Things that are having a moment right now: Anti-hustle culture (excellent). Y2K fashion (questionable). And a type of government bond you may not have heard of: series I bonds.

The reason I bonds have been en vogue this year is that they’re designed to help protect savers from inflation — in fact, that name is short for “inflation-linked savings bond.” Before this current period of higher inflation started, I bonds weren’t paying that much. But now — well, now’s a different story. In November, the government set interest rates on I bonds at 6.89%.

But! There are some important rules and caveats you should be aware of. Here’s the must-know info on I bonds, plus some advice to help you decide whether or not you want to invest in them.

What are I bonds? And how do they work?

First, if you need a refresher on bonds in general, we’ve got you. I bonds, specifically, are a type of government bond that pays an interest rate tied to the consumer price index (a measure of inflation). That interest rate changes every six months, in May and November. Between May and November of this year, it was set at 9.62% (hence why they got so much buzz). Now it’s 6.89%. That’s a pretty big change, and the start of a trend that’s likely to continue as long as the Fed is focused on getting inflation back under control.

Now for the rules and logistics: 

• You can only buy a max of $10,000 in I bonds per year. (You can technically buy an extra $5,000 of them if you have the money deducted directly from your tax return — but it’s too late for that option this year.)

• Your money is 100% locked in for one whole year; you cannot withdraw it before then.

• The interest rate changes every six months. But when you buy I bonds, you lock in the current interest rate for six whole months from your date of purchase. So, for example, interest rates are set by the government in May and November. But if you buy in December, you’ll get November’s interest rate from December until June. Then, in June, you’d get May’s interest rate from June until December. And so on.

• After the first year, you can withdraw your money any time you want. But caveat: if you cash out before the five-year mark, you’ll sacrifice your last three months’ worth of interest. Alternatively, you can hold the bond for a max of 30 years.

• Once you’re eligible to cash out, you can withdraw as little as $25 at a time, but you can’t leave less than $25 in there.

• Interest is compounded every six months. That means every six months, any interest you’ve earned will be added to the bond’s principal value, and you’ll start earning interest on that interest.

• You don’t receive your interest payments until you cash in the bonds — but that means you don’t have to pay income tax on that interest until then, either.

• You can only buy I bonds directly from the government, via TreasuryDirect.gov.

The risks associated with I bonds

There’s no such thing as a completely zero-risk investment. So because buying bonds is a form of investing, let’s talk about the risks involved here.

Government bonds have the highest credit rating of all the kinds of bonds (AAA). They’re backed by the “full faith and credit” of the US government, so the risk of default (aka that you’ll lose the money you invested) is preeeetty close to nothing. I bonds are also considered liquid after that one-year mark, which means they can be easily converted into cash (another good thing in terms of risk).

The main risk with I bonds has to do with the changing interest rate — there’s no way to know how much they’ll be paying six months from now. And you’re locked in for one whole year. So there’s always the chance that inflation (and therefore the interest rate) could drop in six months and you’ll end up earning less over the course of the year than you expected. (In fact, if the Fed’s plan to curb inflation works, that’s a likely scenario.)

Should you buy I bonds?

First, and this is important: We do not recommend investing your emergency fund in I bonds. Your emergency fund should be secure and accessible in a liquid, FDIC- or NCUA-insured banking account at all times. I bonds would lock your money up for a whole year, which is not what we want for rainy day savings.

Aside from that, we can’t tell you what’s going to be right for you in a Magazine article — you have to decide for yourself. But here are some things to consider. 

First, while interest rates could definitely drop next year, 6.89% is nothing to shake a stick at, as far as government bond interest rates go (not to mention savings account interest rates). Even if the interest rate dropped all the way to 0% in May (which would be very unlikely), you’d still be earning a pre-tax interest rate of ~3.4% for the year.

Plus, after that first year, if inflation does drop and I bonds’ interest rates no longer feel worth it to you, you can always cash in the bond and invest in something else (although just remember that if it hasn’t been five years yet, you’ll give up three months’ worth of interest). Pro tip: Set yourself a reminder to check the interest rate every six months so you’ll remember to reevaluate.

Ellevest’s typical advice is to save (in an FDIC-insured bank account) any money you’re going to need in less than two years, and invest any money you won’t need for two years or more. But where you decide to draw that line ultimately depends on how much investing risk you’re willing to take for your savings.

So with the current interest rate so much higher than what even high-yield savings accounts pay, I bonds could be an option for timelines right around that 1–2 year mark (again, keeping that 3-month penalty in mind). It could also be an option for any money that you know you won’t need for at least a year, but think you might need sometime soon after that.

At the end of the day, though, it’s up to you. Either way, we’re rooting for you!

Disclosures