What are I bonds? Low-risk investment is designed to protect savings from inflation

(NEXSTAR) – With inflation hitting near-record highs, Americans across the country are facing unprecedented financial challenges. Gas, food, rent — it’s all significantly more expensive than it was last year.

Hedging against inflation can also be a bit tricky, especially after the fact. And the Fed’s recent decision to hike interest rates by 0.75% won’t make it any easier for the average American to invest, or carry debt, until inflation (hopefully) slows in the coming months.

There is, however, one option for investors hoping to protect their current savings from losing value, and it’s becoming more and more popular.

Series I Savings Bonds, also known as I bonds, are a type of savings bond intended to keep pace with inflation. The bonds accrue interest based on two rates: a fixed rate that remains the same over the 30-year life of the bond, and an “inflation rate” determined every six months by the U.S. Treasury. I bonds purchased before Oct. 2022 are currently offering a return rate of 9.62%, with interest being compounded semi-annually.

“I bonds are getting a lot of attention,” Brian Therien, a senior fixed-income analyst with Edward Jones Investments, tells Nexstar. “I’ve definitely been getting more questions about I bonds recently, because of the high interest rates.”

It’s important to remember that those interest rates don’t remain constant. They’re based on the Consumer Price Index (CPI), and the U.S. Treasury calculates and updates those variable inflation rates twice per year.

“That interest rate, that’s not long-term,” says Therien, who explains that the interest rate on I bonds was much lower in recent years, and will drop when inflation slows.

Still, I bonds are considered very low-risk, largely because they can never decrease in value like treasury bonds, corporate bonds or even stocks. The trade-off, Therien says, is that I bonds also won’t pay out interest as income — rather, the interest is added to the principal.

“They’re best suited for investors that don’t need the income from the bonds,” Therien says.

There are a couple other caveats, too. Individuals can only purchase up to $10,000 in electronic I bonds per year (and $5,000 more in paper, if they buy with money from a federal income tax refund). Bond-holders also can’t redeem the bonds for at least a year, and they will be penalized for cashing out before the first five years by having to forfeit the previous three months of accrued interest, according to the Treasury Department.

That said, I bonds offer plenty of benefits for investors who can hold them for at least a year, or ideally at least five.

“Compared broadly to other bonds, they have what we call very strong credit quality,” says Therien. “They’re very high quality in that you can be very certain you’ll get your principal back, because they are backed by the U.S. Government.”

I bonds are also exempt from state and local taxes. Investors only need to pay federal income taxes on the interest, and even that can be deferred until cashing out the bond or waiting until it matures. Qualified taxpayers may also be able to exclude the interest from taxable income, if using the funds to pay for higher education.

“Price stability would be another benefit,” Therien adds. “There aren’t many opportunities to own something where the price really doesn’t fluctuate. Any other treasury bonds, stocks, cryptocurrency you buy, the price is going to fluctuate, but … with I bonds, that value doesn’t change. Not many investments can offer that.”

Series I Savings Bonds are only available to purchase directly through the U.S. Treasury. Click here for more information.