As inflationary pressures continue to mount (e.g., 8.3% for the 12-month period ending April 2022), individuals may look to their financial advisors for practical and, where possible, tax-advantaged strategies for addressing this challenging environment. United States I Bonds may potentially allow advisers to address these concerns by serving not only as vehicles for immediate inflation protection, but also as a foundation for achieving long-term tax savings. Key benefits of I Bonds, beyond offering what is often an above-market interest return (9.62% annual rate, recomputed semi-annually, for the period of May 2022 through October 2022), include their extraordinary flexibility and liquidity. This article begins with a brief overview of the structure and operation of I Savings Bonds, and then explains and demonstrates strategies uniquely applicable to these instruments, which taxpayers may employ to generate significant tax savings.

I Savings Bonds—Structure and Operation

I Savings Bonds are securities issued by the U.S. government that provide an inflation-based rate of interest plus often, but not always, a fixed rate of interest that applies until the bond is redeemed. If, however, inflation is negative (as was the case for one six-month term in 2015) and the resulting combined interest rate is negative, the composite interest rate for the period will be zero (i.e., no negative adjustment). As U.S. government obligations, I Bonds are not subject to state and local taxes.

The formula used by the Treasury Department for computing the composite interest rate is as follows:

Composite rate = [fixed rate + (2 × semiannual inflation rate) + (fixed rate × semiannual inflation rate)]

Example 1–Part 1.

Consider the following scenario: A purchased an I Bond on November 1, 2019. At that time, newly purchased I Bonds provided a fixed annual interest rate of 0.2%. The annual inflation rate in effect at that time was 2.02% (semiannual inflation rate 1.01%). A‘s annualized rate of return for the period through April 2020 was 2.22%:

.002 + (2 × .0101) + (.002 × .0101) = .0222202; Treasury Direct rate 2.22%

Example 1–Part 2.

The annual inflation rate in effect on November 1, 2021, was 7.12% (semiannual interest rate 3.56%). A‘s annualized rate of return for that same I Bond for the period through April 2022 is 7.33%:

.002 + (2 × .0356) + (.002 × .0356) = .0732712; Treasury Direct rate, 7.33%

Example 2.

Consider the following scenario: B purchased an I Bond November 1, 2021. At that time the fixed rate for newly issued bonds was zero. The annualized rate of return for B‘s I Bond is 7.12%:

−0− + (2 × .0356) + (0.00 × .0356) = .0712; Treasury Direct rate, 7.12%

Note that B‘s bond, because it had no fixed component, generated 0.21% less interest income (0.2% fixed rate + .01 fixed rate compounding effect) than A‘s bond, even though both were held during the exact same period of time.

I Bonds can be redeemed at any time after one year of purchase and continue to earn interest up to their 30-year maturity. I Bonds that are redeemed within five years of purchase forfeit the last three months of interest income.

I Bonds can be purchased in electronic form in any denomination, to the penny, from $25 up to a maximum of $10,000 per person per year. There is not, however, a household limitation. A family of four, for example, with each person purchasing the $10,000 maximum could, therefore, purchase $40,000 of I Bonds, in electronic form, in a single year. Electronic I Bonds can be purchased, without fee or commission, through the U.S. government’s Treasury Direct program. Paper form I Bonds can only be purchased with tax refunds and are limited to a maximum of $5,000 per year. Paper I Bonds are available in denominations of $50, $100, $200, $500, and $1,000.

Strategies for Maximizing After-Tax Returns: Children as Owners of I Bonds

Purchases of I Bonds by children potentially allow them to achieve up to $1,150 of tax-free income and $1,150 of income taxable at a child’s individual tax rates. (Rates are for 2022 and subject to periodic Treasury inflation adjustments.) These tax benefits can be further extended by utilizing the election options available for savings bonds.

Example 3–Part 1.

Consider the following scenario: C, child of A and B, became the owner of an I Bond in 2020. C owns no other savings bonds and has not made an election to currently recognize savings bond interest. The bond earns $200 in 2020, and $400 per year in 2021 and 2022. C also earns $150 in investment income from other sources during each of those years. No income is recognized nor reported for 2020 or 2021.

For tax year 2022, C elects to report all savings bond interest accrued to date and not previously reported, $1,000, on his tax return. Because the total reported investment income, $1,150 [$1,000 + $150], does not exceed the threshold, there will be zero income tax for 2022; because it is currently reported, there will be no taxable recognition of that I bond interest income upon redemption.

In future years, if investment income remains at $1,150 or less, the income tax will continue to remain at zero. If investment income exceeds $1,150 but remains no more than $2,300, the amount within that range will be taxed at the child’s rate.

