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April Series I Savings Bonds - A Little Better Deal Than 1-Year CDs

POSTED ON BY

The Labor Department released the March CPI-U numbers today, and with these numbers, the next I Bond inflation component can be computed. If you have been following the CPI-U numbers over the last several months, you probably know that inflation hasn’t been that high even after factoring in the high gas prices. That has caused the next I Bond inflation component that will be announced in May to be on the low side. It should be an annualized rate of 1.18%. This number is added on to the I Bond fixed rate to derive the I Bond composite rate. The current I Bond inflation component is 1.76%.

I Bond Rates of Return for April 2013 Purchase

If you buy I Bonds before May, your I Bond will have a fixed rate of 0.00% and an inflation component of 1.76%. Thus, the composite rate is the same as the inflation rate of 1.76%. This rate will remain in effect for six months until October 1, 2013. The I Bond inflation component that the Treasury announces in May will take effect for your I Bond (purchased this month) in October. That will remain in effect for six months. Since we know the May I Bond inflation component, we can compute the I Bond return for the next year for I Bonds purchased in April.

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 2012 was 231.407. The March 2013 CPI-U was 232.773. This is an increase of 0.59%. The annualized version of this is 1.18%.

If you buy before May, you'll receive the current I-Bond fixed rate of 0.00% 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 1.76%, and the composite rate is 1.76%. Here's an estimate of the return for the next year:

  • 1.76% from April 2013 through September 2013
  • 1.18% from October 2013 through March 2014

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 May. 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 30, 2013 (best not to wait to the last day), the redemption value of the I Bond on April 1, 2014 would be about 1.18% higher. For 11 months, this comes out to an annualized yield of about 1.28%.

Below is an estimated annualized return for I Bond redemption from April 1, 2014 to July 1, 2014. It is assumed you will buy the I Bond on April 30, 2013 which gives you almost an extra month of interest. This effectively reduces the 3-month penalty to 2 months.

  • 1.28% - redeem on 4/1/14, 6mo of 1.76%, 3mo of 1.18%, and 3mo of 0% (penalty)
  • 1.27% - redeem on 5/1/14, 6mo of 1.76%, 4mo of 1.18%, and 3mo of 0% (penalty)
  • 1.27% - redeem on 6/1/14, 6mo of 1.76%, 5mo of 1.18%, and 3mo of 0% (penalty)
  • 1.26% - redeem on 7/1/14, 6mo of 1.76%, 6mo of 1.18%, and 3mo of 0% (penalty)

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 at least two business days to ensure they are officially purchased before the end of the month. I did an experiment in 2011 to see how close to the end of the month one could wait (see the middle of this post).

I Bond Purchases AFTER April 2013

We won't know the I Bond fixed rate until May. However, it's very likely to remain zero percent in this interest rate environment. So the worst case composite rate will be 1.18%. If inflation continues to increase this year, the November I Bond inflation component may be over 1.18%. That could make an I Bond purchase after April a better deal.

Remember the $10K Annual Purchase Limit

Don’t forget that the annual purchase limit is $10K (excluding the purchases using your tax refund). Also, remember that the Treasury ended offering paper savings bonds at banks. However, it did double the annual purchase limit at Treasury Direct (see post).

How It Compares to Today’s CDs

So if you earn 1.27% APY for 12 months on $10K, the total dollar amount of interest is about $127. In today’s environment, you can easily get a 12-month CD with a 1.05% APY (such as at CIT Bank). If you invest $10K in this type of CD, the total interest earned would be $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 (excluding purchases using your tax refund) - 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
11 Comments.
Comment #1 by Robert (anonymous) posted on
Robert
It's my understanding that the $10K limit only applies to a single Social Security Number.  For example, I can buy $10,000 and my wife can buy another $10,000. Mine can be registered as "Husband name WITH Wife name" ownership, and my wife's can be registered as "Wife name WITH Husband name".  http://www.treasurydirect.gov/indiv/research/faq/annualpurchaselimitchangeqa.htm  So if you are married, the limit is really $20K/calendar year.

