I Bonds vs. CDs: Which Makes More Sense?

In 2024, inflationary pressure and economic uncertainty are weighing heavily on the average American investor. With interest rates as high as they have been in 15 years, many people are carefully considering whether to incorporate low-risk investment vehicles into their portfolios.

U.S. Series I savings bonds and certificates of deposits (CDs) are at the top of the list. Given the current state of interest rates for both products, CDs may make more sense right now for investors, specifically those who stay on the short end of the maturity spectrum. However, there are some factors beyond interest rates to take into consideration before choosing between the two. It’s important to compare the two instruments to help you determine which is the best fit for you, given your unique personal finances.

Both I bonds and certificates of deposits (CDs) can provide protection in your investment portfolio. Because of redemption restrictions, I bonds may be more suitable for investors with longer waiting periods and who may be more sensitive to the effects of inflation while CDs are appropriate if you have a shorter timeframe.

Toby Walters, CFA®Senior Financial Analyst

Toby Walters, CFA®, is a senior financial analyst with over 25 years of experience in financial research. His knowledge spans researching and analyzing financial data to developing a one-of-a-kind viewpoint on money-related topics.

I Bonds vs. Certificates of Deposit: What Are the Features?

A Series I savings bond, or I bond, is an inflation-protected security issued by the U.S. Department of the Treasury. Money invested in these instruments earns interest based on a fixed rate of return (set by the U.S. government), plus a variable interest rate indexed to the Consumer Price Index (CPI). The sum of the two rates is known as the composite rate, and it is updated every six months, in May and November.

A certificate of deposit (CD), on the other hand, is a special type of savings account offered by financial institutions to their banking customers. These instruments provide accountholders a guaranteed rate of interest in exchange for a commitment to leave their savings in the account for a specified amount of time — the CD term. Early withdrawal of the money normally triggers a loss-of-interest penalty.

What Features Do I Bonds and CDs Offer?

How Do I Bonds and CDs Compare?

I bonds and CDs are both very safe investment vehicles that offer guaranteed rates of return. However, they have some notable differences.

Term Length

I bonds mature after an initial period of 20 years, but the maturity period may be extended by an additional 10 years. After a period of 30 years, I bonds are automatically redeemed. That said, I bonds can be redeemed at any time following a one-year holding period. However, if you redeem the bond within the first five years of ownership, there are penalties involved.

Financial institutions issue CDs with a variety of maturity terms to cater to the liquidity preferences of their customers. Short-term CDs have terms that range from a month to a year. Long-term CDs typically have terms of four years and above. 

Liquidity

Both I bonds and CDs are nonmarketable and inherently illiquid. The minimum amount of time you must own an I bond before redemption is one year. However, if you redeem the bond within the first five years of ownership, you must pay a penalty equal to the last three months of interest.

A CD requires you to lock up your money for the entire term, which commonly spans between one month and five years. Early withdrawal is subject to a loss-of-interest penalty, which usually equates to a certain number of months of interest. However, some CDs impose penalties that can result in a loss of principal. 

Interest Rates

When you purchase an I bond, the prevailing composite rate will be applied for a period of six months. For example, if you were to purchase an I bond on Feb. 1, 2024, with a composite rate of 5.27%, then that rate would apply through July 29, 2024.

Regarding CD rates, holding all else constant, the longer the CD term, the higher the interest rate — but only during times of economic stability and growth. During bouts of instability, which often precede recessions, short-term CD rates tend to exceed long-term CD rates – a phenomenon known as a yield curve inversion. As a result, CD investors are advised to carefully evaluate the rates offered for various terms. Strive to capture a relatively high yield without assuming a long lockup period. 

Credit Risk and Insurance

I bonds are backed by the full faith and credit of the U.S. government, which eliminates all credit risk and assures investors they will recoup their money at redemption. CDs are just as safe, but not due to an explicit government guarantee.

CDs’ safety stems from a comprehensive insurance framework administered by the Federal Deposit Insurance Corporation (FDIC) and the National Credit Union Administration (NCUA). The former insures CDs issued by banks, while the latter insures CDs issued by credit unions. Up to $250,000 of coverage is provided for individual accounts, and up to $500,000 of coverage is provided for joint accounts.

Tax Considerations

Interest earned on I bonds is subject to federal income tax, but you can exclude some or all of it if you are paying for certain educational expenses at the point of redemption. Regardless, you can defer taxation until the interest is received at redemption. No taxes are levied at the state and local levels.

For most CDs, the money invested and interest earned is locked up until the maturity date. However, the issuing financial institution periodically applies interest to your account and reports it at regular intervals (usually, monthly, quarterly or semiannually).

As the interest is reported, it is taxable. So, while you may not receive any of the funds until maturity, you will be liable for the income tax on the periodic accrued interest.

Other Similarities and Differences

Beyond the ideas above, it is important to note that I bonds come in a single flavor with no structural optionality or add-on features. Conversely, there are many different types of CDs, offering a myriad of terms, special features and compounding frequencies. 

Another important distinction relates to investment limits. There is no limit on the amount of money you can put into CDs. However, I bond purchases are limited to $15,000 per year – $10,000 worth of electronic I bonds and $5,000 worth of paper I bonds (assuming you have a tax refund of $5,000 or more).

Should You Invest in an I Bond or a CD?

Neither I bonds nor CDs are necessarily good or bad investments. Both assets make sense for some investors but can be suboptimal for others. The decision whether to include I bonds or CDs in your portfolio is dependent on your investment objectives and tolerance for risk. 

Generally, I bonds are a good investment for people with a low tolerance for credit risk and inflation risk and the ability to endure some illiquidity. They currently offer a decent risk-adjusted return, but they have disadvantages, including their one-year liquidity lock-up and early redemption penalty. For investors with long horizons, I bonds can also significantly underperform growth-oriented assets, such as stocks.

CDs are suitable for people that seek high-quality, stable-value investments that offer guaranteed interest and are willing and able to lock up their cash for a specified amount of time. Generally, they make the most sense when intermediate- to long-term inflationary expectations are moderate.

Final Verdict

From May 1, 2021, through Apr. 30, 2023, investing some money in I bonds was a no-brainer. However, on May 1, 2023, the I bonds rate was reduced from 6.89% to 4.30%, removing a lot of the luster from these government-backed instruments. As of November 2023, the I bond rate has risen to 5.27%, and will remain as such until April 30, 2024.

As of January 2024, short-term CDs – with terms of either six months or one year – offer similar return potential. In fact, the most competitive CD issuers offer rates that range between 5.00% and 6.00% for these terms.

As a result, CDs may be a slightly better investment than I bonds, assuming you stay on the short end of the maturity spectrum. Going longer exposes you to incremental illiquidity and inflation risk without corresponding yield compensation. Given the similar interest rate range, what’s best for you will depend on your financial goals, investment amounts and desire for add-on features.

What Are the Benefits of Investing in Both?

Thus far, we have discussed investing in either I bonds or CDs, but there is nothing preventing you from investing in both instruments. Simultaneously investing in I bonds and CDs can alleviate some decision-making stress and provide some flexibility for generating downstream cash flows.

That said, you should always strive to avoid incurring excessive opportunity costs. This entails monitoring key macroeconomic factors, such as inflation, interest rates and unemployment, and formulating investment strategies designed to capitalize on these continually changing readings. The average investor may not have the time or experience to do this, so it can be beneficial to consult with a financial advisor when assessing your investment options.