The I Bond is a type of savings bond, issued directly by the U.S. government. I Bonds are available through banks, most financial institutions or directly over the Internet at www.treasurydirect.gov.
Yields on I Bonds are known as a composite rate, which is a combination of two factors:
- A fixed interest rate that stays the same throughout the life of the I Bond, announced each May and November.
- A semiannual inflation rate, announced each May and November.
The fixed portion of the yield is locked in at the time of purchase for 30 years. The inflation portion of the yield changes every six months, based on the current inflation rate, as gauged by the Consumer Price Index. Depending on this change and how the inflation portion of the yield is adjusted every six months, a new investor may or may not receive a higher annualized yield, as compared to previously issued I Bonds or other comparable investments. Fixed and semiannual inflation rates are combined to determine the composite earnings rate. The composite rate from November 2010 to April 2011 is 0.74%. Interest is added to the bond on a monthly basis and is paid when the bond is redeemed.
Below are some additional facts on I Bonds:
- Sold at face value and can be purchased in denominations of $50, $75, $100, $200, $500, $1,000, $5,000 and $10,000;
- Maximum purchase amount is $5,000 in one calendar year in paper bonds and in Treasury Direct;
- Minimum purchase amounts are $50 when purchasing a paper bond certificate and $25 when purchasing electronically through TreasuryDirect;
- Issued at face value, i.e., $100 for a $100 bond.
- 30-year interest earning period, with a minimum term of ownership of 1 year. If you redeem early, or before 5 years, you will be “penalized,” meaning you forfeit the 3 most recent months’ interest. If you redeem after 5 years, there are no penalties;
- They can be gifted or used for education.
Interest on I Bonds is exempt from local and state income taxes (subject to state and local estate, inheritance, gift and other excise taxes), but subject to federal income taxes; however, you can choose to defer interest reporting for federal income tax purposes for up to 30 years from issue or until redemption of the bond. Additionally, all or a portion of the interest may be federal income tax free if the proceeds are used for education.
One primary difference between I Bonds and other types of bonds is that the interest you will receive over the years is unknown at the time of purchase. The fixed portion of the yield is locked in, but the inflation portion changes every six months. Therefore, in a low-inflation environment, returns on these bonds may be lower than comparable fixed-rate bonds. In a high-inflation environment, yields on these bonds may outperform yields on similar fixed-rate bonds.
The I Bond is yet another option for the investor seeking a fixed-income investment. The primary drawback is that investors today who purchase I Bonds lock in the fixed rate for the life of the bond. The inflation element of the bonds will vary with inflation. Investors are also limited to a maximum purchase amount per year, per individual. Finally, you may be locked in for 30 years.
The bottom line is to be careful when you are shopping rates on fixed investments. Be sure you understand what the interest rate is comprised of, how it is calculated and how it compares to other comparable securities. Finally, know and understand the term to maturity.