investing

I bond interest exempt from fed taxes?

Savings bonds are Treasury securities that are payable only to the person to whom they are registered. This means that you can't resell them, but you can cash them in. Savings bonds can earn interest for up to 30 years, although you can cash them in after one year -- the minimum holding period -- with a penalty. If you redeem a bond before five years, there's a three-month interest penalty.

The government issues two savings bonds -- the I bond and the Series EE Patriot bond.

The I bond is an inflation-indexed savings bond. It has a fixed rate of return plus an inflation premium. The fixed rate and the inflation premium are adjusted every May and November by the Treasury Department. But the fixed rate assigned when you buy the bond is good for as long as you hold the bond. The inflation premium ensures that you do not lose the purchasing power of your investment over time.

I bonds
  • Inflation-indexed savings bond.
  • Fixed rate of return plus inflation premium repriced semiannually.
  • Value increases monthly; compounds semiannually and paid at maturity.
  • Investor control over payment of taxes.
  • I bonds may be used to pay for college tuition and fees.
  • Purchase denomination additionally through TreasuryDirect online.
  • Maximum in paper I bonds annually is $5,000 online through TreasuryDirect.

At a glance

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 premium was set in November. When June rolls around your inflation premium will be changed to whatever rate was established in May, but your fixed rate will remain fixed.

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.

I bonds can be used to pay for college tuition and fees. Up to 100 percent of the interest in I bonds may be exempt from federal taxes if the bond owner pays qualified higher education expenses at an eligible institution in the same calendar year the bonds are redeemed.

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.

When purchased through financial institutions or payroll savings, the bonds can be bought in eight denominations: $50, $75, $100, $200, $500, $1,000, $5,000 and $10,000. When you buy them online through TreasuryDirect, a $25 denomination also is available.

Investors may purchase up to $5,000 worth of paper I bonds per year per Social Security number. You may also purchase an additional $5,000 in electronic I bonds through TreasuryDirect.

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