Series i bond

A Series I bond is a unique type of savings bond issued by the U.S. Department of the Treasury that offers protection against inflation. As a form of fixed income investment, the Series I bond (or I bond) is designed to preserve the purchasing power of an investor's capital, making it an attractive option for those seeking a safe haven for their money. This makes them a key tool in a diversified portfolio, especially for long-term savings or as part of an emergency fund. Series I bonds are distinct among Treasury securities due to their composite interest rate structure, which combines a fixed rate and a variable inflation rate.

History and Origin

The concept of U.S. savings bonds dates back to 1935, when President Franklin D. Roosevelt signed legislation to create a new type of security to encourage saving during the Great Depression. These early bonds, such as the Series A, B, C, and D, were designed to be accessible to the general public. The program expanded significantly during World War II with the introduction of Series E bonds, often referred to as "war bonds," which were a major source of financing for the war effort.²⁴, ²⁵

Building upon this history, the Series I bond was introduced in September 1998, specifically designed to offer investors a defense against the eroding effects of inflation. Its innovative structure, combining a fixed base rate with an inflation-adjusted rate, provided a new level of security for retail investors looking to maintain the real value of their savings over time.

Key Takeaways

• Inflation Protection: Series I bonds are designed to protect investors' capital from the negative impacts of inflation through a variable rate tied to the Consumer Price Index.
• Composite Rate: The interest rate for an I bond is a composite of a fixed rate, which remains constant for the life of the bond, and a variable inflation rate that adjusts every six months.
• Safety and Backing: As debt securities issued by the U.S. Department of the Treasury, Series I bonds are backed by the full faith and credit of the U.S. government, making them one of the safest investment vehicles available.
• Tax Advantages: Interest earned on Series I bonds is exempt from state and local income taxes and can be tax-deferred until the bond is redeemed or matures.
• Liquidity Restrictions: While highly liquid after a certain period, I bonds cannot be redeemed within the first 12 months of purchase, and a penalty of the last three months' interest is applied if redeemed before five years.

Formula and Calculation

The interest rate for a Series I bond is known as the composite rate, calculated by combining a fixed rate with a variable inflation rate. This ensures that the bond's value keeps pace with changes in the cost of living.

The formula for the composite rate is:

$\text{Composite Rate} = [\text{Fixed Rate} + (2 \times \text{Semiannual Inflation Rate}) + (\text{Fixed Rate} \times \text{Semiannual Inflation Rate})]$

Here's a breakdown of the components:

• Fixed Rate: This is a real interest rate that the Treasury Department sets and announces every May and November. Once an I bond is purchased, its fixed rate remains constant for the entire life of the bond (up to 30 years).
• Semiannual Inflation Rate: This component is based on the Consumer Price Index for All Urban Consumers (CPI-U), specifically the non-seasonally adjusted CPI-U for all items, including food and energy. The Bureau of Labor Statistics (BLS) releases the CPI data monthly.²², ²³ The semiannual inflation rate is determined by the percentage change in the CPI-U over a six-month period. This rate is also announced every May and November and applies for the next six-month period.²¹

I bonds earn interest monthly, and that interest is compounded semiannually. This means that every six months, the earned interest is added to the bond's principal value, and the new composite rate is then applied to this higher principal for the subsequent period, allowing for compounding growth.¹⁹, ²⁰

Interpreting the Series I Bond

Interpreting the Series I bond's value involves understanding how its composite rate adapts to economic conditions. The bond's primary appeal lies in its ability to shield investors from inflation. If inflation rises, the variable component of the Series I bond rate increases, protecting the investor's original capital and accrued interest from erosion. Conversely, if there is deflation (negative inflation), the variable rate can fall to zero, but the composite rate will never drop below zero percent, meaning the bond will never lose principal value.¹⁸

The fixed rate reflects the "real" return an investor earns above or below inflation. A higher fixed rate means a better return regardless of inflation, while a lower or zero fixed rate means the bond's growth is primarily driven by the inflation adjustment. When assessing an I bond, investors should look at both the fixed rate (which locks in for the bond's life) and the current composite rate (which changes every six months) to understand its potential yield.

Hypothetical Example

Consider an investor, Sarah, who purchases an electronic Series I bond for $10,000 on November 1, 2024.