6
Comment #2 by KenBDG posted on
KenBDG
That is correct. Here's what the Treasury says about the maximum purchase:

$10,000 each calendar year for each Social Security Number. You may buy up to $10,000 in electronic I Bonds, and up to $5,000 in paper I Bonds bought with your IRS tax refund.

4
Comment #3 by KevinM posted on
KevinM
You can also buy $10K for your living trust in an entity account at TD, so the "per SSN" is not exactly correct. The statement on the TD site is misleading. This has been discussed extensively on bogleheads.org. I have purchased the limit for my personal account and entity account the last couple of years (and also purchased the max of  paper I Bonds as an individual and for my trust the year before they were discontinued).

Kevin

2
Comment #4 by Anonymous posted on
Anonymous
"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."

Mistake in the last word of that statement. I think you meant to type "May".

 

 

1
Comment #5 by KenBDG posted on
KenBDG
@anon #4, Yes, that is correct. It should be "May". I've updated the post with the fix. Thanks.

2
Comment #6 by KevinM posted on
KevinM
Ken, you had it right the first time. If you buy before the end of April, you receive interest for the full month of April. However, you won't see this intereat credited to your account on May 1 because of the 3-month EWP. You don't see any increase in your account balance until after three months. If you hold for at least five years, then you'll finally see the interest for the full month of April even if you purchased in last few days of April.

Kevin

1
Comment #7 by mikek753 posted on
mikek753
when to sale I Bond?

is current IBond has fixed rate of 0.00%, so it's only inflation component that makes sense.

what if in 1 year CD rate will be at 2%, while  inflation component will be 1% only will it make sense to sale this I-Bond right after 12 months holding?

Or what is the logic to keep for long time I-Bond with fixed rate of 0.00% ?




Would you explain in simple English? Please




Thanks.

1
Comment #8 by KevinM posted on
KevinM
I plan on keeping mine as long as it makes sense to me. If a 1-year CD is yielding 2% and inflation is 2%, it still will make sense to hold I Bonds with a fixed rate of 0%. If a 1-year CD is yielding 2% and inflation is 1%, then I might consider selling my I Bonds with fixed rate of 0%.

However, some years ago I sold some I Bonds with a pretty good fixed rate because I could get a higher return from safe, short-term investments. I haven't analyzed what would have been better since then, but given how long we've had 0% short-term interest rates, I wish I still owned those I Bonds. In other words, just because short-term real rates increase, they could go down again in the future.

Including some I Bonds in your portfolio gives you a hedge against unexpected inflation, even if the current return isn't as much as you could get from a nominal interest rate instrument. If real rates increase, you could sell your I Bonds and buy some TIPS for a higher real return, and buy more I Bonds at the higher fixed rate.

I would say just buy some now, and worry about what to do with them when real interest rates increase later. For now, you get a nominal return comparable to a short-term CD, but with the added protection against unexpected inflation. I buy the limit of I Bonds each year, but still own a bunch of CDs as part of the  fixed-income portion of my portfoio.

Hope this is not too complicated.

Kevin

2
Comment #9 by Anonymous posted on
Anonymous
So you lose 3 month interest (<5 years) based on the rate when you bought the bond, not the rate when you sell the bond ? This doesn't sound right ?

1
Comment #10 by KevinM posted on
KevinM
The 3-month interest penalty is based on the most recent 3 months of interest, so it will be based on the fixed rate at the time of purchase (currently 0%) and the inflation component for the most recent three months. So if the you sell after one year, and the inflation component for the last three months of that year is 0%, you won't lose any interest (assuming fixed rate of 0%), because there is no interest to lose. You will not lose the inflation component earned in the first three months.

Kevin

1
Comment #11 by Anonymous posted on
Anonymous
Would it be better to just buy and hold a EE Bond as well for 20 years to let it get the 1-time adjustment for doubling the face vale of the electronic EE bond? (This would beat the current longest-term CD?)

3