The election to change from the cash to the accrual method for recognizing saving bond interest is made by reporting, for the year of change, all interest accrued to date and not previously reported. The election, once made, applies to all savings bonds currently held and purchased in the future. However, an election can be made to change savings bond income reporting back to the cash method.

Example 3–Part 2.

C purchases a $10,000 I Bond on December 31, 2024, and a $10,000 I Bond on January 1, 2025. As a result of these purchases and an increase in interest rates, he has a significant increase in I Bond interest income in 2025. C elects, effective for the 2025 tax year, to change back from the accrual method to the cash method for reporting of savings bond interest. As a result, any savings bonds interest earned in 2024, 2025, and future years will not be recognized until redemption. (See IRC section 454(a) and Treasury Regulations section 1.454-1 for more details.)

Switching from the accrual method to the cash method is more involved than vice versa. This requires IRS permission, which is automatically granted when the taxpayer submits a statement, attached to the tax return in the year of change, which fulfills a specified set of IRS requirements. Those specific requirements—listed in Publication 550, Investment Income and Expenses –are focused on listing the complete set of bonds held and the interest to be reported. Alternatively, the taxpayer may request permission to make the reporting change by using Form 3115.

Tax Bracket Management and Gain Harvesting

Because I Bonds are not subject to FIFO (first in, first out) nor weighted average income recognition rules, they provide their owners with opportunities to recognize, depending upon the circumstances, more optimal levels of taxable gain.

Example 4.

Consider the following scenario: D & E, a married couple, incur an unexpected expense, and need to generate $25,000 in cash. They hold two sets of I Bonds, both currently valued at $25,000. One set was purchased five years ago for $20,000; the other set was purchased 20 years ago for $5,000. The couple redeems the bonds that were purchased five years ago to minimize recognition of taxable income in the current year.

Example 5.

Same scenario as Example 4, except that D & E are experiencing serious, but what they believe to be temporary, financial difficulties in the current year. As a result, their projected taxable income for the year, without consideration of the I Bond redemptions, is expected to be minimal. D & E redeem the bonds that were purchased 20 years ago to avail themselves of the benefits of their lower current year tax brackets.

Example 6.

F, a single individual, seeks to generate approximately $20,000 in cash to fund a trip. She has been purchasing $10,000 in I Bonds for each of the last six years. Currently, the applicable inflation-based interest rate is 0.16% (semiannual inflation rate is 0.08%). F, therefore, chooses to redeem the two most recently purchased and available (held more than 12 months) $10,000 bonds, which, by virtue of their shorter holding periods, would contain the lowest amount of unrecognized accrued interest. Although the early redemption (prior to five years) entails a loss of the last three months of interest, the actual amount forfeited, $8.00 ($20,000 × .0016 × 3/12) is de mini-mis and, therefore, provides a beneficial tradeoff for F.

I Bonds for Retirement Funding

Taxpayers may initially use I Bonds as part of a long-term plan to build—tax-deferred—a significant safe (principal-protected) fixed investment component of a retirement portfolio. After retirement, taxpayers may benefit by taking redemptions during key phases when they may potentially be subject to lower marginal tax rates.

Example 7–Part 1.

Consider the following scenario: G & H, both age 45, pursuant to a 20-year plan to build a fixed safe (principal protected) component of their retirement portfolio, begin making $20,000 annual purchases of I Bonds. After 20 years, assuming a 4% interest rate, the I Bonds would be valued at $663,206, which would include $263,206 in unrecognized interest income. This I Bond portfolio, being subject neither to credit nor market risk, is 100% principal protected. Its high level of protection may provide G & H with the flexibility to assume more risk in other areas of their portfolio (e.g., stock or real estate).

As of March 25, 2022, the year-to-date return for the S&P U.S. Aggregate Bond Index was -6.46%. An I Bond, in contrast, will never experience a decline in principal value, thereby providing a reduction in fixed investment risk (as compared to non-principal-protected securities), potentially creating opportunities for an investor to assume more risk in other areas, including equities.

Nevertheless, investors may need to be reminded that bond investments, including I Bonds, are generally expected over the long term, in accordance with the risk/return tradeoff, to generate lower investment returns than equity investments. Thus, referring to Example 7, purchases of the fully allowable annual amount of I Bond investments may not necessarily be appropriate, if it were to move the investors away from their target asset allocation (e.g., 60% equities/40% bonds).

Through careful planning, substantial amounts of the tax-deferred I Bond interest income, accumulated during the prior 20-year period, can potentially be distributed and recognized at lower marginal tax rates.

Example 7–Part 2.

