The Best Bond Investment for the Little Guy

Photograph: Getty Images Close

Photograph: Getty Images


Photograph: Getty Images

It’s rare that any investment is a “no-brainer.” For many middle-class families right now, Series I savings bonds appear to be just that. 

Issued by the federal government, I bonds have the highest credit quality, cannot decline in price and pay yields indexed to inflation. What’s more, I bond income isn't subject to state or local taxes and, when used to pay for a child’s education, can be free of federal tax as well. 

Compare that with cash or a CD, and I bonds win hands down. New I bonds currently yield 1.76 percent, a payout that rises and falls with inflation. The average 5-year CD pays a fixed 0.93 percent, according to Bankrate, and is subject to taxation.

What’s the catch? An individual can't legally invest more than $10,000 a year in I bonds, so they're of limited use to wealthy investors. 

For a middle-class family of four, however, that’s $40,000 a year, more than enough to stash the extra cash most families have on hand. The only liquidity drawback is that the bonds must be held for at least a year, and if they're cashed out before five years, you forfeit three months of interest -- still better than the six months of interest 5-year CDs typically charge for early redemptions. 

Premium prices

Low interest rates have I bonds looking attractive not only next to CDs but against some of the most popular bond categories, such as 10-year Treasury Inflation-Protected Bonds. TIPS, which are also indexed to inflation, are trading at a premium to their underlying face value, even though inflation is currently tame. That premium price translates into a yield that is 0.66 percentage points less than the inflation rate.

That means that if there's no pickup in inflation, or if there's deflation, investors who buy at today's prices and hold the bond to maturity could wind up with a negative return. At maturity, the bond's price will fall to face value, after all, and with no inflation adjustment to counteract the decline in price, you have an unhappy investor. In contrast, an I bond investor would get inflation protection without the haircut, says financial planner Charlie Ryan of Atlantic Financial Planning in Anapolis, Maryland. 

Tricky tax benefits

The tax advantages of I bonds are an added benefit. Whether you use the bonds for education or not, all taxes on their income are deferred until you sell the bonds or they mature. Their value compounds tax-free, as with an IRA.

To qualify for the federal tax exemption for a child’s educational costs, the bonds you use to pay for those expenses must be held in your name, not theirs. You must be older than 24 when you buy them, and there are personal-income limits. For married taxpayers filing jointly, the exemption starts shrinking at a $106,650 modified adjusted gross income and is eliminated for incomes above $136,650. 

Some investors complain about the difficulty of buying I bonds through the Treasury site. One is the wife of financial planner Stan Richelson of Scarsdale Investment Group in Blue Bell, Pennsylvania. “My wife Hildy went to open an I bond account to put money aside for our grandchildren,” says Richelson. "She's extremely computer literate, but it took her a long time. The site has three different levels of passwords. She said, ‘I can’t believe it. The man on the street is supposed to do this? He’s not going to do it.’ What a nightmare.” 

There may be a more insidious reason why most investors have never heard much about I bonds: Planners can’t earn commissions selling them or collect a percentage of their assets as a fee. (For planners that charge by the hour, that's not an issue.) This may be one of those rare instances in which the informed do-it-yourself investor can do much better than those with hired guns. 

(Lewis Braham is a freelance writer based in Pittsburgh.) 

To contact the editor responsible for this story: Suzanne Woolley at

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