• Initial Period (November 2024 - April 2025): Suppose the fixed rate for bonds issued during this period is 1.20%, and the semiannual inflation rate is 0.95%.
  • Using the composite rate formula: $[0.0120 + (2 \times 0.0095) + (0.0120 \times 0.0095)] = [0.0120 + 0.0190 + 0.000114] = 0.031114$ or approximately 3.11%.¹⁷
  • After six months (April 2025), Sarah's bond would have earned interest on her $10,000. For simplicity, if we apply the composite rate to the principal for half a year (as it compounds semiannually), the principal would grow. The exact method involves monthly accrual and semiannual compounding based on the calculated composite rate.
• Second Period (May 2025 - October 2025): The Treasury announces new rates. Let's assume the fixed rate remains 1.10% for new bonds, but the semiannual inflation rate is now higher at 1.43%.¹⁵, ¹⁶
  • The new composite rate on Sarah's existing bond (which retains its original fixed rate of 1.20%) would be recalculated with the new inflation rate. The rate for new bonds issued during this period might be 3.98%.¹⁴ Sarah's bond, however, continues to use its original fixed rate.
  • The interest earned in the first six months is added to the principal, and the new composite rate (based on her bond's fixed rate and the new inflation rate) is applied to this increased principal for the next six months.

This example illustrates how the Series I bond adjusts its earnings with inflation while also benefiting from compounding to increase the bond's overall value.

Practical Applications

Series I bonds are primarily used by individual investors as a secure, inflation-protected savings vehicle. Their practical applications include:

• Long-Term Savings: Due to their inflation protection and tax-deferred interest, I bonds are well-suited for long-term goals such as retirement savings or education funding. If used for qualified higher education expenses, the earnings may even be tax-exempt.¹³
• Emergency Funds: While funds are locked for the first year, I bonds can serve as a component of an emergency fund once the initial holding period passes. They offer a safe place for capital that needs to maintain its purchasing power, although a three-month interest penalty applies if redeemed before five years.¹²
• Low-Risk Diversification: For investors building a diversified portfolio, Series I bonds can provide a low-risk asset class that hedges against inflation, complementing other investments like stocks or mutual funds.
• Gift-Giving: I bonds can be purchased as gifts, providing a secure and growing asset for recipients.

The ability to purchase Series I bonds directly from the U.S. Treasury via TreasuryDirect simplifies the investment process for individuals, making them a readily accessible option for those looking to protect their savings.¹¹

Limitations and Criticisms

Despite their benefits, Series I bonds have certain limitations and criticisms that investors should consider:

• Purchase Limits: There are annual purchase limits for Series I bonds. As of late 2024, individuals can purchase up to $10,000 in electronic I bonds per calendar year through TreasuryDirect. Additionally, up to $5,000 in paper I bonds can be purchased using a federal tax refund, bringing the total maximum to $15,000 per person per year. These limits can restrict their utility for investors with large sums of money to protect from inflation.¹⁰
• Liquidity Restrictions: Funds invested in Series I bonds are illiquid for the first 12 months. Any redemption before five years incurs a penalty equal to the last three months of interest, which means they are not ideal for short-term needs or immediate access to capital.⁹ This makes them less suitable as a primary liquid cash equivalent compared to a traditional savings account or money market fund.
• Electronic-Only Purchase (mostly): As of January 1, 2025, electronic Series I bonds are the primary method of purchase through TreasuryDirect, with paper bonds only available via tax refunds. This shift may pose a barrier for individuals less comfortable with online transactions.⁸
• Yield vs. Other Investments: While protecting against inflation, the overall return on investment from I bonds, particularly the fixed rate component, may sometimes be lower than other bonds or asset classes, especially during periods of low inflation or when interest rates on other fixed-income instruments are high.⁷

Series I Bond vs. Treasury Inflation-Protected Securities (TIPS)

Both Series I bonds and Treasury Inflation-Protected Securities (TIPS) are U.S. Treasury securities designed to protect investors from inflation. However, they differ significantly in structure, accessibility, and how they pay interest.

While both offer inflation protection, I bonds are simpler and primarily for retail investors with a fixed purchase limit and deferred tax interest. TIPS are more complex, marketable, and better suited for larger institutional investors or those needing more liquidity and a market-driven yield.⁶

FAQs

How often does the Series I bond interest rate change?

The composite interest rate on a Series I bond changes every six months, specifically on May 1 and November 1. This adjustment is based on a fixed rate, which is set when you buy the bond and never changes, and a variable inflation rate, which is tied to the Consumer Price Index.⁵

Can I lose money with a Series I bond?

No, you cannot lose money with a Series I bond. The principal value of a Series I bond is guaranteed by the U.S. government and will never decline. While the inflation component of the interest rate can be zero if there is deflation, the composite rate will never fall below 0%.⁴

How long do Series I bonds earn interest?

Series I bonds earn interest for 30 years from their issue date or until you cash them in, whichever comes first.³

Are Series I bonds taxable?

Interest earned on Series I bonds is exempt from state and local income taxes. Federal income tax on the interest can be deferred until the bond is redeemed, matures, or changes ownership. Furthermore, if you use the proceeds to pay for qualified higher education expenses, the interest may be entirely federal tax-exempt.² This tax-deferred growth is a significant advantage.

Where can I buy Series I bonds?

You can primarily buy electronic Series I bonds directly from the U.S. Department of the Treasury through their TreasuryDirect website. You can also purchase paper Series I bonds using your federal tax refund.¹