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 can’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.

RELATED TERMS
  1. Government Bond

    A government bond is a debt security issued by a government to ...
  2. Savings Bond Plan

    A savings bond plan allows employees to purchase U.S. savings ...
  3. Bond

    A bond is a fixed income investment in which an investor loans ...
  4. U.S. Savings Bond Adjustment

    U.S. savings bond adjustment describes a change in the amount ...
  5. Fixed Income

    Fixed income is a type of investment in which real return rates ...
  6. Series EE Bond

    The Series EE Bond is a non-marketable, interest-bearing U.S. ...
Related Articles
  1. Investing

    Surprise! The Best Long-term Bond Investment May Be Savings Bonds

    A 20-year Series EE savings bond pays more interest than a 20-year Treasury bond. So are government-issued long-term bonds the best bet going?
  2. Investing

    5 Reasons to Invest in Municipal Bonds When the Fed Hikes Rates

    Discover five reasons why investing in municipal bonds after the Fed hikes interest rates, and not before, can be a great way to boost investment income.
  3. Investing

    Corporate Bonds for Retirement Accounts

    Corporate bonds are usually the preferred choice in retirement accounts. Here are some of the benefits of corporate bonds, and strategies for a portfolio.
  4. Investing

    Understanding Interest Rates, Inflation And Bonds

    Get to know the relationships that determine a bond's price and its payout.
  5. Investing

    Corporate Bonds: Advantages and Disadvantages

    Corporate bonds can provide compelling returns, even in low-yield environments. But they are not without risk.
  6. Financial Advisor

    Corporate Bonds and the Impact of Inflation Risk

    The impact of inflation risk affecting corporate bond returns can be significant. It may even result in a real loss of purchasing power.
  7. Investing

    Find the Right Bond at the Right Time

    Learn about the types of bonds you should consider investing in, when you should be buying them and how to compare yields against their time to maturity.
  8. Investing

    Spice Up Your Portfolio With International Bonds

    Going global can add flavor and diversity to an otherwise bland basket of bonds.
  9. Investing

    The Basics Of Municipal Bonds

    Investing in municipal bonds may offer a tax-free income stream, but such bonds are not without risks. Check out types of bonds and the risk factors of muni-bond.
RELATED FAQS
  1. Which factors most influence fixed income securities?

    Learn about the main factors that impact the price of fixed income securities, and understand the various types of risk associated ... Read Answer >>
Hot Definitions
  1. Socially Responsible Investment - SRI

    Socially responsible investing looks for investments that are considered socially conscious because of the nature of the ...
  2. Business Cycle

    The business cycle describes the rise and fall in production output of goods and services in an economy. Business cycles ...
  3. Futures Contract

    An agreement to buy or sell the underlying commodity or asset at a specific price at a future date.
  4. Yield Curve

    A yield curve is a line that plots the interest rates, at a set point in time, of bonds having equal credit quality, but ...
  5. Portfolio

    A portfolio is a grouping of financial assets such as stocks, bonds and cash equivalents, also their mutual, exchange-traded ...
  6. Gross Profit

    Gross profit is the profit a company makes after deducting the costs of making and selling its products, or the costs of ...
Trading Center