Latest / The Financial Freedom Podcast with Fexingo: Quitting Your Job, Living Off Investments, Independence / How Early Retirees Handle Inflation With I Bonds
Transcript
- Lucas: So last week we talked about Treasury ladders and how they give you predictable income in early retirement. Today I want to layer on something that's gotten a lot less attention in the FIRE community recently — Series I Savings Bonds, or I Bonds. Luna: I Bonds. They had their moment back in 2022 when inflation was spiking and everyone was rushing to buy the max. But I feel like people forget about them in a lower-inflation environment like we have now. Lucas: Exactly. And maybe they shouldn't. Because I Bonds have this unique structure — a fixed rate that stays with you for the life of the bond, plus an inflation-adjusted component that resets every six months based on cpi u. So when inflation jumps, your yield jumps. When inflation drops, your yield drops, but your fixed rate still earns something. Luna: Right. So it's not like a TIPS where the principal adjusts and you can have deflation risk. I Bonds never lose principal. The composite rate can't go below zero. Lucas: That zero floor is huge for retirees who are nervous about deflationary scenarios — rare, but possible. And unlike TIPS held in a fund, I Bonds are tax-deferred until you cash them in. You don't get a 1099 every year. That's valuable if you're trying to manage your taxable income in early retirement. Luna: Especially if you're living off a brokerage account and trying to stay under a certain tax bracket. Deferring interest for 20 or 30 years can be a real advantage. Lucas: Let's get concrete. As of May 2026, the fixed rate on new I Bonds is 4.5 percent. That's actually one of the highest fixed rates since the program started in 1998. The composite rate right now — fixed plus inflation — is around 7.2 percent. That's not bad for a risk-free instrument backed by the US government. Luna: So if someone bought I Bonds today with that 4.5 percent fixed rate, they'd lock that in for up to 30 years. But the inflation component will fluctuate. How does that compare to a 10-year TIPS yielding maybe 2.2 percent real right now? Lucas: It's better on a nominal basis, but there are trade-offs. TIPS are more liquid — you can sell them on the secondary market anytime. I Bonds have a one-year lockup period, and if you redeem before five years, you forfeit the last three months of interest. So it's not your emergency fund. It's more of a tactical allocation for the part of your portfolio that you want to keep up with inflation but won't need for at least a year, preferably five. Luna: That sounds a lot like a cash buffer for sequence risk. You know, that three to five years of expenses in safe assets that you draw from in a downturn. Could I Bonds serve that role? Lucas: Absolutely. In fact, they're almost purpose-built for it. Imagine you're retiring at 50 with a $1.5 million portfolio. You want a five-year cash buffer of $150,000. You could put $10,000 per person per year into I Bonds — so $20,000 for a couple — and gradually build that buffer over time. The interest keeps pace with inflation, and you don't have to worry about market fluctuations. Luna: But $10,000 per person per year is a hard cap. That's the main criticism — you can't scale it. For a couple, that's $20,000 a year. It would take seven and a half years to build a $150,000 buffer, and that's not even accounting for inflation. Lucas: True. But you can also buy an extra $5,000 per year using your tax refund. And if you have a trust or a business entity, you can sometimes purchase more. But for most people, it's a supplement, not the whole buffer. You'd pair it with a Treasury ladder or a money market fund. Luna: What about the tax treatment? If you're in the 12 percent bracket in early retirement, I Bonds interest is federally taxable but state-tax-free. That's another advantage over a CD or a corporate bond. Lucas: Yes. And if you use the bonds for qualified higher education expenses, the interest may be completely tax-free. That's not relevant for most early retirees, but if you have kids heading to college in your 50s, it's worth knowing. Luna: So who is the ideal candidate for I Bonds in an early retirement portfolio? Give me a profile. Lucas: Someone who's still in the accumulation phase, maybe five to ten years from retirement. They can buy $10,000 per person per year, let the bonds compound tax-deferred, and then start redeeming them in retirement for inflation-adjusted income. The second profile is someone in early retirement who has a cash buffer and wants to replace a portion of it with an inflation-sensitive asset. If you have $50,000 in a high-yield savings account earning 3 percent, swapping some into I Bonds earning 7.2 percent with inflation protection is a no-brainer. Luna: Except you have to hold them for one year, and the penalty applies before five. So you can't just swap everything at once. You have to phase it in. Lucas: Right. You'd buy a batch each year, let it age past the one-year lockup, then decide if you want to hold longer. The penalty is only three months of interest. On a $10,000 bond earning 7.2 percent, that's about $180. Not trivial, but not devastating either. Luna: I want to talk about the fixed rate for a second. The current 4.5 percent fixed is historically high. In 2020, the fixed rate was 0 percent. So someone who bought then is getting only the inflation component, which is now around 2.7 percent. That's a huge difference. Lucas: It is. And that's the timing risk with I Bonds. You can't control what the fixed rate will be when you buy. But if you're buying every year as part of a systematic plan, you dollar cost average the fixed rate. Some years you'll get 4.5 percent, some years you'll get 1 percent. Over a decade, the blended rate should be reasonable. Luna: That's a good argument for buying them every year, regardless of the current fixed rate. Treat them like a bond ladder. Lucas: Exactly. And there's another nuance: I Bonds can be redeemed after 12 months, but if you hold them for