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New I Bond Rates Will Surpass Short-Term CD Rates

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The Labor Department released the March CPI numbers today, and with these numbers, the next I Bond inflation component can be computed. Thanks to the recent inflation, it's a very high 4.60%. This 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 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 component (0.74%). The next 6 months will be based on this new rate (4.60%). After that, it'll depend on future inflation numbers. The current fixed component of zero percent 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 May fixed rate component. At least we know it can't drop below zero percent (at least by the current rules at the Treasury). Based on today's rate environment, I think it's very likely to stay zero percent. Based on this we can easily compute the short-term rate of return, but first, I'll compute the rates of return if the I Bond is purchased before May.

I Bond Rates of Return for April 2011 Purchase

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 2010 was 218.439. Last March 2011 CPI-U was 223.467. This is an increase of 2.301%. The annualized version of this is about 4.60%.

If you buy before May, you'll receive the current I-Bond fixed rate of 0% 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 0.74%, and the composite rate is 0.74%. Here's an estimate of the return for the next year:

  • 0.74% from April 2011 through September 2011
  • 4.60% from October 2011 through March 2012

I Bonds increase in value on the first day of the month. So on May 1st, 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 redeem an I Bond before 5 years, you lose the last 3 months of interest. So based on this and the above numbers, if you buy an I Bond on April 29, 2011, the value of the I Bond on April 1, 2012 would be about 1.53% higher. For 11 months, this comes out to an annualized yield of about 1.66%.

Below is an estimated annualized return for I Bond redemptions from April 1, 2012 to July 1, 2012. It is assumed you will buy the I Bond on April 29, 2011 which gives you almost an extra month of interest. This effectively reduces the 3-month penalty to 2 months.

  • 1.66% - redeem on 4/1/12, 6mo of 0.74%, 3mo of 4.60%, and 3mo of 0% (penalty)
  • 1.90% - redeem on 5/1/12, 6mo of 0.74%, 4mo of 4.60%, and 3mo of 0% (penalty)
  • 2.11% - redeem on 6/1/12, 6mo of 0.74%, 5mo of 4.60%, and 3mo of 0% (penalty)
  • 2.29% - redeem on 7/1/12, 6mo of 0.74%, 6mo of 4.60%, and 3mo of 0% (penalty)

The highest guaranteed rate would be an annualized return of 2.29% for about 14 months (from 4/29/11 to 7/1/12). 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.

I Bond Rates of Return for May 2011 Purchase

As I mentioned above, we won't know the I Bond fixed rate until May. However, it's very likely to remain zero percent. So the worst case composite rate will be 4.60%. If inflation stops rising in the next several months, and the November 2011 I Bond inflation component is zero percent, the rate of return is easy to calculate. It will be half of 4.60% (4.60% for 6 months and 0% for 6 months). And in that case the 3 month penalty is also zero. So the total rate of return is 2.30%. If you buy the I Bond at the end of May 2011 and redeem the I Bond at the start of May 2012, the time period is close to 11 months. Thus, the annualized rate of return becomes 2.51%. We can also estimate the annualized return for I Bond redemptions for June, July and August. The following assumes the I Bond will be purchased on May 31, 2011. As I mentioned above, this effectively reduces the 3-month penalty to 2 months.

  • 2.51% - redeem on 5/1/12, 6mo of 4.60%, 3mo of 0.00%, and 3mo of 0% (penalty)
  • 2.30% - redeem on 6/1/12, 6mo of 4.60%, 4mo of 0.00%, and 3mo of 0% (penalty)
  • 2.12% - redeem on 7/1/12, 6mo of 4.60%, 5mo of 0.00%, and 3mo of 0% (penalty)
  • 1.97% - redeem on 8/1/12, 6mo of 4.60%, 6mo of 0.00%, and 3mo of 0% (penalty)

So if you're going to wait until May, a 2.51% APY for 11 months is probably the best you can do. Each month you wait, the period of zero percent increases. Going out any further requires an estimate for the inflation component in May 2012 in addition to November 2011.

What if the I Bond inflation component in November 2011 is 2.00%? This seems like a reasonable estimate. Recalculating the above with all other assumptions the same results in the following:

  • 3.05% - redeem on 5/1/12, 6mo of 4.60%, 3mo of 2.00%, and 3mo of 0% (penalty)
  • 2.97% - redeem on 6/1/12, 6mo of 4.60%, 4mo of 2.00%, and 3mo of 0% (penalty)
  • 2.89% - redeem on 7/1/12, 6mo of 4.60%, 5mo of 2.00%, and 3mo of 0% (penalty)
  • 2.83% - redeem on 8/1/12, 6mo of 4.60%, 6mo of 2.00%, and 3mo of 0% (penalty)

So if you buy an I Bond on May 31, 2011 and you redeem that I Bond on May 1, 2012, your annualized yield for 11 months will be at least 2.51%, and it could easily be 3.05%.