G & H, at age 65, retire and begin annually drawing $125,000 (cost $75,000, estimated) from their I Bond portfolio and $60,000 of taxable interest income from other sources to fund their projected annual cash funding requirement of $175,000. They plan to follow this strategy for five years, until the year in which they turn age 70 and become eligible to draw maximum Social Security benefits.

Cash Generated; Adjusted Gross Income
I Bond redemptions; $125,000; $50,000 [$125,000–$75,000]
Other taxable interest income; 60,000; 60,000
Cash generated before income taxes; $185,000; $110,000
Applicable income taxes; 9,736*
Net cash; $175,264
*Standard deduction of $28,700 (includes additional $2,800, age 65+ deduction for married couple filing jointly) reduces AGI of $110,000 to taxable income of $81,300.

By redeeming the I Bonds over the five-year period, G & H meet their cash funding needs and maximize the tax benefits by fully utilizing the 10% and 12% tax brackets. The taxpayers meet their cash funding needs and maximize the tax benefits by fully utilizing the 10% bracket and nearly fully utilizing the 12% tax bracket (ends at taxable income of $83,550).

Additionally, Medicare beneficiaries may need to consider how I Bond redemptions can potentially generate an increase in Medicare Part B and Part D (drug plan) premiums. Although not applicable in this example, if joint tax return income had been above $182,000 (yearly income for 2020, used for 2022 payments), Part B monthly premiums would have risen from $170.10 to $238.10. Similarly, for Part D (drug benefits), monthly costs would have risen by $12.40 beyond the plan premium. (For full schedules of premiums by income, see and

Another phase of retirement during which I Bonds may be redeemed at potentially lower marginal tax rates is that of advanced aging, when taxpayers may be more likely to incur medically deductible costs for age-related expenses, such as nursing homes or assisted living facilities.

Example 8.

Consider J, a single individual, age 87, who has $1,000,000 in investments generating $50,000 per year in taxable interest income and $200,000 in I Bonds ($100,000 in unrecognized income). She also receives $40,000 ($34,000 taxable) per year in Social Security benefits. J resides in an assisted living facility costing $90,000 per year and has other unreimbursed medical costs of $10,000. Those medical expenses are J‘s only itemized deductions. During the year, J redeems $100,000 in I Bonds generating $50,000 in taxable income.

Taxable income
Investment income (other than I-bonds); $50,000
Social Security income ($40,000 gross); 34,000
I Bond redemption ($100,000 gross); 50,000
Adjusted gross income; $134,000
Medical expense deduction; 92,500 [net of 7.5% floor]
Taxable income; $41,500

As a result of the I Bond redemption, J is able to almost fully utilize the lower 10% and 12% tax brackets. The 22% tax bracket begins at taxable income over $41,775.

Because taxpayers normally will not know years ahead of time whether they will need to incur expensive age-related expenditures, this example may be viewed in the context of contingency planning. If it turns out that the funds are not needed, the I Bonds can continue to grow tax deferred, without any income recognition, until their 30-year maturation.

I Bond Redemptions for Tax-Free or Reduced College Tuition

In order to fully qualify for the exclusion of savings bond interest, several criteria must be met, including the following: 1) funds must be used by the taxpayers only for qualifying education expenses for themselves, their spouse, or their dependents; 2) the bond owner must have been at least 24 years of age at the time of purchase; and 3) the taxpayer’s income must be below a qualifying threshold, subject to a phaseout. (See IRC section 135, which also details other limitations—e.g., no double benefit of taxable income exclusion and scholarships).

Example 9.

Consider the following scenario: K & L are married taxpayers with modified AGI of $100,000, before redemptions of I Bonds. They redeem two I Bonds, one purchased when their daughter was a young child and the other more recently, with redemption values of $14,000 (cost $5,000) and $8,000 (cost $5,000), respectively, to pay $22,000 of their daughter’s qualified tuition expenses. Because their modified AGI after redemptions ($112,000) is below the threshold ($124,800–$154,800 phaseout range for married couples filing jointly for 2021) the entire amount of interest earned, $12,000, is excluded.

Note that, in comparing the exclusion amount between the two bonds, that the longer a bond is held, the greater is the potential tax exclusion benefit. Taxpayers should be advised, therefore, that to achieve the greatest benefit, they should purchase bonds as early as possible. This example, as is the case with Example 8, may also be viewed in the context of contingency planning. In the event that the funds are not needed or if the taxpayers’ income turns out to be too high to qualify for the exclusion, the taxpayers may still benefit from up to 30 years of tax deferred income growth.

A potential key benefit of the savings bonds for education provisions is that even if all of the income was accrued when the taxpayers’ modified AGI was in excess of the threshold, it will still qualify for tax-free treatment, provided that the taxpayers meet the requisite criteria at the time of redemption.

