The Real Rate of Return on I Bonds

The Treasury’s Series I savings bond is guaranteed to provide a real rate of return, which is a return above the inflation rate. Inflation-protected returns are often underappreciated by savers when inflation is low. Yet anyone who has lived through the shocking effects of rising inflation will appreciate the peace of mind afforded by an investment that guarantees a real rate of return. I bonds are available directly from the Treasury in small denominations, without a fee.

Real Rate of Return

The real rate of return on a bond is its annual nominal, or stated, return minus the annual rate of inflation. The Treasury uses the All-Urban Consumers Price Index to measure inflation. A real rate of return ensures the purchasing power of your investment. For instance, if a bond is paying 2 percent a year, but the CPI’s annual increase is 3 percent, your real rate of return is -1 percent — your investment is actually losing 1 percent of its purchasing power each year. For the period of May through October 2012, the CPI rate was 0.88 percent and the Series I bond paid an annual rate of 1.76 percent.

Series I Savings Bond

The Series I savings bond has a 20-year initial maturity period and another 10-year extended period during which it continues to earn interest. The Series I pays two interest rates. The first is fixed and set by the Treasury when the bond is issued. The second rate, based on inflation, is added to the first rate to get the final rate. Every May and November, when savings bonds accrue interest, the Treasury resets the inflation-based rate according to the increase in the CPI for the previous six months.

Accrued Interest

Savings bonds earn accrued interest — interest that is credited to your bond but not paid until you cash in the bond on or before maturity. You must hold a Series I savings bond for at least a year before redeeming it. If you redeem it within the first five years, you will forfeit the last three months of accrued interest. You do not have to pay taxes on the accrued interest on a savings bond until you redeem it.

Tax Features

At redemption, savings bond interest is free from state and local taxes. While you have the right to postpone the tax payment on your savings bond until redemption, you can instead choose to pay the tax annually. This may be desirable if you are in a low tax bracket or anticipate high deductions for the foreseeable future. You are allowed to deposit savings bonds into a traditional individual retirement arrangement but not a Roth IRA. The advantage of IRA deposits is that you may be eligible for a federal savers tax credit of up to $2,000 per year per couple if your combined income is less than $59,000. See Internal Revenue Service Form 8880 for details.

About the Author

Based in Chicago, Eric Bank has been writing business-related articles since 1985, and science articles since 2010. His articles have appeared in "PC Magazine" and on numerous websites. He holds a B.S. in biology and an M.B.A. from New York University. He also holds an M.S. in finance from DePaul University.

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