How Do I Bonds Work?
An I bond is a U.S. Treasury savings bond whose interest rate combines two pieces: a fixed rate that stays the same for the entire life of the bond, and an inflation rate that the Treasury resets every six months. Together they form a single composite rate, which is what makes I bonds a hedge against inflation. You buy them directly from the government, the interest compounds inside the bond instead of being paid out, and a few timing rules decide when you can cash out without a penalty. Here is exactly how each part works.
I bonds are non-marketable — you cannot buy or sell them on an exchange. You purchase them straight from the U.S. Treasury at TreasuryDirect, hold them in your own account, and redeem them back to the Treasury. There is no broker and no market price — the bond is always worth its principal plus the interest it has earned.
How the Rate Is Built: The Composite Rate
Every I bond earns a composite rate made of two components:
- Fixed rate — set when you buy and locked for the full 30-year life of that specific bond. The Treasury sets a new fixed rate every six months, but once your bond has one, it never changes.
- Inflation rate — based on changes in the Consumer Price Index (CPI-U) and reset every six months. This is the part that rises and falls with inflation.
The Treasury combines them with a published formula:
| Step | Calculation | Illustrative Example |
|---|---|---|
| Fixed rate | Set for the life of the bond | 1.30% |
| Semiannual inflation rate | From CPI-U, resets every 6 months | 1.97% |
| Composite rate | fixed + (2 × inflation) + (fixed × inflation) | ≈ 5.27% |
Formula and rate history: U.S. Treasury, I bonds interest rates. The numbers above are illustrative — check TreasuryDirect for the current fixed and inflation rates.
New rates are announced every May 1 and November 1. Your own bond’s rate changes on a six-month cycle tied to the month you bought it — not on the calendar dates the Treasury publishes. So a bond bought in September picks up each new inflation rate in September and March. During periods of high inflation, I bonds have paid eye-catching rates: the composite rate reached a record 9.62% for bonds issued between May and October 2022, which set off a surge in purchases.
How the Interest Accrues
I bonds do not send you a check. Interest is added to the value of the bond and compounds semiannually — earnings start earning their own interest. You only receive the money when you redeem the bond. This is the same compounding math that drives long-run growth in any account; see how the doubling time works in our Rule of 72 explainer, or model a lump sum with the compound interest calculator.
Because the composite rate can never fall below 0%, an I bond’s redemption value never drops. In a month of negative inflation the bond simply earns nothing for that period — it does not lose principal.
The Rules That Matter: Limits, Lock-Up, and Maturity
| Rule | Detail |
|---|---|
| Annual purchase limit | $10,000 electronic per person, per calendar year ($25 minimum) |
| Where to buy | TreasuryDirect.gov (electronic only) |
| Minimum holding period | 12 months — you cannot redeem before then |
| Early-redemption penalty | Cash out before 5 years → forfeit the last 3 months of interest |
| Final maturity | Stops earning interest after 30 years |
Source: U.S. Treasury, Series I savings bonds. The $10,000 cap is per Social Security number; separate limits can apply to trusts and businesses.
The 12-month lock-up is why I bonds are not a substitute for an emergency fund — you cannot touch the money for a year. They sit best alongside more liquid savings. For how they stack up against other safe places to park cash, compare the yields in high-yield savings vs CDs vs Treasury bills.
How I Bonds Are Taxed
The tax treatment is one of the quieter advantages:
- Exempt from state and local income tax. You never owe state tax on I bond interest.
- Federal tax is deferred. You can wait to report all the interest until you cash the bond or it reaches final maturity, rather than paying tax each year. (You may elect annual reporting instead.)
- Possible education tax break. Interest can be fully or partially tax-free if you use the proceeds for qualified higher-education expenses and your income is under the IRS limits — the education savings bond exclusion, claimed on Form 8815.
Source: IRS, Topic No. 403, Interest Received, and IRS Publication 970 (education savings bond exclusion).
Where I Bonds Fit
I bonds are a low-risk, inflation-protected place for money you will not need for at least a year — think of them as a savings tool, not a growth engine. They behave very differently from a bond fund you buy through a broker, which trades on the open market and can lose value when rates rise. Our sister site breaks down that other category in bond ETFs vs individual bonds.
This article is educational and not financial advice. Rates, limits, and rules change — confirm the current figures with TreasuryDirect before you buy.
Frequently Asked Questions
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