I Bonds Can Generate Passive Income

The Series I Savings Bonds (aka I bonds) have several features that can prove particularly useful to middle-income pre-retirees and retirees who are building a retirement income portfolio as a part of their retirement savings. These securities offer a number of advantages, including high-interest rates (currently yielding 7.12% per year), interest and principal guarantees, and long-term liquidity (with a few restrictions).  

There are three ways to use I bonds to fund retirement expenses in the coming five to ten years when it can be more challenging to use volatile investments like stocks to fund retirement expenses. You can use I bonds to develop your retirement income portfolio and to support the type of spending that may take place over a long period of time exceeding ten years.

1. Replace conventional bonds and bond funds with I bonds

Plenty of retirees do not want to invest all of their retirement savings in stocks or real estate since stocks can drop in value, sometimes significantly, in the event of a stock market crash. For retirees, fixed-income investments are very common, such as individual bonds, bond mutual funds, and exchange-traded funds (ETFs), since, during a stock market crash, bonds generally won’t decline, or they will decline much less than stocks. There is, however, an interest rate risk associated with these latter investments, meaning they could lose value if interest rates rise. A bond’s maturity or a bond fund’s maturity will determine the interest rate.

Indeed, I bonds are currently earning higher interest rates than most fixed income investments, and they don’t have the same risk of interest rate fluctuations as other fixed income investments. Your investment will never lose value as long as you keep it invested. I bonds would be an excellent investment as an alternative to some of the bond investments that pre-retirees and retirees currently hold. The I bond could be one of the investment assets you use to generate a regular retirement income.

2. Invest in a stock market buffer fund

If you invest many of your retirement assets in stocks, you face a risk called a “sequence of returns.” If you’re not familiar with the term, do an internet search. In the event of a significant decline in the stock market (which is inevitable during a long retirement), you’re better off stopping withdrawals until your stock investments rebound. At that time, you’ll have less money to spend. 

To address the sequence of returns risk, you could build a buffer fund of I bonds to use for living expenses when you stop withdrawing from your stock investments. Since I bonds are liquid after a year of purchase and your interest earnings aren’t taxed until you withdraw them, they’re ideal for this purpose.

3. The expenditure of money or the giving of gifts for education expenses

If you are using an I bond to pay for qualified education expenses for yourself, your spouse, or a dependent; the federal government will not tax the interest income on the bond. Because interest income earned from I bonds is not taxable by states, the interest earned on the bonds is entirely free of income tax.

A bond can also be gifted to another person, such as a child or an adult relative. In that case, your adult child would be able to use the I bond for the education of their children and your grandchildren, should they have any. A calendar year is limited to a maximum amount that each individual can purchase; for example, you can give each adult child an I bond with a value of up to $10,000, as well as buying these bonds yourself and your spouse if you’re married.