I bonds for the cushion

In short

I once watched a neighbor tuck a few hundred dollars into a coffee can, and I thought, well, there is a person who understands why a cushion matters. If you are holding savings meant for a rainy day, an I bond is one place the Treasury lets you park that money. It is a savings bond that pays a rate made of two parts, and the rate resets twice a year. It is bought mainly through TreasuryDirect, the Treasury's website, and each person faces a yearly purchase cap of the current figure, which the official source publishes each year. The bond cannot be cashed for the first twelve months. If you cash it before five years, the Treasury takes back the last three months of interest. That is the whole trade.

The whole of it

What it is

A friend of mine once called an I bond "a savings account with a leash," and I have never heard it put better. It is a bond sold by the United States Treasury. The word I stands for inflation, which is the slow rise in what things cost. The bond pays interest, and part of that interest is built to rise when prices rise.

You lend the government your money. The government promises to pay it back with interest. That promise is backed by the federal government, which is why people think of these bonds as a quiet place for a cushion.

The interest does not arrive in your pocket each month. It builds up inside the bond. You collect it all when you cash the bond out, or when the bond reaches its thirtieth birthday and stops earning.

How it works

If you have ever wondered why the rate keeps changing, the answer is that two pieces are stacked together. The first piece is the fixed rate. The Treasury sets it on the day you buy, and it stays the same for the life of that bond. The second piece is the inflation rate. It is adjusted every six months, in May and November, based on changes in consumer prices. The Treasury combines the two into one composite rate, and that is what your bond earns.

The fixed rate can be zero, and in some years it has been. A low fixed rate does not mean the bond is broken. It means the bond leans entirely on the inflation piece to keep up with prices.

Now the leash. For the first twelve months, the money is locked. Nobody can touch it, not even in an emergency. After that, the owner may cash out any time. But if the bond is less than five years old, the Treasury keeps the last three months of interest as a fee.

Think about what that means for a cushion. Money you might need within a year does not belong here at all. Money you might need in year two or three costs you three months of interest to reach. That is the price of the promise, and it is a fair thing to know before you start.

Buying happens mainly in one place. A buyer opens an account at TreasuryDirect, links a bank account, and buys electronically. The Treasury has also offered paper bonds through tax refunds, and the official TreasuryDirect pages explain how that works. Either way, a buyer faces the yearly cap of the current figure, which the official source publishes each year per person.

Taxes come in two flavors. The interest is subject to federal income tax but is free of state and local income tax. The owner can pay the federal tax each year as interest builds, or wait and pay it all at cashing out. The IRS explains the choice in its publication on U.S. savings bonds.

The numbers, and where to find yours

I like a number I can check for myself, so here is where each one lives. The current fixed rate, the current inflation rate, and the combined composite rate are all posted on TreasuryDirect, on its page about I bonds. The Treasury updates it every May and November. The rate you see there applies to bonds bought during that window.

The yearly purchase cap is the current figure, which the official source publishes each year. The minimum purchase is also posted on TreasuryDirect. The tax rule on interest sits with the IRS. If your bond is old and you want to know what it is worth today, TreasuryDirect has a savings bond calculator for exactly that.

Your own number is the one that matters most, though. Write down how many months of expenses make up your cushion, and how much of it you could leave alone for a year. That second figure is the only amount that fits here.

A worked example

Let me tell you about a woman named Marcy. She is a school bus driver who earns $52,000 a year, and she keeps $9,000 in a regular savings account for emergencies. She figures her monthly bills run about $3,000, so that cushion covers three months.

Marcy decides she has a little more than she needs sitting around. She sets aside $2,000 she is sure she will not touch for at least five years. She buys an I bond with it.

Here is the cost if she ever cashes out early. Say the bond is earning a composite rate of 4 percent a year, a plain figure for this example. Interest for one year on $2,000 is $2,000 times 0.04, which is $80. That is about $6.67 a month. The Treasury keeps three months of interest if she cashes before year five, so three months is 3 times $6.67, or about $20. She would walk away with her $2,000 plus the interest earned, less roughly $20.

Now look at the other side. If Marcy had needed that money in month six, she could not have touched it at all. So her $9,000 stays in the regular account, where it is ready. The $2,000 is the extra, not the cushion itself.

Notice what she did. She did not move her whole safety net. She kept three months of bills within easy reach and gave the spare dollars a patient home. Smart. Plain, too.

Where it goes wrong

I have made my share of mistakes with money, and most of them came from not reading the fine print until later. The first trouble spot is the lock. A person puts emergency money in an I bond, then needs it in month eight. The bond will not budge. That is the most common way people get hurt, and it is entirely avoidable.

The second trouble is the three month fee. It is small, but a buyer who forgets about it may feel surprised. The third is the rate itself. The composite rate can fall as well as rise, because the inflation piece follows prices, and prices do not always climb. A bond bought when the rate looked high may pay less later.

A fourth thing is the cap. If a household needs to save a large sum, the limit of the current figure, which the official source publishes each year per person per year means this tool only holds so much. It cannot be the whole plan.

Last, the account itself. TreasuryDirect has a reputation for being a little fussy to set up and to log into. Keep your login details safe, and write down how to recover them. A lost password on a bond you hold for thirty years is a headache nobody wants.

Questions to answer before you leave this page

If you were to need this money next spring, would you be glad it was locked away, or would you be reaching for it in a hurry? How many months of bills sit in an account you can reach today, and is that number one you feel good about? Could you leave a set amount alone for at least five years without losing sleep? Have you looked at the current fixed rate and composite rate on the TreasuryDirect page, and do you know what they mean in dollars on the sum you have in mind? Do you know how much of the yearly purchase cap the current figure, which the official source publishes each year you would use, and whether your spouse could buy a bond of their own? Are you comfortable paying federal tax on the interest, and have you chosen whether to pay it each year or all at the end? And finally, who else knows your TreasuryDirect login, in case something happens to you?