Inflation-Linked Savings Bond (I Bond)

What Is an Inflation-Linked Savings Bond (I Bond)?

Inflation-linked savings bonds (I-bonds) are U.S. government-issued debt securities similar to regular savings bonds but with protection against inflation.

Understanding Inflation-Linked Savings Bonds (I Bond)

Inflation-linked savings bonds (I-bonds) are issued and backed by the U.S. government and have no default risk. The bonds sell for face value and pay the stated rate on the bond at maturity, typically 30 years after the date of purchase. I-bonds must be held for at least five years, otherwise losing three months of earned interest as a redemption penalty applies. 

Inflation-linked savings bonds (I-bonds) differ from Treasury Inflation Protected Securities (TIPS), although, like TIPS, the amount of interest paid adjusts based on the rate of inflation.
Unlike TIPS, inflation-linked savings bonds, also known as Series-I bonds are very low-risk investments typically sold to retail investors. Like traditional savings bonds, they are made available directly from the U.S. Treasury.

Like all savings bonds, Series-I bonds do not trade on a secondary market and cannot be transferred either. In other words, they need to be redeemed by either the original purchaser or that person's estate. Because they have such a low default risk, series-I bonds typically pay very low rates of interest, relative to most other securities. However, like most municipal bonds, they are exempt from income tax. Interest on most other fixed-income securities is taxable.

Advantages of I-Bonds

Adjusting for inflation can result in higher returns for Series-I bonds over a 30-year period, relative to regular savings bonds. However, it's worth noting that Series I bonds do not work like TIPS, which actually pay more or less interest based on the movements of CPI. Rather, the fixed rate of interest paid on Series-I bonds is adjusted regularly, based on CPI inflation.

Series I-bonds also cannot lose value due to deflation or negative interest rates.

How I-Bonds Adjust for Inflation

Inflation-linked savings bonds are tied to the movements of the consumer price index (CPI), a longtime measure of inflation issued by the U.S. Bureau of Labor Statistics (BLS). CPI measures the price change of a basket of consumer goods over time, including food, consumer staples, medical care, and transportation. It differs from PCE inflation, which is the preferred inflation figure of the U.S. Federal Reserve.

The PCE number tends to report a slightly lower inflation figure relative to CPI. The CPI figures are released monthly, and the BLS tracks the results of CPI over time.