How Series I bonds work

A Series I savings bond has two rate components. The fixed rate is chosen by the United States Treasury for new issues and stays with that bond for its life. The semiannual inflation rate is based on the change in the Consumer Price Index for All Urban Consumers, or CPI-U, over a six-month measurement period.

The annualized composite rate is:

$$c = f + 2i + fi$$

$f$ is the annual fixed rate as a decimal. $i$ is the six-month inflation rate as a decimal. The $2i$ term annualizes the six-month change, and the product $fi$ accounts for earning the fixed component on an inflation-adjusted value.

With $f = 0.012$ and $i = 0.015$, the result is $0.012 + 2(0.015) + 0.012(0.015) = 0.04218$, or 4.218 percent. Leaving out the product would produce 4.2 percent. The difference is small in this example, but it is part of the Treasury formula.

The composite rate has a floor of zero. A negative inflation component can offset some or all of a positive fixed component, but the bond's redemption value does not decline through a negative composite rate.

The Treasury announces fixed rates and inflation components on its regular May and November schedule. The fixed rate available when a bond is issued becomes that bond's permanent fixed component. Buying after a later announcement can attach a different fixed rate to a new bond.

Each bond receives a new inflation component every six months according to its issue month. A bond bought between announcement dates does not reset on the day of the next public announcement. Its own six-month earning period finishes first, then the newly applicable component begins.

That creates a sequence of composite rates over the holding period. The formula stays the same while $i$ changes. If measured inflation rises, the next composite rate generally rises. If measured inflation falls or turns negative, the next composite rate generally falls, subject to the zero floor.

The inflation component looks backward at CPI-U changes. It compensates the bond on the published index path rather than predicting prices over the coming six months. Inflation and purchasing power explains why an index and one household's spending can move differently.

Interest is earned monthly. Every six months, accrued interest is added to the bond's value, and the next six months earn on that larger base. This is semiannual compounding even though the displayed composite rate is annualized.

The redemption value shown during the early holding period can reflect the early-redemption penalty. That display convention does not change the interest rate credited to the bond; it shows what the owner would receive under the current redemption rule.

An I bond cannot be sold to another investor. It is registered to the owner and redeemed through the Treasury or an authorized process for paper bonds. That removes secondary-market price movement. Rising real yields can lower the market price of a TIPS, but they do not mark down an I bond because there is no market quote to move.

The return is therefore a credited-value path rather than a traded-price path. Nominal rate describes the stated rate before inflation, while real rate describes growth in purchasing power. The fixed component is the closest part of the I bond formula to a real rate before tax.

A Series I bond cannot be redeemed during its first 12 months. Redeeming after that lock but before five years generally forfeits the most recent three months of interest. After five years, the early-redemption penalty ends. The bond earns interest for as long as 30 years unless it is redeemed sooner.

Those rules make the purchase date part of liquidity planning. The inflation formula can work exactly as stated while the bond is still unavailable for an unexpected expense. Liquidity is the ability to turn an asset into spendable money on the needed date, not simply the stability of its value.

Purchase channels, registration, annual purchase limits and permitted tax-refund purchases are administrative rules separate from the composite-rate equation. They can change without changing how $f$ and $i$ combine.

A beneficiary or co-owner designation affects transfer at death, not the rate. The bond's fixed component and earning history stay with the bond when an authorized ownership change occurs.

Series I bond interest is subject to federal income tax but exempt from state and local income tax. An owner can generally defer reporting federal interest until redemption, final maturity or another taxable disposition, or elect to report accrued interest each year and continue that method consistently.

Deferral means the bond can compound before federal tax is paid. It does not make the interest tax-free. A qualified education exclusion can remove some or all interest from federal income when ownership, age, expense, filing and income conditions are met.

Tax timing and inflation protection answer different questions. The composite rate determines credited interest. Tax rules determine how much of that interest remains after tax and when the tax is recognized. How real returns work places tax and inflation on the same return path, and the real return calculator shows the arithmetic.

The inflation calculator converts a price change into purchasing-power terms. The I bond uses an official six-month CPI-U change as one input to its statutory rate formula.

The first example combines a fixed rate of 0.012 with semiannual inflation of 0.015. The decimal composite is 0.04218 and the annualized composite rate is 4.218 percent. The second sets the fixed rate to 0, keeps semiannual inflation at 0.015 and produces a decimal composite of 0.03, or 3 percent.

These examples calculate the announced composite rate. A holding-period return also follows the bond's issue-month reset schedule, monthly accrual, six-month compounding and any early-redemption penalty. Tax treatment then determines the after-tax result.

Current Treasury terms identify the rate period and redemption rules for an actual bond. This is educational material, not financial advice.