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What Are I Bonds and How It Works

Updated: November 1, 2023

Investments can be a good way of maximizing your earnings and saving for retirement. A long-term, low-risk investment offers more security than a high-risk but potentially high-earning investment. I bonds are one of several investment products offered by the U.S. Treasury. They are a low-risk investment with a fixed interest rate and an inflation interest rate. When left to mature to full term, an I bond can offer strong rewards in a diverse portfolio. Read on to learn more about I bonds, how they work, and the tax advantages.

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    KEY TAKEAWAYS

    • I bonds are federally issued, interest-earning savings bonds.
    • I bonds mature at 30 years.
    • I bonds have both a fixed rate and an inflation interest rate.
    • You can purchase electronic I bonds through your TreasuryDirect account or paper bonds with your federal tax refund.

    What Are I Bonds?

    I bonds, also known as Series I Savings Bonds, are U.S. Treasury Department-issued interest-bearing savings bonds. As an investment, they can protect your savings from the financial damage caused by inflation and rising prices. For example, if you are retired and living off a non-interest-bearing savings account, your dollar is fixed because it is not growing any interest. As the cost of living rises, the amount of money you have does not. 

    There are paper and electronic I bonds. Generally, I bonds are a higher-yielding, lower-risk investment. The interest rate consists of a fixed interest rate and a rate that changes with inflation. The rates are reassessed every 6 months for the 30-year term. The interest rate is guaranteed to never drop below zero. This means your investment is never in a deficit.

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    How Do I Bonds Work?

    I bonds increase in value because they are interest-earning savings. You can see the growth of your bond 6 months after you make your purchase. Treasury I bonds have a fixed 30-year rate. Because the I bond carries a composite rate with a fixed and inflation interest rate, the overall rate will change over the term. However, that rate is guaranteed to never drop below zero.

    The bonds earn interest that accrues monthly and is compounded semi-annually. Every 6 months, the interest is added to the principal value. Interest earned over the next 6 months is on the new principal. 

    When Do I Bonds Mature?

    Treasury-issued bonds in Series I mature after 30 years. The Treasury automatically pays out an Electronic I bond when it matures. You have to submit the Paper I bond to cash it. 

    You cannot cash in your bond in the first year. If you cash it between years 1 and 5, you forfeit the last 3 months of interest earned. You can cash your bond anytime after 5 years without penalty. 

    When Do I Bonds Pay Interest?

    Bonds earn interest monthly. The composite rate compounds the interest onto the principal every 6 months. This means that the interest payments are added to your bond every 6 months, and the interest over the next 6 months is now on the new principal. 

    You can cash in a minimum of $25 and over to the penny, but you must leave a minimum of $25 in your account. If you only take out a portion of the bond, you only get the interest on the part you cash. You cannot only take out the interest.

    How to Calculate Series I Bonds

    The Series I savings bond carries a composite rate with a fixed and an inflation interest rate. The fixed rate for each bond depends on the issue date. For bonds issued from May 1, 2023 to October 31, 2023, the fixed rate is 0.9%, and the inflation rate is 1.6% for a combined annual rate of 4.3%. How is that calculated? The composite rate formula is the fixed rate + (2 x semi-annual inflation rate) + (fixed rate x semi-annual inflation rate). 

    How Are I Bonds Taxed?

    I bond earnings are subject to federal tax but not state and local income tax. You can pay the tax annually or lump sum when you cash in the bond. If you choose to pay annually, you must continue to pay each year for the term of the bond. You cannot pay the tax owed on interest rates for some years, then stop and pay the remaining when you cash it out.

    Whoever is in possession of the bond is responsible for the bond interest tax. If you received it as a gift, the tax liability is yours. 

    State estate or inheritance taxes and federal estate, gift, and excise taxes also apply.

    You may not have to pay tax on the earnings if you spend the bond on qualified higher education expenses.

    I Bonds Pros and Cons

    There are pros and cons to Series I Savings Bonds.

