I Bond vs. CD: Which Investment Option Is Right for You?

Choosing between I Bonds and Certificates of Deposit (CDs) depends on interest rates, liquidity needs, and tax considerations. Both are low-risk investments but serve different financial goals. Understanding their differences helps determine the best fit for your savings strategy.

Eligibility and Purchase Requirements

I Bonds, issued by the U.S. Treasury, are available only to U.S. citizens, residents, or federal employees, even if living abroad. They must be purchased through TreasuryDirect, with a minimum investment of $25 for electronic bonds. Individuals can buy up to $10,000 per year, plus an additional $5,000 using a federal tax refund.

CDs, available through banks and credit unions, have no citizenship or residency restrictions. They can be purchased by individuals, businesses, and trusts. Minimum deposits vary, with some institutions requiring as little as $500, while others set higher thresholds. Unlike I Bonds, there’s no annual purchase limit, allowing for larger deposits based on bank policies.

Interest Rate Structures

I Bonds earn interest through a fixed rate, which remains constant, and an inflation-adjusted rate that changes every six months based on the Consumer Price Index (CPI-U). This structure protects against inflation—higher inflation increases returns, while lower inflation reduces them, though the fixed portion provides a baseline return.

CDs typically have fixed interest rates for the duration of the term, ensuring predictable earnings. The rate is locked in at purchase and does not change, which benefits investors when rates are high. However, if inflation rises, fixed-rate CDs may lose purchasing power. Some banks offer variable-rate or bump-up CDs, which allow for rate adjustments under certain conditions, though these often start with lower rates.

Holding Periods and Withdrawals

I Bonds must be held for at least a year before they can be redeemed. If cashed out before five years, the last three months of interest are forfeited as a penalty. After five years, they can be redeemed without penalty, making them less suitable for short-term access but flexible for long-term savings.

CDs have terms ranging from a few months to several years. Early withdrawals usually incur penalties, which vary by institution and term length. A typical penalty for a one-year CD is three to six months of interest, while longer-term CDs may impose steeper penalties. Some banks offer no-penalty CDs, which allow early withdrawals without forfeiting interest, though they often have lower rates.

Tax Implications

I Bond interest is exempt from state and local taxes. Federally, tax is deferred until redemption or final maturity at 30 years, allowing earnings to compound without immediate tax liability. Interest may also be tax-free if used for qualified higher education expenses, subject to income limits. In 2024, tax-free eligibility phases out for single filers starting at a modified adjusted gross income (MAGI) of $96,800 and for joint filers at $145,200.

CD interest is subject to federal and state income taxes in the year it is earned, regardless of whether it is withdrawn or reinvested. This immediate taxation can reduce net returns, especially for those in higher tax brackets. Holding CDs in tax-advantaged accounts like IRAs can defer or eliminate taxes on earnings, depending on the account type.

Backing and Insurance

I Bonds are backed by the full faith and credit of the U.S. government, making them virtually risk-free. They are not subject to market fluctuations, ensuring investors receive their full principal and earned interest upon redemption.

CDs are insured by the Federal Deposit Insurance Corporation (FDIC) for banks and the National Credit Union Administration (NCUA) for credit unions, covering up to $250,000 per depositor, per institution, per ownership category. This insurance protects against bank failures, but deposits exceeding the insured limit may be at risk unless spread across multiple institutions or structured under different ownership categories.