Is 'Inflation' Savings Bond Worthwhile?

Inflation is in hiding these days, but when it surfaces again--and it will--small investors have a new weapon to fight back with. The instrument is a Federal savings bond with a return that will rise and fall with the inflation rate--the U.S. Series I savings bond, or "I-bond" for short.

The interest rate on the bond comes in two parts. The government will guarantee a fixed minimum interest rate for the life of the bond--up to 30 years. That rate will be based on a fraction of the interest rate paid for auctioned five-year Treasury notes. On top of the fixed rate, the government will tack on an additional interest rate based on the official inflation rate. The flexible rate will be adjusted every six months, depending on Consumer Price Index changes.

The I-bonds are similar in several respects to their older EE savings bond cousins. Interest payments are deferred until the bonds are cashed in. Earnings are exempt from state and local taxes, and Federal taxes are deferred until you cash in the bonds or they reach their 30-year earning limit. Earnings can escape Federal tax altogether if they are used to pay for qualified college expenses by bondholders whose income isn't too high.

In addition to the inflation protection, I-bonds differ in another important respect from EE bonds. The bonds are sold at their face value, unlike EE bonds, which sell at half their face value. For example, a $50 I-bond sells for $50, and interest will be earned on top of that. A $50 EE bond sells for $25, then gradually matures to $50 or more. The I-bond is offered in eight denominations: $50, $75, $100, $200, $500, $1,000, $5,000, and $10,000.

Are these inflation-indexed savings bonds...