7690 / How is the owner of Series I bonds taxed?

Between 1998 and January 1, 2012, the Treasury Department offered a type of savings bond that offered inflation-adjusted interest rates. Series I (inflation-indexed) savings bonds were sold at par value (face amount) in denominations ranging from $50 to $10,000.¹ Prior to January 1, 2012, an individual could purchase no more than $10,000 in Series I bonds during any calendar year.² The difference between the purchase price and the redemption value is taxable interest, which is payable when the bond is redeemed or finally matures.³ Series I savings bonds mature in 30 years.⁴

Series I savings bonds accrue earnings based on both a fixed rate of return and the semiannual inflation rate.⁵ A single rate is constructed to reflect the combined effects of the two rates.⁶ The following example demonstrates how the composite earnings rate is determined:

Example: The 4.60 percent composite earnings rate for Series I savings bonds bought from May through October 2011 applied for the first six months after their issue. The earnings rate combined the fixed rate, then 0, with the 2.30 percent semiannual inflation rate (as measured by the Consumer Price Index for all Urban Consumers (CPI-CU)).⁷

The formula for computing the composite rate is:

Composite rate = [Fixed rate + (2 x semiannual inflation rate) + (fixed rate x semiannual inflation
rate)]

For 2011, the composite rate was calculated as follows:

Composite rate = [0 + (2 × 0.0230) + (0 × 0.0230)]

Composite rate = [0 + 0.0460 + 0]

Composite rate = 0.0460

Composite rate = 4.60%

The fixed rate of return, applicable at the time a Series I savings bond was issued, will apply to the bond throughout its 30-year life.⁸ The semiannual inflation rate, announced each May and November, will be reflected in a Series I savings bond’s value beginning on that bond’s next semiannual interest period following the announcement.⁹ In general, a bond’s composite rate will be higher than its fixed rate if the semiannual inflation rate reflects any inflation. In other words, inflation will cause a bond to earn additional interest. Likewise, a bond’s composite
rate will be lower than its fixed rate if the semiannual inflation rate reflects any deflation. Deflation will cause a bond to increase in value slowly, or not increase in value at all. However, even if deflation becomes so great that it would reduce the composite rate to below zero, the Treasury will not allow the value of a bond to decrease from its most recent redemption value.¹⁰

A Series I savings bond may be redeemed any time after six months for issue dates of
January 2003 and earlier. Bonds with issue dates on or after February 1, 2003, can be cashed any time after 12 months. A bond redeemed less than five years from the date of issue will be subject to a three-month interest penalty.¹¹ Tables of redemption values are made available in various formats and media, including the Internet (www.savingsbonds.gov).¹² The bonds have an interest paying life of 30 years after the date of issue, and cease to increase in value as of that date.¹³