The bond earns interest for 30 years or until it is cashed, whichever comes first. The purchase price is equivalent to the face value of the bond. For example, a $50 purchase would result in a $50 I Bond and the bond increases in value as it earns interest.
What Is the Return on an I Bond
I Bonds increase in value on the first day of each month. Interest compounds semi-annually based on the month of purchase. The return is a combination of two interest rates. One is a fixed income rate, which applies to all I Bonds issued in the six months following the rate determination and stays the same for the 30-year life of the bond. Fixed rates are determined each May 1 and November 1. The other is an inflation-adjusted variable rate, which is based on changes in the non-seasonally adjusted consumer price index for all urban consumers, known as the CPI-U based on date from October through March and then again through September. Like fixed rates, variable rates are also determined on May 1 and November 1 and all I Bond interest rates are adjusted accordingly.
I Bonds can be purchased through October 2022 at the current rate, which is 9.62%. That rate is applied to the 6 months after the purchase is made. The variable component of the bond rate is expected to decrease the Nov. 1 interest rate down to around 6%. However, even a rate of 6% is higher than many rival rates.
The interest rate can never go below zero and the face amount of the bond can never decline, ensuring you maintain your investment despite fluctuating interest rates that may diminish the underlying value of other types of bonds. In contrast to an EE Bond, the value of the I Bond is not guaranteed to double or grow to a specific value, so the future value cannot be predicted.
I Bond Drawbacks
There are a several drawbacks to the purchase of I-Bonds:
How Do I Buy I Bonds
I Bonds can be purchased electronically or in a paper version. Electronic I Bonds come in any amount to the penny for $25 or more. However, paper I Bonds are sold in five denominations: $50, $100, $200, $500, or $1,000. Both can be purchased at www.TreasuryDirect.gov.
The following investment limits apply per calendar year regardless of income or assets:
The limits are applied per Social Security Number of the first person named as owner of an I Bond or, for an entity, per Employer Identification Number. The limits apply separately, meaning you could acquire up to $15,000 in I Bonds in a calendar year. If you plan tax payments and withholding to ensure a $10,000 federal tax refund and a couple could potentially acquire $30,000 of I Bonds during one calendar year. In addition, these limits could be used for any business entity with an EIN number, enabling someone to invest more.
I Bonds can be purchased as gifts subject to the above limits. Ones you buy for yourself and/or that are received as gifts count toward the limit with two exceptions. First, if an I Bond is transferred to you due to the death of the original owner, the amount does not count toward your limit. Second, if you own a paper I Bond issued before 2008, you can convert it to an electronic bond in your account in TreasuryDirect regardless of the value.
Taxation of I Bond Interest
Interest is taxed as ordinary income federally and is tax exempt for state income tax purposes. It can be reported annually. However, reporting interest can be put off until the tax return is filed for the year it was cashed. This provides an opportunity to defer taxation. Tax is owed at the following stages of ownership:
Once you start to report the interest every year, it must continue every year after that for all I Bonds and any acquired under that social security number in the future. As a result, it often makes sense to defer taxation until the bond is sold. If you cash electronic I Bonds in your TreasuryDirect account, interest will be reported to the IRS and a 1099-INT will be available early the next year in your account.
The federal government allows qualified holders of I Bonds to exclude from their income any interest paid when the bonds are cashed, as long as the bond owner pays qualified education expenses at an eligible educational institution. The rules for claiming the exclusion include any filing status except married separate, having a maximum modified adjusted gross income within certain parameters, and documentation of qualified educational expenses greater than the amount of interest being excluded from taxation. Additionally, the bond owner must be age 24 or older before your savings bonds were issued. The bonds must be in your name or titled jointly with a spouse. Interest from an I Bond purchased by a parent and issued in the name of a child, under age 24, is not eligible to be excluded by either the parent or the child.
I Bonds are an excellent option to ensure stability of underlying value, stay ahead of inflation, and defer tax. They should be considered for long-term emergency funds and potentially as a college funding vehicle, among other purposes. They can be a valuable part of a long-term diversified portfolio. Although annual contribution limits are low, within a few years, a significant I Bond position could be attained.