When and How Is I Bond Interest Paid?

I Bonds are a type of U.S. Treasury savings bond designed to protect investors from inflation. Backed by the full faith and credit of the U.S. government, they offer a secure, low-risk investment. They provide a return that adjusts with economic conditions, helping individuals preserve their purchasing power.

How I Bond Interest is Determined

The interest rate on an I Bond is a composite rate, calculated from two components: a fixed rate and an inflation rate. The fixed rate is set at purchase and remains constant for the bond’s 30-year life. The inflation rate is variable, adjusted every six months on May 1 and November 1. This rate is based on changes in the Consumer Price Index for all Urban Consumers (CPI-U), which includes food and energy prices. This combination ensures the bond’s value keeps pace with inflation.

Monthly Accrual and Compounding

I Bond interest accrues monthly, with interest earned added to the bond’s value at the beginning of the subsequent month. This involves semi-annual compounding, where interest accumulated over six months is added to the principal. The new interest rate then applies to this increased balance, allowing the investment to grow. While interest accrues monthly, the updated value may not be immediately visible in a TreasuryDirect account, with a delay of up to six months in displaying current accrued interest. This delay, especially during the first five years, accounts for the potential early redemption penalty.

Receiving Your Interest at Redemption

I Bond interest accumulates and is received only when the bond is redeemed. Bondholders cannot redeem an I Bond until it has been held for at least 12 months from its issue date. If redeemed before five years, a penalty applies, forfeiting the last three months of interest. For instance, a bond redeemed after 18 months would yield only 15 months of interest. No interest penalty is incurred if held for five years or longer.

Electronic I Bonds are typically redeemed through a TreasuryDirect account. The full value, including principal and accrued interest, is transferred to the bondholder’s linked bank account. While paper bonds can be redeemed at financial institutions or by mail, electronic bonds offer a more direct method. Funds are typically transferred to a linked bank account after a processing period.

Tax Considerations for I Bond Interest

Interest earned on I Bonds is subject to federal income tax but exempt from state and local income taxes. For most investors, tax on this interest can be deferred until the bond is redeemed, matures, or changes ownership. This is known as the cash method of accounting for interest. Alternatively, a bondholder may elect to report the interest annually as it accrues.

A tax advantage exists if I Bond proceeds are used for qualified higher education expenses, allowing interest to be entirely excluded from federal income tax under specific conditions. To qualify, the bond must have been issued after 1989 to an owner at least 24 years old at issuance. Proceeds must pay for eligible tuition and fees at a qualified educational institution in the same tax year the bond is redeemed. Income limitations apply, and the taxpayer must file their federal income tax return with any status except married filing separately. This exclusion is claimed by filing IRS Form 8815.