I Bond Rates Just Dropped -- but There Are Still 4 Good Reasons to Invest

In 2022, when inflation was soaring and consumers were racking up credit card debt left and right just to stay afloat, there was a teeny tiny silver lining -- the interest rate on I bonds rose tremendously, making them an attractive investment.

If you're not super familiar with I bonds, they're government bonds whose interest rate is pegged to inflation. In May 2022, the rate on I bonds adjusted to 9.62%, which drove many people to invest in them. But as of this current May, the interest rate on I bonds has fallen to 4.28%.

That rate isn't set for good. Rather, it's effective through the end of October, since the rate on I bonds adjusts every six months based on economic conditions. And while some people might argue that 4.28% is a pretty good rate of return on an investment that's virtually risk-free, others might say it's not high enough to make the case for I bonds.

Indeed, other vehicles could put more money in your pocket than I bonds. CDs, for example, are a good choice because they're paying generously right now following the Federal Reserve's interest rate hikes. And if you're investing for long-term goals, buying stocks is generally a far better bet than I bonds. But while I bonds may not be the perfect investment for everyone, here are a few reasons to consider putting them into your portfolio.

1. You could come out a winner if inflation picks back up

At this point, we should hope that inflation will continue to cool rather than reverse course and start surging again. But if inflation does pick up, the rate on your I bonds could adjust upward like it did back in 2022. The result? More money in your pocket. 

2. You're nearing retirement and want an investment that's safe

I bonds aren't a great bet for people who are trying to build retirement wealth. That's because the stock market, historically, has delivered considerably higher returns. But if you're someone who's nearing retirement and needs a safer, more stable investment, I bonds could fit the bill. That said, just know that you cannot redeem I bonds for at least a year after buying them, and that there's a penalty for cashing them out before having held them for five years.

3. You won't pay state or local taxes on your interest income

It's not just the federal government that can go after your income. Many states charge their own income tax, and in some cases, you'll be subject to local taxes, too (for example, residents of New York City pay a separate city tax). The nice thing about I bonds is that their interest isn't taxable at the state or local level, so you get a tiny bit of a break.

4. You may be able to use your I bond income tax-free to pay for higher education

Given that the cost of college keeps rising, many parents worry about paying for their children's education. One lesser-known benefit of I bonds is that you may qualify to take your interest tax-free at the federal level if you use it to pay for higher education. There are, however, income limits associated with this benefit that can change over time.

All told, I bonds certainly aren't the ideal investment for everyone. But it pays to read up on the benefits they offer so you'll know whether they're a good choice for you or not.