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

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The Labor Department released the March CPI-U numbers on Tuesday, and with these numbers, the next I Bond inflation component can be computed. Inflation as reported by the government continues to be on the low side. Thus, the next I Bond inflation component that will be announced in May won’t be anything to get excited about. Nevertheless, it will be high enough to make I Bonds a good deal as compared to 1-year CD rates. Based on September and March CPI-U numbers, the inflation component for the May I Bond should be 1.83% (annualized). 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 1.18%.

I Bond Rates of Return for April 2014 Purchase

If you buy I Bonds before May, your I Bond will have a fixed rate of 0.20% and an inflation component of 1.18%. Thus, the composite rate is the same as the inflation rate of 1.38%. This rate will remain in effect for six months until October 1, 2014. 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 2013 was 234.149. The March 2014 CPI-U was 236.293. This is an increase of 0.916%. The annualized version of this is 1.83%.

If you buy before May, you'll receive the current I-Bond fixed rate of 0.20% 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 1.18%, and the composite rate is 1.38%. Here's an estimate of the return for the next year:

  • 1.38% from April 2014 through September 2014
  • 2.03% from October 2014 through March 2015

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, 2014 (best not to wait to the last day), the redemption value of the I Bond on April 1, 2015 would be about 1.20% higher. For 11 months, this comes out to an annualized yield of about 1.31%.

Below is an estimated annualized return for I Bond redemption from April 1, 2015 to July 1, 2015. It is assumed you will buy the I Bond on April 30, 2014 which gives you almost an extra month of interest. This effectively reduces the 3-month penalty to 2 months.

  • 1.31% - redeem on 4/1/15, 6mo of 1.38%, 3mo of 2.03%, and 3mo of 0% (penalty)
  • 1.37% - redeem on 5/1/15, 6mo of 1.38%, 4mo of 2.03%, and 3mo of 0% (penalty)
  • 1.42% - redeem on 6/1/15, 6mo of 1.38%, 5mo of 2.03%, and 3mo of 0% (penalty)
  • 1.46% - redeem on 7/1/15, 6mo of 1.38%, 6mo of 2.03%, 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 2014

We won't know the I Bond fixed rate until May. I doubt we’ll see much change from its current value of 0.20%. It had been zero for years before it increased to 0.20% last November. So it’s possible it could go back down to zero which would be the worst case. Remember that this fixed rate lasts for the life of your I Bond.

If the fixed rate stays at 0.20%, the May I Bond composite rate will be 2.03%. That will be your I Bond rate for the first six months if you purchase in May. We’ll have to wait until mid October to know the inflation component for the next six months.

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 1.37% APY for 12 months on $10K, the total dollar amount of interest is about $137. 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
16 comments.
Comment #1 by Anonymous posted on
Anonymous
Need to wait for the fixed rate, which we will know soon.

3
Comment #2 by Anonymous posted on
Anonymous
Except the inflation rate is manipulated by the FEDs to always be bellow the real inflation, so you are buying into make believe I bond, not the real deal in my opinion. You can do much better elsewhere.

8
Comment #3 by Anonymous posted on
Anonymous
Your i-bond purchases are limited to $10K an year + up to $5K more on a tax return.  Considering if you live in a high state tax like California, i-bonds can be somewhat better than 100% taxable dividends.

2
Comment #4 by Anonymous posted on
Anonymous
That's true, until they mature that is.  Then the tax deferred interest has to be reported as taxable income and possibly the amount reported might even throw you in a higher income tax bracket.

3
Comment #5 by Anonymous posted on
Anonymous
Only on federal return.

7
Comment #9 by Anonymous posted on
Anonymous
I see what you mean. 

My state does not have state income taxes so I forget not all states have this tax advantage.

1
Comment #10 by Anonymous posted on
Anonymous
#3, I bond can put you in an AMT tax bracket, there is no deductibles of state and federal income of any kind, actually people in state with state income tax always get caught in AMT tax nightmare, good luck with it.