Remember the $10K Annual Purchase Limit

Before you get too excited, remember that the annual purchase limit is $5K for online and $5K for paper. So if you earn 2.51% APY for 11 months on $10K, the total dollar amount of interest is about $230. For 3.05% APY it'll be about $280. As a comparison, a $10K deposit into Ally Bank's No-Penalty CD (at 1.15% APY) would return about $105. So you won't make that much more with the I Bond. Nevertheless, I Bonds have some nice features that CDs don't have such as being exempt from state and local income tax.

I Bond Features

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.



Related Posts

Comments
34 comments.
Comment #1 by Mike posted on
Mike
That rate passes most 5 year CD rates...  Thanks for taking the time to explain that so clearly. 

6
Comment #2 by Sandra posted on
Sandra
Something I don't understand in your analysis: I-bonds have to be held for at least 12 months. So if you purchase an I-bond on May 31, 2011, how can you redeem it on May 1, 2012? That's less than 12 months.

3
Comment #3 by KenBDG posted on
KenBDG
A savings bond's issue date is based on the month that it is purchased. So from the Treasury point of view, there isn't any difference between an I Bond purchased on May 1st vs one that is purchased on May 31st. That's why it's best to buy savings bonds near the end of the month and redeem them at the start of the month.

15
Comment #4 by Steve (anonymous) posted on
Steve
Thank you for this timely post and for your blog in general.  It has helped me a lot.

1
Comment #5 by Anonymous posted on
Anonymous
A well done and thorough analysis! Thanks!

2
Comment #6 by Anonymous posted on
Anonymous
can the 3 month penalty be deducted on income taxes(like the cd early withdrawl can be)?

1
Comment #7 by Anonymous posted on
Anonymous
Anonymous #6, You receive proceeds net of the 3 month penalty when you cash in your bond.  The net of penalty amount is what shows on the 1099.  Unlike a bank where you have the gross and net amount on the 1099.  It's been a couple years since I cashed in a bond early, but that is what I remember receiving.

2
Comment #8 by Anonymous posted on
Anonymous
Is it easy to redeem them? What is the process?

2
Comment #9 by Anonymous posted on
Anonymous
For paper, you can redeem at the bank.  I haven't used TD, but it should be quick, since it is web based.

3
Comment #10 by lou posted on
lou
Too bad they restict it to $10,000. At that amount it's not worth the time and energy.

4
Comment #11 by Anonymous posted on
Anonymous
will this result in a 1099-int or -div?

2
Comment #12 by Tom (anonymous) posted on
Tom
Hi, Thank you for a great article and for the information.  I found a website that lists the history of the fixed rates on i Bonds. 

My question is this:.  Do we have any clue as to how the Us treasury determines the fixed rate on i bonds? 

Inverstors that bought back in 1998-2001 have a solid 3% fixed rate and they must be very pleased.  Thank you again, Tom

1
Comment #14 by Saver posted on
Saver
I remember the days of the $60K maximum per person and the 3.0% fixed rate on I bonds.  Fortunately, I took advantage of them.  The icing on the cake was that I was able to charge my savings bond purchases to a credit card, thus raking in a lot of frequent flier miles.  Not only did I get a good rate, I had free flights to Europe for several years. 

4
Comment #15 by Anonymous posted on
Anonymous
To 8 and 9:

Using Treasury Direct is pretty easy.  I have bought and redeemed savings bonds using my account there.  It is pretty much like any online savings account.  You just buy the bonds with money from your linked bank account and when you redeem them, you can have the money moved right into your linked bank account. 

5
Comment #16 by Anonymous posted on
Anonymous
I was lucky to lock in that rate in 2000-2002 on 60k. We used CC and borrowed on 0 loan for 6 months, or earned 1% cash back, got 28 days free for payment, etc. Made one error, forgot to ask anuual Div. statement did not report each yr. will have a big tax bill when we cash out.  Ust follow his advice, he has done a difficult work for all of us.  He is right. It is almost worry free. Even wehn the int went down, we did not cash them out. We are not smart enough to take Stock Risk, we lost lot in stocks in 2000---they rip you off every which way. You can't time the market.  We have too many bubbles, they all bust one by one.  People sold stocks and bought homes, stockbrokers became realty brokers, now they are selling commodities.  Everybody is diversifying in Commodities, all the 401ks and mutual funds are buying commodities, this bubble shall burst too.  There is no bubble in Bonds, it is in Gold, Silver, Oil, Corn.  coffee, sugar, cotton, and the rest of it. You all wait and see, it shall burst...can't last forever. Poorest of the poor can't afford to buy food.  

