Series I savings bonds are a low-risk investment option that currently offer higher returns than you can get with most savings accounts. That’s even though interest rates on I bonds have fallen from their recent peak. New bonds are now paying annual interest of 4.30%, down from 9.62% in 2022.
The U.S. Treasury makes it easy to buy I bonds with your tax refund. If you expect a refund after filing your tax return, the windfall could be the perfect opportunity to move some money into this excellent low-risk investment.
What Are I Bonds?
I bonds are a popular type of U.S. savings bond. They are designed to provide inflation protection for your money because you earn both a fixed rate of interest and a rate that adjusts along with inflation.
The way this works is simple. When you buy an I bond, it comes with a set, lifetime interest rate. It also comes with a variable, inflation-based rate that’s adjusted by the Treasury twice a year.
The quoted interest rate on an I bond is a combination, or composite, of the fixed interest rate and the inflation-adjusted rate. They earn interest monthly, and the interest is compounded semiannually. In other words, every six months, the government applies the bond’s new interest to its principal, so you’re earning interest on top of interest.
Because prices have been rising more slowly, the inflation-based component of the I bond interest rate is widely expected to plunge when it resets on May 1—and push the overall rate on the bonds below 4%.
Over time, your bond’s value should grow as it earns inflation-adjusted returns and the principal value increases.
How To Cash Out an I Bond
Series I bonds earn interest for 30 years or until you cash them out, whichever comes first. You receive your interest payments when the bond is redeemed or it reaches its maturity date.
As an added benefit, I bonds are exempt from state or local income taxes. And if you use the money for qualified education expenses, such as college tuition, you may not have to pay taxes on the earnings.
You can cash out an I bond after just 12 months. But if possible, hang onto the bond for at least five years. Otherwise, you’ll lose the last three months of interest.
Benefits of Using Your Tax Refund To Purchase I Bonds
As of April 28, 2023, the average tax refund from a 2022 return was $2,777. For most people, that’s not a minor windfall. If you spend it on I bonds, you can make the money work harder for you by earning interest.
Buying I bonds with your tax refund gives you the following benefits:
- You can buy more bonds. The government sets limits on how much you can invest in I bonds. You can buy up to $10,000 per year in electronic I bonds. However, if you use your tax refund to buy I bonds, you can buy an additional $5,000 of bonds. Using your tax refund allows you to buy up to $15,000 in I bonds per year.
- You get protection against inflation. If you tucked your tax refund into a savings account, it could earn a very low annual percentage yield (APY). By investing the money in I bonds, you’d earn a higher rate of interest. And because the rate adjusts as inflation changes, I bonds can ensure you get the most value from your refund.
- Buying bonds prevents you from wasting your refund. When you receive an influx of cash, it’s tempting to splurge on new electronics, clothing or travel. But if you invest in I bonds, you can use the refund wisely before it reaches your bank account, preventing you from spending it on unnecessary purchases.
- Bonds are a relatively safe investment option. While investing in index funds may produce higher returns, you may not be willing to risk your money in the stock market if you have a shorter time horizon. Compared to stocks and other investment options, I bonds are a much safer investment choice, so they’re a good option for those focused on limiting risk.
- You can give bonds as a gift. When you purchase I bonds, even if you’re using your tax refund, you can buy them as a gift for a friend, relative or child.
How To Buy I Bonds With Your Tax Refund
You can purchase bonds at any time at TreasuryDirect.com. But the IRS makes it easy to buy I bonds with your tax refund.
Paper Bonds
Buying paper bonds allows you to purchase bonds without opening a separate account with Treasury Direct.
If you’re using tax software, the program will ask if you want to use your refund to buy paper bonds and guide you through the process. If you’re working with a tax preparer or completing your taxes on your own, you’ll need to fill out an IRS Form 8888: Allocation of Refund (Including Savings Bonds Purchases).
Complete Part II of the form, designating how much you want to purchase in bonds.
When using your tax refund to purchase bonds, bonds are available in $50 increments. If you only want to use a portion of your refund to buy bonds, you can designate how much you want to use for bond purchases and receive the remainder as a check.
If you purchase paper bonds, it can take the IRS up to three weeks to process your request and mail your bonds.
Digital Bonds
If you’d prefer to buy electronic I bonds, you can do so by creating an account with TreasuryDirect.
Once you have an account, fill out Form 8888 and put your TreasuryDirect account information under the direct deposit section. With this option, check the “savings account” option next to your account number.
Enter the amount of money you want to use to purchase bonds in $50 increments.
If you want to use a portion of your refund to buy I bonds, you can opt to receive the remainder as a check or electronically deposited into a checking or savings account.
For example, if you have a refund totaling $530, you can request that $500 be deposited into your TreasuryDirect account, and receive the remaining $30 as a deposit to savings.
Alternatives to I Bonds
While I bonds are an appealing investment, one downside is that they offer limited liquidity since you cannot cash out the money until 12 months have passed. And if you cash out before five years have passed, you lose out on three months of interest.
If you’re looking for other low-risk ways to increase your returns, consider the following:
High-Yield Savings Accounts
According to the Federal Deposit Insurance Corporation (FDIC), the national average APY for savings accounts was 0.39% as of April 17, 2023. But you can find high-yield savings accounts from some banks and credit unions offering APYs as high as 5.00%.
Unlike CDs or I bonds, high-yield savings accounts don’t have time restrictions on when you can access your money, so they’re a useful option for building an emergency fund.
Certificates of Deposit (CDs)
A certificate of deposit is a type of deposit account that holds a fixed amount of money for a specified period of time, such as six, 12 or 60 months. In exchange, the bank pays you a higher rate of interest than you’d usually get from most savings accounts.
The best CD rates stretch to 5.20%, and rates are fixed for the duration of the CD’s term.
The money in a CD cannot be touched until its maturity date. If you do make a withdrawal, you could be on the hook for hefty penalties.
