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Next I Bond Inflation Component Will Be 4.83%

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The Labor Department released the March CPI numbers today, and with these numbers, the I Bond inflation component can be computed. Thanks to the recent inflation, it's a very high 4.83%. The only time this rate has been higher was in November 2005 which was after the Katrina-induced energy price spike. This 4.83% number is added on to the I Bond fixed rate to derive the I Bond composite rate.

The new rate makes an attractive no-risk opportunity. However, with the new annual I-Bond purchase limit of $5,000 online and $5,000 paper, the opportunity is limited.

If you buy I Bonds before the end of April, you can know the rate you'll receive for the next 12 months. The interst rate for the first 6 months will be based on the current inflation componet (3.06%). The next 6 months should be based on this new rate (4.83%). After that, it'll depend on future inflation numbers. The current fixed component of 1.2% will stay the same for the life of the bond. I describe the details of calculating the expected return below.

If you decide to wait after April to buy I Bonds, you'll have to guess about the next fixed rate component. Currently, it's 1.20%. I have a feeling it's likely to drop. Based on the low TIPs rates (see article) and the low interest rate environment, I think there's a good chance the Treasury will drop the rate to 1% or lower. The lowest it has ever been is 1% (see I Bond rate history). The only thing that may encourage the Treasury to increase the rate would be to compensate for the slashing of the annual purchase limit. But I don't give this much weight.

Estimating I Bond rate of return for the next 11 to 14 months

From Treasury Direct I Savings Bonds FAQs
The semiannual inflation rate announced in May is the change between the CPI-U figures from the preceding September and March

All previous CPI-U numbers are available from this government webpage. The CPI-U for September 2007 was 208.49. Last March 2008 CPI-U was 213.528. This is an increase of 2.4164%. The annualized version of this is about 4.83%.

If you buy before May, you'll receive the current I-Bond fixed rate of 1.2% for the life of the I-Bond. The inflation component will be added to this rate and will change every 6 months. The current inflation component is 3.06%, and the composite rate is 4.28%. Here's an estimate of the return for the next year:
  • 4.28% from April 2008 to September 2008
  • 6.06% from October 2008 to March 2009

I Bonds increase in value on the first day of the month. So on May 1 2008, you'll earn the interest for the full month of April. So for maximum return, it's best to buy I Bonds near the end of the month and redeem them early in the month.

If you buy them on April 30, 2008, the value of the I Bond on April 1, 2009 would be about 5.17% higher. For 11 months, this comes out to an annualized yield of about 5.64%.

If you want to redeem them on April 1, 2009, you'll be hit with a penalty of 3 months interest (the most recent months). So if you want to maximize the time you earn 6.06%, you'll want to hold on to them for 3 more months.

Below is an estimated annualized return for I Bond redemptions from April 1, 2009 to July 1, 2009. It is assumed you bought the I Bond on April 30, 2008 which gives you almost an extra month of interest.
  • 3.99% - redeem on 4/1/09, 6mo of 4.28%, 3mo of 6.06%, and 3mo penalty
  • 4.16% - redeem on 5/1/09, 6mo of 4.28%, 4mo of 6.06%, and 3mo penalty
  • 4.31% - redeem on 6/1/09, 6mo of 4.28%, 5mo of 6.06%, and 3mo penalty
  • 4.43% - redeem on 7/1/09, 6mo of 4.28%, 6mo of 6.06%, and 3mo penalty

The highest guaranteed rate would be an annualized return of 4.43% for about 14 months (from 4/30/08 to 7/1/09).

Note, it's best not to wait until the last day of the month to buy I Bonds at Treasury Direct. You probably want to give yourself a few days to ensure they are officially purchased before the end of the month.