4
Comment #17 by Anonymous posted on
Anonymous
What exactly do you look for in the CPI numbers to calculate the bond rate? Are all the bonds based on the CPI? Thanks.

2
Comment #18 by Anonymous posted on
Anonymous
To Anonymous # 11

You will receive a 1099-INT from the bank (if you redeemed it there) or the Burequ of Public Debt (if you sent the bond to WV).  US Government payments are considered interest and not dividends unlike stocks and mutual funds.  Treasury securities are treated the same like corporate and municipal bond interest payments.

2
Comment #19 by Ed (anonymous) posted on
Ed
Thanks for the informative article, I'm still trying to wrap my head around how this works.

So the rate changes every May 1 and Nov 1, but the rate applies for 6mos from *your* purchase date, which is not necessarily May-Nov or Nov-May?  Then after 6mos the new, current rate applies for the next 6 months?

Thanks in advance!

1
Comment #20 by Ed (anonymous) posted on
Ed
One other question:  Where does the current inflation rate of .74% come in?  The I bond website says the current rate is .37%?

1
Comment #21 by Anonymous posted on
Anonymous
So the rate changes every May 1 and Nov 1, but the rate applies for 6mos from *your* purchase date, which is not necessarily May-Nov or Nov-May?  Then after 6mos the new, current rate applies for the next 6 months?


That is correct. The rate announced (4.60%) applies to the first six months of bonds purchased between May and November. Bonds purchased before May would have the current (0.74%) component for six months, then the May-November component for six months.

2
Comment #22 by Anonymous posted on
Anonymous
One other question:  Where does the current inflation rate of .74% come in?  The I bond website says the current rate is .37%?

.37% is paid over six months. Annualized, that is .74%

2
Comment #23 by Saver posted on
Saver
Just to add to the response from #21.  There are two elements to the I bond interest rate - the fixed rate which remains constant for the life of the bond and the variable rate, which changes each six months, according to the rate of inflation.  The fixed rate also is determined every six months, but once you buy the bond, it will not change.  I am not sure how the fixed rate is determined, but there must be some magical formula.   It is possible for the total interest rate on an I bond to be zero as happened about two years, but, at least for now, it is not allowed to be negative, even if the rate of deflation should exceed the fixed rate on the bond.

3
Comment #24 by Anonymous posted on
Anonymous
Thanks very much! I just want to be sure of one thing: my husband and I can EACH buy $10,000 worth using our respective SSNs, correct?

2
Comment #25 by Saver posted on
Saver
# 24  -  That is correct, but you each have to buy $5K through Treasury Direct and $5K through a bank.

3
Comment #26 by Anonymous posted on
Anonymous
Is the credit card purchase option still available?

1
Comment #27 by Saver posted on
Saver
They got rid of that boondoggle years ago.  The credit card companies quickly got wise.

3
Comment #28 by Anonymous posted on
Anonymous
It appears the rate released is actually half of what the CPI-U indicated and the author estimated. Why is this?

2
Comment #29 by Raj Against The Machine (anonymous) posted on
Raj Against The Machine
As far as actually purchasing through the TD website, does it allow periodic purchases over time like a mutual fund, or do you have to "ladder" purchases like a CD?

 

Thanks, - Raj

1
Comment #30 by Anonymous posted on
Anonymous
Raj

You can set up monthly purchases but you would need to pay attention to when the interest rate changes as it might not always be worth buying more.

1
Comment #31 by Anonymous posted on
Anonymous
  I bought $24000 worth in June 2002. This is the next to last asset I will sell in retirement (after my Roth IRA). Whot a deal.  

1
Comment #32 by Anonymous posted on
Anonymous
I want to be an I bond from tressury direct. I ahve set up an account. Now i want to know if i should wait till October 2011 to buy ? Or go ahead and buy now 

2
Comment #33 by Anonymous posted on
Anonymous
I find the website unusually annoying to use (for buying I-bonds)   I appreciate security but this nonsense of trying to get into the system, and then having to use the keyboard for some info, the mouse for other, winds up being all wrong!    I am not a computer novice and I know what I am doing, but what about novices trying to negotiate, it could be too much. 

1
Comment #34 by anonymous (anonymous) posted on
anonymous
Please reconsider phasing out of paper Ibonds.    I give them as gifts and a bond gift on the webiste just is not as pleasing as a bond in hand.   Also, raise the limit per SSN...that would be nice. 

1