    The major pros are:

    • There are no state or local income taxes on earned interest
    • Flexibility in how you pay the tax—annually or as a lump sum at maturation or cash out
    • The interest rates adjust every 6 months based on current inflation rates
    • You may be able to waive federal income taxes if you use it for qualified higher education expenses
    • They have a low initial investment price of $25 for electronic and $50 for paper I bonds
    • They are backed by the U.S. Treasury, which is unlikely to default on a debt

    The cons to Series I Bonds are:

    • Federal income tax applies to earned interest
    • You cannot redeem them in their first year
    • There is a penalty if you cash them out in the first 5 years
    • There is an annual purchase limit
    • You cannot buy them in an IRA or other tax-deferred accounts
    • The federal tax rate that applies to bonds is higher for more investors than the capital gains tax that applies to riskier investments

    How To Buy I Bonds

    You can buy Electronic I bonds through your TreasuryDirect account. The minimum purchase is $25 and up. Above $25, you can spend any denomination to the penny on a single bond. Purchasing through a TreasuryDirect account is the most convenient way to purchase I bonds because you can log in at any time to track the bond’s value. The annual purchase limit is $10,000 per Social Security Number (SSN).

    You can purchase paper bonds through a federal income tax return with your tax refund. They are available in $50, $100, $200, $500, and $1,000 denominations. You must use the Treasury’s Savings Bond Calculator to assess the value of your paper bonds. The annual purchase limit is $5,000 through your tax return.

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    Now that you have some guidance about Treasury-offered Series I Bond, you can make an informed decision about whether or not you’ll invest. The best investment for you should match your risk comfort level while allowing you to maximize your hard-earned dollars. Investing in your tax refund can be a great way to jumpstart your investment portfolio.

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    Sandra Habinger headshot

    Written by Sandra Habiger

    Sandra Habiger is a Certified Public Accountant with a Bachelor’s Degree in Business Administration from the University of Washington. Sandra’s areas of focus include advising real estate agents, brokers, and investors. She supports small businesses in growing to their first six figures and beyond. Learn more about her work at http://www.sixfiguresaccounting.com/ .

    Sandra Habinger headshot

    Written by Sandra Habiger

    Sandra Habiger is a Certified Public Accountant with a Bachelor’s Degree in Business Administration from the University of Washington. Sandra’s areas of focus include advising real estate agents, brokers, and investors. She supports small businesses in growing to their first six figures and beyond. Learn more about her work at http://www.sixfiguresaccounting.com/ .

    FAQs About What Are I Bonds

    How risky is an I bond?

    I bonds are low-risk investments because they are backed by the U.S. Treasury, carry a combination of fixed and inflation interest rates, and are guaranteed to never drop below 0%. The inflation interest rate is adjusted every 6 months to reflect current inflation rates.

    Can you buy I bonds at a bank?

    U.S. Treasury I bonds are no longer available for purchase through a bank or financial institution. You can purchase paper bonds through your annual tax return or set up a TreasuryDirect account and purchase them directly or through your Payroll Savings Plan.

    When should you sell I bonds?

    The best time to cash in your savings bond is after 5 years because there are no penalties. However, I bonds are considered a long-term compound investment. The longer you let them mature, the more value they gain. Talk to your financial advisor about when the best time to cash in would be for your portfolio.

    How often can you buy I bonds?

    There is no limit to how frequently you buy electronic I bonds. There is an annual financial limit of $10,000 per SSN. You can only purchase paper bonds once a year with your tax refund. The annual limit for paper I bonds is $5,000.

    What is the current I bond rate?

    The interest rate for I bonds issued from May 1, 2023, to October 31, 2023, is the fixed rate of 0.9%, and the variable inflation rate of 1.6% for a combined annual rate of 4.3%. The fixed rate is determined at the time of purchase and remains for the term. The inflation interest rate changes every 6 months.

    Are I bonds a good investment?

    I bonds are a low-risk investment that protects your savings from the damages of inflation. Whether or not that is a good investment is up to the investor. It is recommended to purchase I bonds to diversify an investment portfolio to offset higher-risk investments like stocks. Talk to a financial advisor to determine if you should invest in I bonds.

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