I Savings Bonds
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I Savings Bonds are government bonds that pay both
a fixed interest rate and an adjustable interest rate that
corresponds with the U.S. Consumer Price Index (CPI).
The fixed rate of return is determined when the bond is
purchased. The variable rate is calculated semiannually
based on the inflation rate.
How It Works
The variable rate on an I Savings Bond is determined
using the Consumer Price Index for Urban Consumers (CPI-U) for the months of May and November of
each year. Fixed rates and semiannual inflation rates
are combined to determine composite earnings rates.
An I Bond’s composite earnings rate changes every six
months after its issue date.
Fixed and variable rates for I Savings Bonds issued over
the last 10 years are posted on the Treasury Direct Web
site (www.treasurydirect.gov).
Different From EE Bonds
The government also offers EE Savings Bonds, which are
similar to the I Savings Bonds but with a few differences.
EE Bonds have fixed rates that are adjusted each May 1
and November 1, with each new rate effective for all
bonds issued in the six months following the adjustment.
Like I Bonds, these savings bonds are exempt from
state and local taxes and if the bonds are used to pay
qualifying college expenses, they are exempt from federal
taxes as well.
What if the value of the CPI is falling?
Unlike I Bonds, the U.S. Treasury guarantees that, at a
minimum, an EE Bond will double its value after 20
years and will continue to earn the fixed rate unless a
new rate or rate structure is announced.
This happened in the most recent pricing of these
bonds. In May of 2009, the fixed rate for newly issued
bonds was 0.10% and the semi-annual inflation rate was
–2.78%. The formula for determining the interest rate
is as follows:
If an EE Bond does not double in value as the result
of applying the fixed rate for 20 years, the U.S. Treasury
will make a one-time adjustment after 20 years to make
up the difference. EE bonds continue to earn interest
for 30 years.
Composite rate = [fixed rate + (2 × semiannual inflation rate) + (fixed rate × semiannual inflation rate)].
To learn more about EE Bonds, see the Offbeat Offerings column that appeared in the November 2007 AAII
Journal (available at AAII.com).
This equation led to a composite rate of –5.74%. The
Treasury will not allow composite rates to be negative,
so the interest rate was set at 0%.
I Savings Bonds have 30-year maturities; however, you
can redeem them at any time after a 12-month minimum
holding period from the date of purchase. These bonds
increase in value monthly and all of the interest is paid
when you redeem the bond. If you redeem a bond before it is five years old, you will forfeit the most recent
three months’ interest.
I Savings Bonds are sold at face value (meaning you
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pay $50 for a $50 I Savings Bond). These bonds can
be bought electronically in any dollar amount over $25.
Paper I Bonds are sold in the following denominations:
$50, $75, $100, $200, $500, $1,000, and $5,000.
How to Invest
You can purchase I Savings Bonds directly from the
government using the Treasury Direct Web site. You
can set up automatic purchases of the bonds in $25
increments.
You can also purchase I Bonds via some banks and
other financial institutions. The purchase limit for both
paper and electronic I Bonds is $5,000 per calendar year.
I Savings Bonds are non-transferrable and cannot be
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redeemed within 12 months of purchase. If you redeem
the bonds within five years of purchase, you will forfeit
three months of interest payments.
You can redeem bonds via Treasury Direct or through
the financial institution where you originally purchased
the bonds.
Investor Suitability
I Savings Bonds are for investors wanting a safe place
to put money. The interest rates are low, but you are
guaranteed a fixed plus variable rate of return. If inflation is high, your interest rate will increase, making these
bonds a good choice for investors looking to protect
themselves from inflation.
Tax Implications
Any interest earned on I Savings Bonds is subject to
federal income tax, which can be deferred until redemption, final maturity or you sell the bond. Savings bonds
are subject to estate, inheritance, gift, or other excise
taxes, whether federal or state.
Like EE Bonds, special tax benefits are available to
qualified owners of I Bonds under the Education Savings Bond Program. Investors using the proceeds of
the I Bond for qualified higher education expenses can
exclude all or part of interest earned from their income
for federal tax reporting. Only certain types of expenses
qualify, so be sure to fully understand the program before
purchasing the bonds.
The Pros
Guaranteed by the Government
I Savings Bonds are fully backed and guaranteed by the
U.S. government, making them a virtually safe investment.
October 2009
Tax Benefits
I Savings Bonds are exempt from state and local income
taxes, and if used for college tuition, are exempt from
federal income taxes as well.
Inflation Protection
I Bonds have a fixed rate of return combined with a
variable rate based on the CPI. As inflation rises (and,
in consequence, the value of the CPI), the interest rate
on the I Bond will rise.
The Cons
Early Redemption Consequences
You cannot redeem an I Bond within 12 months of
purchase and if you redeem it within five years of purchase, you will forfeit some interest payments.
Low Rates
As of May 2009, newly issued I Bonds had a fixed rate
of only 0.10%. Combine this with a negative inflation
rate, and the bonds issued were earning 0% for the first
six-month holding period. During times of falling inflation, you may not earn any interest on the bond.
Additional Information
TreasuryDirect
www.treasurydirect.gov
TreasuryDirect is sponsored by the U.S. Department of
the Treasury’s Bureau of the Public Debt. TreasuryDirect
is a financial service Web site that allows investors to
purchase and redeem securities directly from the U.S.
Treasury Department in paperless, electronic form.
The site also offers product information and research
tools for a variety of Treasury securities, including a Savings Bond Calculator that allows you to find out what
your bonds are currently worth.
―Cara Scatizzi, AAII Associate Financial Analyst
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