonds, you’ll need to keep your bonds safe and remember where they are. In our busy world, it can be easy to forget all about your I bonds. Since they won’t show up in your brokerage or other investment accounts, your family members may have no idea you own them if you pass away before cashing in your bonds.

I Bonds and Retirement Savings – Can I Bonds Save Your Retirement

As you approach retirement, (or if you’re already there), it’s critical to protect your retirement savings from risky investments. However, if you put your money under a mattress or into a low-yield savings account, inflation will gnaw away at the value of your money.

I bonds offer a good balance between safety and growth in the retirement scenario. They are about as safe as you can get and offer a strong return during high inflation years. Even during times of moderate inflation, they may still return more than most savings accounts and CDs.

I bonds can also help protect retirees against something called sequence of return risk. Even as you approach your retirement years, you may wish to keep some of your savings in stocks, real estate, and other investments that can offer a higher rate of return but also carry risk. If the market drops just before retirement or at the beginning of your retirement you could lose a large amount of money. This could threaten your ability to retire on time or force you to live on less money than you expected.

Given enough time, you could probably regain your losses as the markets recover, but that’s not always possible for someone who needs to withdraw retirement savings to cover their living costs. Withdrawing money from your investments during a down market will permanently lock in your losses.

I bonds can give you an option for taking out the cash you need to live during retirement without pulling money from investments that are down. This may give you the time you need to see the riskier parts of your portfolio recover.

Are I Bonds Right for Anyone Else?

You bet they are. While this article has focused on I bonds and retirement, I bonds aren’t just for older Americans. Anyone who is looking for a safe place for their money to ride out high inflation may benefit from investing in I bonds. (Here’s what else you can do to ride out market storms.)

Safe Savings

Even if your retirement is far into the future, I bonds can help you keep your retirement or investment portfolio balanced and hedge against your riskier investments.

Rainy Day Fund

You need a rainy day fund anyway, so why not have it work for you while it’s also serving as your safety net? The tricky part here is that you have to give your I bonds a year to mature before you can cash them out. You may want to consider putting a portion of your rainy day fund in I bonds and keeping a portion in a savings account that you can access if you face a financial crunch during that first year.

Your Kid’s College Fund

I bonds are perfect for saving a college fund, especially during high inflation years. This is money you won’t be touching for a while (assuming your children are young), so you won’t have to worry about the penalty. Don’t forget, your earnings are tax-free if you use them for qualified education expenses.

How Do You Purchase I Bonds?

You can purchase I bonds directly from the United States Treasury Department. (You’ll need to create an account to do this.) The minimum purchase for I bonds is $25 for electronic bonds and $50 for paper bonds.

Don’t forget, you can also purchase up to $5,000 of paper I bonds using your federal tax return. Make sure to alert your tax preparer if this is what you want to do. Most tax preparation software will also allow you to use your refund to purchase I bonds.

I Bonds and Inflation – Too Good to Be True?

An extremely safe investment vehicle that protects your money from inflation? If it sounds a little too good to be true, well, sometimes good things really do exist. High inflation rates aren’t fun for anyone, but they can be especially damaging to retirees who have to live on a fixed income or those who are nearing retirement and need to save as much as possible.

In times of high inflation, I bonds can offer you a superb rate of return, allowing you to rest a little easier on your way to retirement.

Reminder: the information on this website is for general educational purposes only and is not intended to provide specific advice or recommendations. Please discuss your particular circumstances with an appropriate professional before taking action.

1 thought on “What Are I Bonds and Can They Protect Your Retirement Savings from Inflation?”

  1. This is great information! I bought IBonds because I heard about them on tv. I also read about them but this article really explains them. I also bought my son and daughter Ibonds.

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