3
Comment #12 by Anonymous posted on
Anonymous
#10 You are confusing i-bonds with municipal bonds, which are definitely not the same thing.

I've never heard of i-bonds imposed with AMT.

2
Comment #16 by hoho (anonymous) posted on
hoho
Not all muni bonds are subject to AMT

3
Comment #18 by Anonymous posted on
Anonymous
#16 Right.  Only for private bonds according to the IRS.

Some idiot was spreading FUD on i-bonds.

5
Comment #47 by Anonymous posted on
Anonymous
AMT need not apply unless all I Bonds are cashed out in the same calendar year AND if your applicable AMT exclusion amount is not high enough to keep your AMT income low enough to prevent AMT. If you purchase your I bonds in smaller denominations and do not need to cash out everything in the same calendar year you can avoid bunching the taxable interest and possibly avoid the AMT. BTW, there is no such thing as an "AMT bracket" - take a look at the official IRS Form 6251 and the instructions for filing the form to properly understand the AMT formula.

2
Comment #15 by henry (anonymous) posted on
henry
"You can do much better elsewhere."

Like where?

6
Comment #6 by Anonymous posted on
Anonymous
I sold my I Bonds last December and January and bought PenFed 3% CDs.  No looking back.  I Bonds are another gov't scam.

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Comment #17 by Anonymous posted on
Anonymous
Where can I buy PenFed 3% CDs now?

4
Comment #20 by Anonymous posted on
Anonymous
Nowhere!  You can not buy them now.

4
Comment #7 by Anonymous posted on
Anonymous
Can I assume that I better wait until end of May if I decide to buy $10,000 I-Bond ? Sure nobody knows what happens in mid Oct., just an estimate ??

1
Comment #13 by Anonymous posted on
Anonymous
As someone posted earlier, we will know the fixed i-bond rate when we approach the end of this month.  When the rates are announced, you can then make a decision to buy then (i.e. April's rate) or buy later (i.e. May's rate).

2
Comment #8 by rules posted on
rules
Half my I-bonds have a base rate of 1.6% and the other half has a base rate of 3% also have ee bonds that still pay me 4%......yay!

3
Comment #54 by Anonymous posted on
Anonymous
No one knows where interest rates or inflation will be in the future!  I bonds are hedge against future inflation.  I ladder bonds and diversify bond investment by different types and rates.  So I have I-bonds (some with 5% rates), CD's with different maturity.  CD's are Roth IRA's, Traditional IRA's and different terms on normal bank CD's.  Each has pro's and con's.  If one wishes to defer income taxes, then IRA's and I'bonds work.  One size doesn't fit all and individual situations change so I say diversify.

2
Comment #14 by Anonymous posted on
Anonymous
Ken, I am confused.
(1) If you buy an I-bond in April, does the current inflation factor apply for the next six months even though a new inflation factor takes effect for I-bonds purchased in May and applies to them for six months?  Given the spread between the current (1.18%) and next (1.83%) inflation factors, doesn't this make it a no-brainer to wait until May to make any purchases?
(2) Is it true, as one commenter suggests, that we will know the new fixed component that applies to bonds purchased starting in May before the May 1 start date?

2
Comment #19 by Anonymous posted on
Anonymous
(1)  Yes.  You lock the current rate for 6-months as i-bonds change their rate biannually.  Then it will update to the last rate change.  The fixed rate changes once in May and once in November.

We don't know the fixed rate yet in May as it may go down to 0.00%.  That means the rate will be 1.83% instead of 2.03%.  The fixed rate was 0.00% for a a couple years.

(2)  Most of the time yes.  Last time we had a government shutdown which delayed the announcement of the rate change.

