### DEFINITION of Series I Bond

Series I bond is a non-marketable, interest-bearing U.S. government savings bond that earns a combined:

1) fixed interest rate; and

2) variable inflation rate (adjusted semiannually).

Series I bonds are meant to give investors a return plus protection on their purchasing power. Most Series I bonds are issued electronically, but it is possible to purchase paper certificates with a minimum of $50 using your income tax refund.

### BREAKING DOWN Series I Bond

Series I bonds are non-marketable bonds that are part of the US Treasury savings bond program designed to offer low-risk investments. Their non-marketable feature means they cannot be bought or sold in the secondary markets. The two types of interest that a Series I bond earns are 1) an interest rate that is fixed for the life of the bond; and 2) an inflation rate that is adjusted each May and November based on changes in the non-seasonally adjusted consumer price index for all urban consumers (CPI-U). In effect, the interest on Series I bonds is variable and changes over time, making it difficult to forecast the value of the bonds years from today.

The fixed rate component of the Series I bond is determined by the Secretary of the Treasury and is announced every six months - on the first business day in May and first business day in November. That fixed rate is then applied to all Series I bonds issued during the next six months, is compounded semiannually, and does not change throughout the life of the bond. Like the fixed interest rate, the inflation rate is announced twice a year in May and November and is determined by changes to the Consumer Price Index (CPI), which is used to gauge inflation in the US economy. The change in inflation rate is applied to the bond every six months from the bond's issue date.

The actual rate on the bond, known as the composite rate, is calculated by combining the fixed and inflation rates. Clearly, the inflation rate impacts the fixed rate set on the bond. However, the minimum level that the interest rate on a Series I bond can fall to is zero, which is the floor placed on the bond byt he Treasury. If the inflation rate is so negative that it would take away more than the fixed rate, the composite rate will be set at zero. The formula for calculating the composite rate is given as:

Composite rate = fixed rate + (2 x semiannual inflation rate) + (fixed rate x semiannual inflation rate)

For example if the fixed rate is 0.30% and the semiannual inflation is -2.30%, the composite rate on the bond will be:

= 0.003 + (2 x -0.023) + (0.003 x -0.023)

= 0.003 - 0.046 - 0.000069

= -0.04307, or -4.31%.

However, since it's negative, the composite ratio will be adjusted to 0.00%.

Series I bonds are considered low risk since they are backed by the full faith and credit of the U.S. government and their redemption value canâ€™t decline. But with this safety comes a low return, comparable to that of a high-interest savings account or certificate of deposit (CD). Corporate and municipal bonds, however, can lose value; with this risk comes a higher return.

Series I bonds can be issued in any amount between the minimum and maximum purchase thresholds. The minimum purchase is $25, and the maximum annual purchase is $10,000 per Social Security number. I-bonds can be held for as little as one year or as long as 30 years, but if they are sold after fewer than five years, the holder sacrifices the last three months worth of interest.

Additionally, the interest income is taxable at the federal level, but not at the state and local levels. The series I bond is a zero-coupon bond, meaning that no interest is paid during the life of the bond. The interest is, instead, added back to the value of the bond and earns interest on interest. The bondholder has the option of electing one of two methods of taxation - the cash method or the accrual method. Under the cash method, tax is only applied when the bonds are redeemed. So, a taxpayer that holds a bond for seven years before selling it will only be taxed at the time he sells the bond. Using the accrual method, on the other hand, taxes on the imputed interest earned will be applied every year.

Sometimes, the Series I-bond income is tax free at the federal level if it is used to pay for higher education. When you sell an I-bond and use the proceeds to pay for qualified higher education expenses at an eligible institution in the same calendar year, the interest is exempt from federal income tax.