I Bonds are a low-risk savings product sold by the U.S. Treasury as either a paper bond at a financial institution or as an electronic product in the TreasuryDirect section of savingsbonds.gov website. The bonds are similar to other Treasury bonds but these bonds are inflation linked savings bonds and the interest rate paid will vary over the life or term of the bond.
I Bonds are named after their design as an inflation fighting investment. In addition to earning a fixed interest rate, which remains the same during the entire life of the bond, it also earns a variable semiannual inflation rate based on changes in the Consumer Price Index for all Urban Consumers (CPI-U). The Bureau of the Public Debt announces the rates each May and November. The semiannual inflation rate announced in May is the change between the CPI-U figures from the preceding September and March; the inflation rate announced in November is the change between the CPI-U figures from the preceding March and September.
They are an accrual-type security. Interest is added to the bond monthly and is paid when you cash the bond. I Bonds increase in value on the first day of each month, and interest is compounded semiannually based on each I Bond’s issue date. Bonds are dated by month and year.
All I Bonds are sold at face value. You pay $100 for a $100 bond. In one calendar year you cannot buy more than $30,000 worth of I Bonds. The only difference between online I Bonds and paper I Bonds is that of denomination. Online I Bonds can be purchased in any amount of $25 or more, down to the penny. Paper I Bonds are purchased in increments of $50, $75, $100, $200, $500, $1,000, $5,000, and $10,000.
The interest-earning period of an I Bond is thirty years, but you don’t have to hold an I Bond that long. You can actually cash the bond anytime after one year, but there is a penalty to do so. If you cash the bond anytime between one and five years, you lose the three most recent months of interest. After five years you can redeem the bond with no penalty.
Like all investments, I Bonds have particular tax ramifications. Your interest earnings from an I Bond are exempt from State and local income taxes, but you must pay State and local estate, inheritance, gift, and other excise taxes.
You must pay Federal income tax when the time comes to redeem the bond, but interest earnings may be excluded from Federal income tax when used to finance education.
Under the Education Savings Bond Program you might be able to completely or partially exclude savings bond interest from Federal income tax. This can occur when you pay qualified higher education expenses at an eligible institution or state tuition plan in the same calendar year you redeem eligible I Bonds and EE Bonds issued January 1990 and later. You aren’t required to indicate that you intend to use the bonds for educational purposes when you buy them, but you must make sure the program’s requirements are met.