The Lowdown on I Bonds
We have been getting lots of questions about series I savings bonds due to the attention they have been getting recently. Thanks to high inflation, series I bonds issued this year have had favorable interest rates. Here are some answers to frequently asked questions about series I bonds.
How is the interest rate determined? Series I bonds have something called a composite rate. The composite rate has two parts: a fixed rate and an inflation rate. The fixed rate will remain the same for the life of the bond. The inflation rate, however, is based on the consumer price index (CPI). Each May and November, the U.S. Treasury Department announces a new fixed rate and inflation rate that applies to bonds issued in that six-month period. The inflation rate changes every six months from the bond’s issue date.
How does interest accrue? The bonds earn interest monthly from the first day of the month of the issue date, and interest is compounded semi-annually. Interest is added to the bond’s principal value. It is important to know that you cannot redeem and I bond in the first year, and if you cash it in before five years have passed, you must forfeit the most recent three months of interest. When checking your bond’s value within the first five years of owning it, the amount you will see will have the three-month penalty subtracted from it. As a result, when you buy a new bond, the interest does not show until the first day of the fourth month following the issue month. If your bond had an October 2022 issue date interest would first be posted in February 2023.
How much can I buy? An individual can buy up to $10,000 per calendar year in electronic bonds through the U.S. Treasury website, TreasuryDirect.gov. You can also buy up to $5,000 each year in paper bonds with your tax refund.
How are I bonds taxed? I bond interest is free of state and local income tax, and you can defer federal tax until you file a tax return for the you cash in the bond, or it reaches maturity, whichever comes first. You can also report the interest every year which will allow you to spread out the taxes paid instead of one large tax bill further down the road.
If you use I bond proceeds to pay for qualified higher-education expenses for yourself, your spouse, or your dependents, you may avoid federal tax. Although, you must meet several requirements to be eligible. For example, the bond owner must have been at least 24 years old by the issue date and have income that falls below specified limits, to name a few requirements. Please be sure to consult your qualified tax professional for more information.
How much does an I bond cost? Electronic I bonds cost a minimum of $25. You can choose to purchase any amount above $25 to the penny. For example, you could buy an I bond for $34.18. Paper I bonds, however, are sold for $50, $100, $200, $500, or $1,000.
The composite rate separates I bonds from many others. The inflation rate component of I bonds is what has made them so attractive this year. The fixed rate on these bonds is usually very low, but in times of high inflation, the inflation rate can help with increasing the potential interest rate. It is important to keep in mind however that the inflation rate will change every six months and that you are locked into holding the bond for at least five years if you want to avoid penalties.
Series I bonds can be purchased directly through the U.S. Treasury at treasurydirect.gov.