I savings bonds

Series I Savings Bonds (often called I Bonds) are government savings bonds issued by the U.S. Treasury. They offer inflation protection.

Note: Treasury Inflation Protected Securities (TIPS) also provide inflation protection. TIPS are considered alternatives to I Bonds. See I Bonds vs TIPS for similarities and differences between the two instruments.

History
I bonds were first issued in September, 1998. Historical interest rates, along with computation metrics, for I bond issues can be found at I Savings Bonds Rates & Terms.

Features

 * I Bonds have two components that make up their composite rate (total yield) -- a fixed rate and an inflation rate.
 * The fixed rate is fixed for the entire life of any given I Bond. The fixed rate for newly-issued I Bonds is announced on May 1 and November 1 of each year, and applies to all I Bonds issued during that six month period.
 * The inflation component is based on the Consumer Price Index and is also announced every six months, on May 1 and November 1. This inflation adjustment applies to both existing I Bonds and newly-issued ones, but the timing of that adjustment is dependent on the original issue date of any particular I Bond.
 * I Bond interest is calculated in six month cycles, based on the original date of issue. Each I Bond's composite rate (fixed and inflation) remains in effect for a total of six months, and then changes to a combination of that I Bond's fixed rate plus the last-announced inflation adjustment for the next six months. That cycle continues for the life of an I Bond. So, the six-month cycles for I Bonds would be:

Issue Date.....Six Month Cycle

January = Rates change on Jan 1 and July 1 (last-announced inflation adjustment is added to the bond's fixed rate on these dates)

February = Rates change on Feb 1 and Aug 1 (last-announced inflation adjustment is added to the bond's fixed rate on these dates)

March - Rates change on Mar 1 and Sept 1 (last-announced inflation adjustment is added to the bond's fixed rate on these dates)

April - Rates change on Apr 1 and Oct 1 (last-announced inflation adjustment is added to the bond's fixed rate on these dates)

May = Rates change on May 1 and Nov 1 (last-announced inflation adjustment is added to the bond's fixed rate on these dates)

June = Rates change on Jun 1 and Dec 1 (last-announced inflation adjustment is added to the bond's fixed rate on these dates)

July = Rates change on July 1 and Jan 1 (last-announced inflation adjustment is added to the bond's fixed rate on these dates)

August = Rates change on Aug 1 and Feb 1 (last-announced inflation adjustment is added to the bond's fixed rate on these dates)

September = Rates change on Sep 1 and Mar 1 (last-announced inflation adjustment is added to the bond's fixed rate on these dates)

October = Rates change on Oct 1 and Apr 1 (last-announced inflation adjustment is added to the bond's fixed rate on these dates)

November = Rates change on Nov 1 and May 1 (last-announced inflation adjustment is added to the bond's fixed rate on these dates)

December = Rates change on Dec 1 and Jun 1 (last-announced inflation adjustment is added to the bond's fixed rate on these dates)


 * Both paper and electronic versions of I Bonds are available. Each version is limited to $5,000 per person per year. (Investors can also purchase an additional $5,000 in paper bonds for their trust.)
 * I Bonds are not marketable securities, meaning that, unlike other bonds and stocks, you cannot trade I Bonds in the secondary market. To find out what your bonds are worth today and the current interest rate, use the Savings Bond Calculator or the Savings Bond Wizard.
 * I Bonds offer tax-deferral for up to 30 years.
 * I Bonds cannot be redeemed during the first year, and if you redeem them within the first five years after purchase, you lose the most recent three months' interest.
 * When you redeem your I Bonds, you can never get back less than you invested, even if there was a long period of negative inflation (deflation).
 * I Bonds are free from state and local taxation. (See below.)

Where to Purchase
You can buy electronic I Bonds at Treasury Direct.

You can buy paper I Bonds at any bank that's an agent for the Federal Reserve (most are).

You can mail your completed I Bond purchase paperwork and payment directly to the Federal Reserve Bank.

Tax-Deferred Growth
Interest from I Bonds accumulates tax-deferred for up to 30 years. (I Bonds do not distribute interest like CDs and other bonds do.) After 30 years, the I Bonds no longer earn any additional interest. When I Bonds are redeemed, the interest is taxable income for federal income tax purposes, but is free from state and local taxation. However, if the proceeds of the I Bond redemption are used for qualifying educational expenses, the interest is also tax-free at the federal level (see below).

Tax-Free Growth for Qualified Education Expenses
If I Bonds are redeemed for qualifying education expenses, the interest is completely tax free, provided certain conditions are met. According to Publication 970 (2007), Tax Benefits for Education, the tax-free redemption requires the following conditions to be met:


 * You pay qualified educational expenses for yourself, your spouse, or a dependent for whom you claim an exemption on your return.
 * Your modified adjusted gross income (MAGI) is less than $80,600 ($128,400 if married filing jointly or qualifying widow(er)). (This MAGI number is adjusted annually.)
 * Your filing status is not married filing separately.
 * The owner of the Savings Bonds must be at least 24 years old before the bond's issue date. (The issue date is printed on the front of the Savings Bond.)
 * The full proceeds of the savings bond redemption (both interest and principal) must be used for qualifying educational expenses.

Note that redeeming I Bonds to contribute to a 529 plan or a Coverdell education savings account is also considered a qualified educational expense. See Publication 970 (2007), Tax Benefits for Education for more details.

Role in a portfolio

 * If your tax-advantaged accounts are filled up with bond funds, you can "extend" your tax-advantaged accounts by purchasing I Bonds in your taxable account. This process is somewhat similar, but not identical, to placing Treasury Inflation Protected Securities in Non-deductible Traditional IRA.  Buying I Bonds in your taxable account is particularly useful if your tax bracket is too low to justify owning tax-exempt bonds in your taxable account.
 * If you are desperately looking for tax-advantaged space to hold tax-inefficient assets like REITs, you can free up some of your tax-advantaged space by purchasing I Bonds in your taxable account and then exchanging a part of the bond allocation in your tax-advantaged account to a REIT fund.
 * If you have a tax-free growth account like a Roth IRA, but no tax-deferred account like a Traditional IRA, you may want to place stocks in the Roth IRA while buying I Bonds in your taxable account to make the maximum use of the tax-free growth in the Roth IRA.

Redemption while in a high tax bracket
I Bonds redeemed when the investor is in a high tax bracket may provide little or no positive after-tax, after-inflation return, especially if they are held for shorter periods of time. For this reason, if you expect to be in a high tax bracket when you'd redeem your I Bonds, they may not be a suitable investment for you. Specifically, if you are in your 20's, in 30 years you may well be in your peak earning years, which means you'd probably be in a high tax bracket when the bonds mature.

To illustrate the point, here is the after-tax, after-inflation value of $1 invested I bonds compounded for 30 years with 3% inflation and 1% fixed rate and then redeemed in the 35% federal income tax bracket:

(1+(1.04015^30-1)*(1-0.35)) / (1.03^30) = $1.0165153416

which is equivalent to a real after-tax return of 0.05%/year.

Tips for buying I Bonds
Since I Bonds earn the full month's interest if you own them on the last day of that month, it is generally a good idea to buy I Bonds at the end of a month after also earning interest on that same money in a bank account during most of that same month. Conversely, you'd want to redeem your I Bonds at the beginning of any month, since holding them 'til later in the month won't earn you any additional interest, unless you own them on the last day of the month.

Links

 * I Savings Bonds In Depth
 * Treasury Direct
 * Savings Bond Advisor (blog)