U.S. savings bonds are low-risk investments sold by the U.S. Treasury that provide the government with funds to help finance its operations. Series I savings bonds are a type of inflation-indexed bond, with returns that adjust based on the level of inflation in the economy. Savings bonds are governed by a variety of rules and regulations regarding purchases, redemption and taxation.
Series I bond interest rates are based on a combination of two different rates: a fixed rate and an inflation rate. The fixed rate is announced May and November each year and applies to all bonds issued within 6 months of the announcement date. The fixed rate stays the same for the life of the bond and is set to 0 percent as of November 2012. The inflation rate is based on changes in the consumer price index--a value that measures the rate at which prices in the economy are increasing--which is adjusted on a semiannual basis. The inflation rate on Series I bonds is 0.88 as of November 2012. The fixed rate and inflation rate are combined into a composite rate using a formula that takes the sum of the fixed rate, two times the inflation rate and the inflation rate times the fixed rate. This formula yields a composite earnings rate of 1.76 percent for I bonds issued through April 30, 2013.
Buying I Bonds
The government sells series I bonds electronically and in paper form. According to the U.S. Department of the Treasury, as of January 1, 2012 you can no longer buy paper bonds with financial institutions. Instead, you must buy bonds electronically through the government's TreasuryDirect website or use your income tax refund to buy paper bonds. You can buy electronic I bonds for any amount between $25 and $10,000 per calendar year. Paper bonds must be purchased in denominations of $50, $75, $100, $200, $500, $1,000 or $5,000, up to an annual limit of $5,000.
Redeeming I Bonds
You have to wait at least 12 months before you can redeem an I bond for its face value. If you redeem an I bond before it is 5 years old, you forfeit 3 months of accrued interest; bonds redeemed after 5 years are not subject to a penalty. According to the U.S. Treasury, most local financial institutions can cash I bonds; you can also cash electronic bonds by logging into your TreasuryDirect account and following the redemption instructions.
U.S. savings bonds offer three tax benefits. First, interest on savings bonds avoids taxation at the state and local levels. Second, you can defer paying federal income tax on the interest until you cash in the bond or until its maturity date. Finally, low and middle-income taxpayers don't have to pay federal taxes on bond interest if they pay qualified higher education expenses, such as college tuition and fees. Higher education expenses must be incurred during the same tax year that bonds are redeemed to qualify for tax-free interest.
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