Below is a summary of the I Bond features. More information is available at this Treasury I Bond page:
  • Can't be redeemed within 12 months of issue date
  • Lose 3 months interest if redeemed within 5 years
  • Interest is composed of fixed and inflation-based rate
  • Fixed rate remains for life of bond
  • Inflation-based rate changes every 6 months after issue date
  • New rates announced every six months on November and May 1st
  • Federal tax can be deferred on interest until bond is redeemed
  • Interest is exempt from state and local tax
  • Some or all interest is tax exempt when used for educational expenses
  • $10,000 maximum of I Bond purchases per year ($5K online and $5K paper) - total was $60,000 before 2008 (Treasury's press release).

For more details about the purchase limit, please refer to the Treasury Direct's FAQ on the new purchase limit.


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Comments
18 Comments.
Comment #1 by Anonymous posted on
Anonymous
Banking Guy superb I Bond writeup. Thanks. For me, well, I got burned when I went in a few years back north of 6%. It felt good 'till they reset the rate after six months. Got out after the one-year lock in, chalked it up to experience, and have not looked back. So you'll find me on the sidelines during this I bond go-round. Only thing that could change that in the future is if they raise the base rate. After being chastened, I'm just gonna need a little bit better protection on the low side.

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Comment #2 by Anonymous posted on
Anonymous
Dont think you can predict the CPI rate too well over the next 6 months. Therefore, you'll know the rate for the next 6 months, but it will be recalculated in Nov. and added to the base rate. Who knows what that CPI rate will be in Nov? It could be negative, though I doubt it.

These were a great deal with a 3% fixed base rate, but with a 1% rate, who knows?

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Comment #3 by Banking Guy (anonymous) posted on
Banking Guy
Yes, it was great back in 2000 with fixed rates of over 3% and you could pay for them online with a cash back credit card.

About predicting CPI, remember that if you buy an I Bond before May, the rate for the next 6 months will be based on current inflation component (that was set last November). When that ends, the next 6 months will be based on this new CPI number that'll be officially announced in May.

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Comment #4 by Anonymous posted on
Anonymous
I too bought into the 6.7% I-bond a few years back, then sold it after the rate plummeted to 2.2%. And there's something about Treasury Direct's policy of not providing any kind of paper trail, that I just don't trust. Yet, in order to buy an I-Bond online, you have to print out a document on your own printer, take it to a bank officer to have him/her sign it---a notary isn't good enough---then mail it in. So when you told me today about the new $5K/year limit, that was the last straw.

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Comment #5 by Banking Guy (anonymous) posted on
Banking Guy
in order to buy an I-Bond online, you have to print out a document on your own printer, take it to a bank officer to have him/her sign it---a notary isn't good enough---then mail it in.

I don't remember this when I used Treasury Direct to buy I Bonds three years ago. Is this new?

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Comment #6 by Anonymous posted on
Anonymous
Yes, it was a lot easier three years ago when there was a lot less account security. These days you have to do the bank officer / signature guarantee thing whenever you change or add bank links. There is a new randomized keyboard, a gauntlet of login questions, and for some people, some kind of access card with secret codes. Try Googling "treasury direct" and "signature guarantee" for details.

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Comment #7 by Bill (anonymous) posted on
Bill
Banking Guy, yes, Treasury Direct (TD) has tightened up their security considerably. I don't buy I-Bonds, but do have a TD account for T-Bills. At first, when I wanted to link a new bank to the account, all I had to do was provide the bank routing number and account number on the TD Web site. Now, in order to add a new bank, you have to print a PDF form, fill it in, obtain a guaranteed signature (e.g. Medallion Signature Guarantee from a bank -- no notaries public permitted), mail to TD, and wait while they manually process your paper application. The whole process typically takes a bit more than a week.

Even accessing your TD account online has become more cumbersome. They have now issued all their customers a TreasuryDirect Access Card. You have to use this card to generate a daily changing passcode that is required to access your account. So now, in order to access your account you need to provide: 1) Account number, 2) your password, 3) an assigned static serial number, and 4) the passcode generated from the access card.

Being a retired IT type, I do understand the need for security, but I really think TD takes things to extremes. The new bank process may be justified, but the logon process is unnecessarily complicated in my view.

Very nice write up on the I-Bonds, BTW. I appreciate your doing it.