Example 10.

Consider the following scenario: M & N are a married couple of the same age who, at age 50, earn income well in excess of the threshold that would qualify them for the educational savings bonds’ exclusion. They are also subject to the tax on net investment income. M & N’s plan is to continue to work full-time until about age 64 and then become part-time consultants, earning $100,000 per year from thereon for the foreseeable future. Their plan entails having funding available should their children, P & Q, currently ages 10 and 8, respectively, enroll in expensive graduate education programs at some future date. Pursuant to that funding plan, M & N begin purchasing I Bonds.

Fifteen years later, M & N at age 65, earning $100,000 as consultants and $5,000 from other investments, redeem I Bonds valued at $40,000 (cost $24,000), to pay for 25-year-old P’s qualifying graduate tuition expenses. Their modified AGI, having no other adjustments, is $121,000 ($100,000 + $5,000 + $16,000), which is under the beginning phaseout level ($124,800 for married couples filing jointly in 2021). Despite having all or almost all of the interest income, $16,000, accrue while the couple’s earnings were above the income threshold, all of it will qualify for tax-free exclusion. Again, as with some previous examples, this too may be viewed within the context of contingency planning. Here, there is the added benefit that the taxpayers were able to avoid having the I Bond income be subject to the tax on net investment income. (More detailed information about the Education Savings Bond Program may be found in Using Saving Bonds for Education, FS Publication 0051, Department of the Treasury, Bureau of the Fiscal Service, revised July 2015).

Taxpayers may need to be advised that, although I Bonds potentially provide an excellent after-tax return as compared to other bond or fixed-income investments, they should not be expected, over extended periods of time, to outperform equity investments. According to FinAid (, college tuition is rising at a rate of approximately 8% per year. In light of this rising cost landscape, individuals may need to consider and make difficult choices regarding risk/reward alternatives. Similar to retirement planning, the optimal balance between equities (greater risk/greater reward potential) and bonds/fixed income (lower risk/lower reward potential) may vary depending upon an investor’s time horizon. Typically, in practice, this may result in investors with longer time horizons, taking on more risk, because they have more time to recover from losses, whereas those with shorter time horizons take a more conservative approach.

Other Considerations

Utilization of EE Savings Bonds in conjunction with I Bonds.

I Bond holders with a long-term perspective who seek a complementary fixed return investment may wish to consider investing in EE Savings Bonds. Although the current interest rate (i.e., for bonds issued November 2021 to April 2022) is only 0.10%, the Treasury Department guarantees that bonds kept for 20 years will double in value providing, in effect, a fixed annualized return for that period of approximately 3.5%. Therefore, while EE bonds have the same redemption rules as I Bonds (i.e., three months’ loss of interest when redeemed prior to holding for five years), from a practical perspective, the investment strategy would only be worth pursuing if the intent would be to hold the bonds for at least 20 years. Furthermore, because any holding of the bonds beyond 20 years will provide only de minimis incremental returns (i.e., 0.10% rate), the optimal window for redemptions is narrow. Taxpayers, who are confident, however, that the end of a 20-year holding period will occur at a time when they will be subject to a lower tax bracket [e.g., during a retirement phase prior to collection of Social Security benefits (I Bonds Example 7–Part 2)] may potentially achieve the 3.5% fixed return at tax-advantaged rates.

Estate planning consideration—no step-up in basis.

In situations where a taxpayer needing to generate cash must choose between selling an appreciated capital asset or redeeming I Bonds with unrecognized income, an estate planning factor to consider is that the appreciated capital asset will receive a tax-free step-up in basis at the taxpayer’s death, whereas the I Bonds will not receive that benefit.

Estate planning consideration—post-mortem election.

The executor of an estate may make an election to include all previously unrecognized savings bond interest on a decedent’s final tax return (Revenue Ruling 68-145). This election may prove particularly beneficial in situations where the savings bond income can be used to offset high-itemized deductions (e.g., unreimbursed medical expenses) in the year of the decedent’s death.

Long-Term Planning May Provide Significant Tax-Advantaged Payoffs

A theme demonstrated in many of the examples contained here is that the sooner a plan of I Bond purchases begins and the longer it continues, the greater the overall tax benefits may be. Because such benefits may not be immediately visible, particularly when bonds are to be held for extended period of time, advisors may provide valuable services by educating and advising clients as to their usage. Overall, as demonstrated above, I Bonds provide a unique set of planning opportunities that make them an important factor for individuals to consider when developing a broad range of tax-advantaged strategies.

Seth Hammer, PhD, CPA, is a professor of accounting at Towson University, Towson, Md.