Series I bonds: Your protection against inflation
By Laura Bruce • Bankrate.com

Many people seeking shelter from a decline in fixed-income investment returns run for the cover of savings bonds.

One bond in particular, the Series I bond, is especially worth considering because it's the only inflation-indexed savings bond. It has a fixed-rate of return plus an inflation premium. You won't lose principal or the fixed interest rate.

CDs offer no inflation protection and are subject to state and local taxes, which further erode returns.

I bonds earn interest for up to 30 years and are sold in eight denominations: $50, $75, $100, $200, $500, $1,000, $5,000, and $10,000.

You must hold I bonds for 12 months to get the original investment and earnings. However, if you cash them out in less than five years, you'll forfeit three months' interest.

The interest on I bonds is comprised of two separate rates: a fixed rate of return and an annualized rate of inflation as measured by the Consumer Price Index for all Urban Consumers (CPI-U).

The fixed rate and the inflation rate are adjusted every May and November by the Treasury Department. But the fixed rate you buy the bond at is good for as long as you hold the bond.

Rate updates explained
Here's how it works. Suppose you buy an I bond in December. The fixed rate that was set in November will be your permanent fixed rate. You'll also get, for six months, whatever inflation rate was set in November. When June rolls around your inflation premium will be changed to whatever rate was established in May.

I bonds increase in value monthly, and interest is compounded semiannually. The interest accrues and is paid at maturity.

You may choose to report interest each year as it accrues or you may defer payment of the federal tax on the interest until the bond is cashed, which gives you, the investor, control over when to pay the tax.

Investors may purchase up to $30,000 worth of paper I bonds per year per Social Security number. You may also purchase up to $30,000 in electronic I bonds through Treasury Direct.

Be aware that in a co-ownership situation, either party can cash the I bond without the knowledge or approval of the other.

I bonds can be used to pay for college tuition and fees. Up to 100 percent of the interest in I bonds is exempt from federal taxes is you meet certain eligibility requirements.

I bonds can be bought and redeemed at many financial institutions. They may also be available through your employer's payroll savings plan, or you can order them online.