I Bond

What is an I Bond?

The Series I bondis an inflation adjusted savings bond issued by the U.S. government.  It has a fixed interest component but also carries an inflation adjustment as opposed to the Series EE bond.  Similar to TIPS, I bonds are designed to provide the investor with a real rate of return consistent with the inflationary pressures which could devalue their investments.  The I Bond is an accrual bond; meaning, it will not pay out interest payments or inflation adjustments until the maturity of the bond.

Components of I Bond Interest Rate

I Bonds pay accrue interest and an inflation adjustment monthly; the inflation adjustment rate is set every May and November and carries forward until the next adjustment is made.  The inflation index is based on changes that are reported in the CPI-U, or the consumer price index for urban consumers. 

The fixed rate of return on the bond is established when the bond is purchased.  This rate is not changed for the life of the bond.  If the bond is purchased between the reset dates in May and November, the I bond fixed rate of return will be equal to the most recent fixed rate annoucement. 

To calculate the combined rate of return for the bond, you can use the following formula:

Total Rate of ReturnFixed Rate + (2 x Semiannual Inflation Rate) + (Fixed Rate x Semiannual Inflation Rate)

I Bond Rules

Paper I bonds can be purchased through banks and other financial institutions in increments of $50, $75, $100, $200, $500, $1000, and $5000.  For even more flexibility, I bonds can be purchased directly through TreasuryDirect in electronic form.  The minimum purchase amount is $25 and you can purchase these bonds in increments of .01 above $25.  

The annual purchasing limit for an I Bond is $5,000 per year per social security number, regardless of if you buy paper or electronic bonds. 

Similar to the certificate of deposit, there is an early redemption fee equal to 3 months of interest and inflation adjustment if you cash the I bond out before 60 months, or 5 years. 

I-Bonds & Taxes

For tax purposes, the holder of the bond can report interest income through cash basis or accrual basis.  Cash basis tax reporting requires the bond holder to report the aggregate interest and inflation adjustment income as a lump sum when th bond matures.  Conversely, accrual basis tax reporting allows the bond holder to report interest income yearly.  This election is most commonly used when savings I bonds are purchased in a child or minors name.  Tax rates for children are much lower than they would be in the future, when they start earning an income.

I-Bonds Versus Treasury Inflation Protected Securities

The two bonds are very similar in nature; however, the key difference between the two lies in the fact that TIPS can be traded in the secondary market while I bonds cannot.  Secondly, the principal associated with TIPS adjusts with inflation or deflation while I-Bonds have a fixed principal value with a fixed interest rate and variable inflation adjustment.  Other differences lie in the frequency of interest payments, terms to maturity, liquidity, inflation rate adjustment frequency, and purchasing limits to name a few.
Tim Ord
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