Definition
An I-Bond, also known as a Series I Bond, is a savings bond issued by the U.S. Treasury that is designed to offer a return that beats inflation. The interest rate on I-Bonds consists of two components:
- Fixed Rate: Assigned at issuance and remains constant over the life of the bond.
- Inflation Rate: Adjusts semi-annually based on changes in the Consumer Price Index for All Urban Consumers (CPI-U).
Detailed Explanation
I-Bonds are a secure way for individuals to save money while protecting their funds from the eroding effects of inflation. The composite interest rate for I-Bonds is determined by combining the fixed rate and the inflation rate. This dual-rate structure ensures that the bond’s value keeps up with inflation over time, providing a real rate of return.
Interest Calculation
- Fixed Rate: This rate remains the same for the life of the bond, determined at the time of issue.
- Inflation Rate: This is based on changes in the CPI-U and is calculated twice a year.
The composite interest rate is calculated using the following formula: \[ \text{Composite Rate} = \text{Fixed Rate} + (2 \times \text{Inflation Rate}) + (\text{Fixed Rate} \times \text{Inflation Rate}) \]
Purchase Limits
As of the current guidelines, individuals can purchase up to $10,000 in electronic I-Bonds annually through the TreasuryDirect website, and up to an additional $5,000 in paper I-Bonds using their federal tax refund.
Redemption
I-Bonds must be held for at least one year before they can be redeemed. If redeemed within the first five years, the last three months of interest will be forfeited. After five years, no penalty applies for redemption.
Examples
-
Jane Purchases an I-Bond:
- Fixed Rate: 0.5%
- Inflation Rate: 3%
- Composite Rate Calculation: \[ 0.5% + (2 \times 3%) + (0.5% \times 3%) = 0.5% + 6% + 0.015% = 6.515% \]
-
Annual Purchase Limit:
- John purchases $10,000 in electronic I-Bonds via TreasuryDirect.
- John also buys $5,000 in paper I-Bonds using his tax refund, reaching the total annual limit of $15,000.
Frequently Asked Questions
What is the minimum holding period for I-Bonds?
I-Bonds must be held for at least one year before they can be redeemed.
Is the interest earned on I-Bonds taxable?
The interest earned on I-Bonds is subject to federal income tax but exempt from state and local taxes.
How is the inflation rate determined for I-Bonds?
The inflation rate is based on the consumer price index for all urban consumers (CPI-U) and adjusts twice annually, in May and November.
Can I-Bonds lose value?
No, I-Bonds cannot lose value because they are backed by the U.S. government, and at maturity, they return the invested principal along with accrued interest.
How are fixed rates applied to new I-Bonds?
The fixed rate for new I-Bonds is set by the U.S. Treasury at the time of issuance and applies for the life of the bond.
Related Terms
Series EE Bond
A non-marketable, interest-bearing U.S. government savings bond issued at face value. Interest is added monthly and paid when the bond is redeemed.
CPI (Consumer Price Index)
An index that measures the average change in prices over time that consumers pay for a basket of goods and services.
TreasuryDirect
An online platform provided by the U.S. Department of the Treasury that allows individuals to buy, manage, and redeem U.S. government securities directly.
Inflation
The rate at which the general level of prices for goods and services rises, eroding purchasing power.
Online Resources
Suggested Books for Further Studies
- “The Bond Book: Everything Investors Need to Know About Treasuries, Municipals, GNMAs, Corporates, Zeros, Bond Funds, Money Market Funds, and More” by Annette Thau
- “Bond Investing For Dummies” by Russell Wild
- “The Intelligent Investor” by Benjamin Graham
Fundamentals of I-Bond: Finance Basics Quiz
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