What I Bonds are and how the interest rate works

I Bonds are savings bonds issued by the U.S. Treasury that protect you against inflation. The interest rate on an I Bond has two parts: a fixed rate set when you buy the bond, and a variable rate that changes every six months based on inflation.

The fixed rate stays the same for the entire 30-year life of the bond. The variable rate adjusts in May and November each year based on the Consumer Price Index (CPI), which measures how fast prices are rising. The Treasury adds these two rates together to get your total annual return. If inflation drops to zero or below, your rate cannot fall below the fixed rate you received at purchase.

You buy I Bonds directly from TreasuryDirect.gov, the official Treasury website. The minimum purchase is $25, and you can buy up to $10,000 per person per calendar year in electronic bonds. Paper I Bonds are no longer sold, though you may still own older ones.

Key Takeaways

  • I Bonds combine a fixed rate (locked in when you buy) with a variable inflation rate that changes twice a year, so your return adjusts automatically if prices rise or fall.
  • You must hold an I Bond for at least one year before you can cash it in, and if you sell within five years, you lose the last three months of interest as a penalty.
  • Interest on I Bonds is not taxed by your state or local government, but federal income tax is owed on the interest when you cash the bond or it matures.
  • You can defer federal taxes on I Bond interest indefinitely by not cashing the bond, but you must report and pay taxes in the year you finally redeem it.
  • I Bonds are backed by the U.S. government and carry no market risk, but inflation protection comes at the cost of lower returns than stocks during periods of low inflation.

Holding periods and when you can access your money

You cannot cash in an I Bond during the first year you own it. If you redeem it between one and five years after purchase, you forfeit the last three months of interest as a penalty. After five years, you can cash it in without penalty and receive all accrued interest.

I Bonds mature after 30 years. If you do not cash them in by that date, they stop earning interest and you should redeem them to avoid losing the money. You can hold them longer than five years without penalty, but the interest stops accumulating at year 30.

You redeem I Bonds through TreasuryDirect by requesting a transfer to your bank account. The process typically takes a few business days. There is no secondary market for I Bonds — you cannot sell them to another person or trade them like stocks.

How federal income tax works on I Bond interest

Interest earned on I Bonds is subject to federal income tax, but you have control over when you pay it. You can choose one of two approaches: report the interest each year as it accrues, or wait until you cash the bond to report and pay all taxes at once.

Most people defer taxes by not reporting anything until redemption. In the year you cash the bond, you must report the total interest earned over all the years you held it as income on your federal tax return. The Treasury will send you a Form 1099-INT showing the interest amount.

If you inherit an I Bond, the person who owned it before death must report all accrued interest on their final tax return. You do not inherit a tax bill, but you do inherit the bond with its interest history intact.

State and local tax treatment

I Bond interest is exempt from state and local income taxes in every state. This is a federal rule that applies regardless of where you live or where you buy the bond. If you live in a state with high income tax, this exemption can be a meaningful advantage compared to other savings vehicles.

The exemption applies only to the interest you earn, not to any principal you invested. It also does not affect federal taxes — you still owe federal income tax on the interest when you redeem the bond.

Comparing I Bonds to other savings and investment options

I Bonds differ from regular savings accounts, certificates of deposit (CDs), and stocks in several ways. A savings account or money market account offers when ready access to your money but typically earns less interest, especially when inflation is high. A CD locks your money for a set term (three months to five years) and charges a penalty if you withdraw early, similar to I Bonds, but CDs pay a fixed rate that does not adjust for inflation.

Treasury bills (T-bills) and Treasury notes are also government-backed but have shorter terms and fixed rates. T-bills mature in four weeks to one year, while Treasury notes mature in two to ten years. Neither adjusts for inflation the way I Bonds do.

Stocks and stock mutual funds offer the potential for higher long-term returns but carry market risk — you can lose money if prices fall. I Bonds carry no market risk but offer lower returns during periods when inflation is low or stable. Series EE Bonds, another Treasury product, pay a fixed rate for 30 years and do not adjust for inflation.

How inflation adjustments work in practice

The variable rate on I Bonds is based on the Consumer Price Index for All Urban Consumers (CPI-U), published by the Bureau of Labor Statistics. The Treasury calculates the new rate by taking the average inflation rate over the prior six months and adding it to your fixed rate.

Rates are announced in May and November each year on TreasuryDirect.gov. If you buy an I Bond in June, you receive the rate that was just announced in May, and that rate applies until November. When November arrives, a new rate takes effect for all I Bonds, regardless of when you bought them.

The composite rate (fixed plus variable) can change dramatically from one six-month period to the next. For example, if inflation spikes, your rate goes up. If inflation falls, your rate falls but cannot drop below your fixed rate. This means your return is never negative — it can only stay flat or increase.

Penalties and restrictions you should know

The main penalty is the loss of three months of interest if you redeem within five years. This penalty applies to all I Bonds, with no exceptions. If you cash a bond after holding it for two years, you lose the interest from months 21, 22, and 23.

You cannot redeem I Bonds by mail or in person at a bank. You must use TreasuryDirect online or contact their customer service to set up redemption. If your TreasuryDirect account is hacked or compromised, the Treasury has procedures to help recover funds, but the process can take time.

There is an annual purchase limit of $10,000 per person in electronic I Bonds. If you are married, each spouse can buy $10,000 separately. You cannot exceed this limit in a single calendar year, though you can buy again starting January 1 of the next year.

Frequently Asked Questions

Can I buy I Bonds for someone else as a gift?

Yes. You can buy an I Bond registered to another person through TreasuryDirect if you have their Social Security number. The recipient owns the bond and controls when it is redeemed. The purchase counts against your annual $10,000 limit, not theirs.

What happens to my I Bond if I die before cashing it in?

The bond becomes part of your estate and passes to your heirs according to your will or state law. The person who inherits it can hold it, let it continue earning interest, or redeem it. They will owe federal income tax on all accrued interest in the year they cash it.

Can I use I Bonds to pay for education and avoid taxes?

Yes, but only under specific conditions. If you use I Bond proceeds to pay may have access to education expenses (tuition and fees at an accredited school), you may exclude the interest from federal income tax. You must have been at least 24 years old when you bought the bond, and the bond must be in your name, not your child's. The exclusion phases out at higher income levels.

What is the difference between I Bonds and Series EE Bonds?

I Bonds adjust for inflation every six months, while Series EE Bonds pay a fixed rate for the entire 30-year term. EE Bonds are better if you expect inflation to stay low; I Bonds are better if you want protection against rising prices. Both are backed by the Treasury and exempt from state and local taxes.

Do I Bonds keep up with inflation?

I Bonds are designed to keep pace with inflation because the variable rate is based on the Consumer Price Index. However, the fixed rate portion may be zero or very low, so your total return might lag inflation slightly. During periods of very high inflation, the variable rate can exceed inflation, giving you a real return above inflation.