exactly 12 months and cash out, you lose only three months of interest. So the effective yield on a one-year hold is actually lower than the composite rate. For a 7.2 percent composite rate, holding for 12 months and cashing out gives you about a 5.4 percent annualized return. Still competitive with a high-yield savings account, but worth knowing. Luna: So if you need the money in less than five years, you're better off with a CD or a Treasury bill. But if you have a longer horizon, I Bonds start to look better. Lucas: Right. And the real magic happens when you hold for 20 or 30 years. The interest compounds tax-deferred, and you can redeem them in a low-income year to minimize tax. That's a strategy called 'tax arbitrage' — defer interest until your marginal rate is lower. Luna: Let's talk about the practical mechanics. To buy I Bonds, you need a TreasuryDirect account. The website is notoriously clunky. Any tips for our listeners? Lucas: It looks like it was designed in 2003, but it works. The key is to set up your account and link your bank account before you need it. Don't wait until the last day of the month. Also, you can gift I Bonds — you can buy up to $10,000 per person per year as a gift, but the recipient can't receive more than $10,000 in total in a given year. So if you're a couple, you can each buy $10,000, plus you can gift each other another $10,000, but the gift counts against the recipient's limit when delivered. Luna: Right. So the max per couple is $20,000 per year, period, unless you use the tax refund trick for another $5,000. That's $25,000. Not huge, but over 10 years it's $250,000 plus interest. Lucas: And that $250,000 would be a meaningful part of a $1 million portfolio. It's not nothing. For high earners with larger portfolios, I Bonds are more of a rounding error, but for the typical FIRE household aiming for $1.5 to $2 million, it's significant. Luna: What about the alternative — just buying a TIPS ETF like the iShares TIP or a short-term TIPS ETF? You can put as much as you want, no purchase limit, and it's more liquid. Lucas: The trade-off is volatility and tax drag. TIPS funds mark to market, so the NAV fluctuates with real yields. In 2022, the iShares TIP ETF lost almost 12 percent because real yields spiked. I Bonds never do that — their value only goes up. And TIPS funds distribute interest and inflation adjustments annually, creating a tax liability even if you reinvest. I Bonds defer everything until redemption. Luna: So if you're in a high tax bracket during accumulation, I Bonds are better. If you're in a low bracket in retirement, the TIPS fund might be simpler. Lucas: Simpler, yes. But the behavioral aspect matters too. If you see a TIPS fund drop 10 percent in a year, you might panic and sell. I Bonds don't test your nerves. They just sit there and accrue interest. Luna: That's a good point. For someone who wants a set-it-and-forget-it inflation hedge, I Bonds are hard to beat. But you have to be willing to deal with TreasuryDirect. Lucas: And the $10,000 limit. Which brings us back to the question: how much of your portfolio should be in I Bonds? I'd say no more than 10 to 20 percent of your fixed-income allocation, and only if you have a long enough time horizon to build the position. Luna: That feels right. I'd add that you should only buy I Bonds with money you know you won't need for at least five years. Otherwise, the penalty erodes the advantage. Lucas: Let's bring it back to the early retiree's cash buffer. We've talked about using a cash buffer to avoid selling stocks in a downturn. If you build that buffer with I Bonds, you get inflation protection and tax deferral. That's a nice upgrade from a plain savings account. Luna: And if inflation stays low, you still earn the fixed rate. If inflation spikes, you're protected. It's a win-win for the buffer. Lucas: One last thing — I Bonds can be redeemed in any amount, even partial. So if you need $2,000 for a car repair, you can cash in $2,000 worth of bonds and leave the rest to keep growing. That's more flexible than a CD, which often penalizes early withdrawal of any amount. Luna: I think a lot of our listeners who've been buying I Bonds for a few years might be sitting on some with old fixed rates of 0 percent or 0.5 percent. Should they cash those out and buy new ones at 4.5 percent fixed? Lucas: That's the big question. If you hold an I Bond with a 0 percent fixed rate, your composite rate is just the inflation component, which is currently about 2.7 percent. If you cash it out after five years — no penalty — and buy a new one at 4.5 percent fixed plus 2.7 percent inflation, you'd earn 7.2 percent going forward. But you lose the old bond's inflation accrual and you reset the clock on the one-year lockup. I think for bonds held for at least five years, swapping makes sense. For newer ones, run the numbers. Luna: Especially if you're in a low tax bracket when you redeem. The interest from the old bond gets taxed that year, but if you're in the 12 percent bracket, it's manageable. Lucas: Exactly. So the takeaway: I Bonds are a powerful but underused tool for early retirees. They're not a silver bullet, but as part of a cash buffer or a bond ladder, they offer unique inflation protection with tax deferral and a zero floor. And right now, with a 4.5 percent fixed rate, they're as attractive as they've been in decades. Luna: If this episode helped you think about your cash buffer differently, you know what keeps these conversations ad-free — listener support. If you've gotten value from the show, consider tossing a few dollars our way at buy me a coffee dot com slash fexingo. Lucas: Yeah, every little bit helps us keep the podcast independent and focused on the stuff that actually matters for your financial freedom. No pressure, but if we've saved you even one bad financial decision, that's worth a coffee. Luna: Alright, so to wrap up: I Bonds aren't for everyone, but if you're an early retiree building an inflation-sensitive cash buffer, they deserve a spot in your toolbox. Thanks for listening, and we'll see you next time.