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Comment #8 by Banking Guy (anonymous) posted on
Banking Guy
Thanks Bill and Anonymous for the details. I'm glad I still have my initial checking account that I used to originally link with the TD account. At least this new security should make it hard on any hacker who finds a way to gain account access and wants to withdraw the money.

I log into my TD account once a month to check on things, and I use that new access card. It's a hassle, but it should make it harder for hackers to break in.

I've read that the TD doesn't guarantee any reimbursements if a hacker does break and steals your money, so hopefully these new security steps will prevent any theft.

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Comment #9 by Anonymous posted on
Anonymous
If your bank info is incorrect on TD, you can add a custom linked account (thru manage direct), and add the new bank account information to that linked account. Then, you can purchase the ibond thru that custom linked account. At least, this is what I was able to do after discussion with a TD CSR.

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Comment #10 by Anonymous posted on
Anonymous
as a long time user of the i-bond site, i can say, now, at this point, the log in process is so cumbersome and so time consuming to both add *or* get out your $, it just isnt worth the hassle.

i left the bonds in there that i already own, but i am done with it...

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Comment #11 by Anonymous posted on
Anonymous
Gee, what was I thinking when I sold some EE and I bonds late 2006 (thought I could do better in the open market)

Wrong!!!!!

Not a total loss , I kept my 3% base rate I-bonds (stupid , but not nuts)

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Comment #12 by Anonymous posted on
Anonymous
This is an extreme example of how the online version is overly complicated. If you want to buy the paper version, it's a one page form you get at your bank with SSN, name, and address. Write a check payable to the bank and you're done. You have a paper receipt of your purchase, bonds arrive in your mailbox in a couple weeks and can be replaced if lost.

I have a TD account and I haven't taken the time for a bank guarantee to connect to my current checking.

Michael/Atlanta

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Comment #13 by Anonymous posted on
Anonymous
If you just wanted to buy the paper ones and wanted to increase the 5K limit - Would the following work?

Example - Husband, wife, child

Husband buys 5k for him and 5k gift for wife and 5k gift for child

Wife buys 5k for her and 5k gift for husband and 5k gift for child

Total invested = 30K

Would this plan work?

Is it easy to cash in bonds in a child's name? Plus this interest would be at the child's rate.

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Comment #14 by Banking Guy (anonymous) posted on
Banking Guy
I just added a link at the bottom of the post to a FAQ on purchase limits which may help answer your question.

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Comment #15 by Anonymous posted on
Anonymous
If I wait til May 2,2008 I thought the rate will be a little more than the rate if I buy in April (or the same if you think the fixed rate will drop to 1.0%) since the CPI-U has risen more from the last 6month numbers. If fixed is same, wouldnt it be 1.2% + inflation component rate; more than the Nov07 rate?

Also, wouldnt the I-bond purchased by end of April 2008 have a different inflation component beginning May 1, 2008? Or am i missunderstanding?

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Comment #16 by David (anonymous) posted on
David
According to an email I received today from TreasuryDirect, there is a new savings bond purchase limit of $5,000 "per series and TIN" each year. This would seem to mean that instead of being able to buy $5,000 of I Bonds electronically and an additional $5,000 in paper I bonds, you are limited to $5,000 total.

Too bad. I got my $5,000 in electronic I Bonds today before the fixed rate drops.

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Comment #17 by Anonymous posted on
Anonymous
Hi,

I bought the paper bonds at my bank a week ago, I signed up and mailed the treasurydirect form before that (8 days now).

I HAVE NOT received the access card, so I basically lost the deadline of May 30th to purchase and lock into 1.2%.

Can you please advise if I should drop another $5k on Friday (if I get the access card by then).

Where could I check if the 1.2% increased or decreased?

Thanks

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Comment #18 by Anonymous posted on
Anonymous
Good call Banking Guy! Today, May 1, the treasury reduced the fixed rate portion of the I-Bond to 0% from 1.2%
Thanks for the heads-up.

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