Savings Bonds - the I-bond

Savings bonds are a type of Treasury security that earns interest for up to 30 years. They are only payable to the person to whom they are registered and can not be resold. You can cash them in after one year, but if you redeem it before five years you will pay a three month interest penalty.

There are two types of savings bonds issued by the government: the I-bond and the Series EE Patriot Bond. The I-bond is a savings bond that is inflation-indexed. Every May and November, the Treasury Department adjusts the inflation premium. The fixed rate of the bond that you purchased is fixed for the full term of the bond. The inflation premium is adjusted so that you do not lose the purchase power of your investment over time.

For example, you buy an I-bond in December. Your fixed rate was set in November and is your permanent rate. For six months, you will receive the inflation premium that was set in November. In June, you inflation premium is adjusted to whatever rate the Treasury establishes in May. Your fixed rate is not changed.

Each month your I-bond increases in value, and interest is compounded semiannually. The interest is compounded and paid at maturity. You can report the interest each year as it is accrued, or you can defer the payment of federal taxes until the bond is cashed. You decide when you pay the tax.

I-bonds that are used to pay for college tuition and fees are 100% exempt from federal taxes. The =bond owner must pay for the higher education expenses at an eligible institution within the same year as the bonds are cashed.

Many financial institutions, including online institutions, will sell and redeem I-bonds. You may be able to purchase them through your employer's payroll savings plan. You can purchase them through financial institutions in eight denominations: $50, $75, $100, $200, $500, $1,000, $5,000 and $10,000. If you buy them online through TreasuryDirect, a $25 denomination is also available.

You can purchase up to $30,000 in paper I-bonds each year. You can also purchase $30,000 in electric I-bonds in addition to your paper bonds.