6
Comment #25 by Anonymous posted on
Anonymous
The part I'm still not clear about is what inflation factor will apply to the two different bonds (April vs. May) during the course of their lifetimes.  Is the April bond always going to be 6 months behind the May bond in terms of that factor, or do they both use the same inflation factor when it changes again in, say, November?  I understand that the fixed rate stays at the initial rate applicable to the bond, but will the inflation factor being applied to the April 2014 bond for, say, May-October 2016 be the same as the inflation factor applied to the May 2014 bond for May-October 2016?  If so, it would seem that the fixed component is the more important factor to consider over the life of a bond intended to be held for a lengthy period.

1
Comment #21 by Anonymous posted on
Anonymous
No brainer?  If one wants to envision cashing in the bond after 12 months...the no brainer is to buy what is known, i.e. the current rate and the most likely rate to be posted May 1.  Thus, in this situation one would buy before the end of April...get the current rate for 6 months and then have it adjusted for 6 months for the new May 1 rate and then redeem in 12 months.  Of course, one does not know what the rate will be on Nov. 1...it could be such that coupled with the new May 1 rate it is better to wait to purchase and, in effect, forgo the current opportunity being discussed...that is "my read" of this thread.  Anyone else?

5
Comment #24 by Anonymous posted on
Anonymous
Let's assume you are interested in holding for a longer period than 12 months -- say, at least 10 years or more.  If I understand correctly, if you buy in April, your inflation factor will always lag the inflation factor applicable to the May bonds by 6 months, which at least for the moment means you'll have a .65% lower return for the next six months; but who knows whether the next inflation factor adjustment in November will go up or down from 1.83%, so this advantage may not persist for the life of the bond.  On the other hand, the fixed component is .20% for bonds purchased in April, and that may go back down to 0.0% in May, and this difference in the fixed percentage persists through the entire lifetime of the bond.  So you are probably going to want to know what the new fixed component is for the May bonds before deciding whether to purchase in April or May.  Is that number publicly released in time for people to still purchase bonds in April if, say, the fixed component goes back down to 0?
Do I have this correct?

1
Comment #49 by Anonymous posted on
Anonymous
Why would anyone want to purchase an i Bond with a view to holding for 10 years in the current low interest rate environment? One would have to believe that the fixed rate component will lose its competitive appeal long before that. It seems to make more sense to buy I Bonds now as a short term proposition. Suppose the fixed component drops to zero on May. You then earn only the inflation component for the life of the bond. In the first paragraph of this blog, Ken estimated that rate to be 1.83%, applicable to the 6 months from May 1 - October 31. Suppose further, and very conservatively, that the inflation component for the next 6 months (November 1, 2014 through April 30, 2015) will be 1.00%. That gives an approximate 12 month annualized rate (with monthly compounding) of about 1.42%. Who is currently offering a CD rate that high on a CD?

1
Comment #22 by Anonymous posted on
Anonymous
I-bonds are like variable CDs, you never know what will FED do next time, therefore, I shy away from them.

4
Comment #23 by Anonymous posted on
Anonymous
But as Ken said, in effect, this is the best 12 month rate "around" and w/o State taxes...thus if one is looking for a "good" 12 month rate...this is the best deal in the town (country)!  If it is desired to retain past 12 months b/c other rates change or...then cash the bond in and take the money there!

4
Comment #38 by Anonymous posted on
Anonymous
And pay the penalties, no thanks.

1
Comment #56 by Anonymous posted on
Anonymous
The rates Ken calculated are already net of the penalties. 

1
Comment #26 by Shorebreak posted on
Shorebreak
All I bonds purchases up until the last day of April will earn a 1.38% composite rate for six months and a 2.03% composite rate for the subsequent six months.  If these bonds were redeemed after 12 months, you would suffer a penalty (applies to all redemptions within five year) equal to the last three months of interest. But, you’ll still achieve an attractive effective APY of 1.20%.  In addition to a better rate of return, Series I bonds are exempt from state taxes.

Since the fixed rate for the upcoming series of I bonds is unknown until May, and we do not know what the inflation numbers will be for the next six months, it is difficult to project the effective earnings of I bond purchases in May. However, assuming that the May 2015 fixed rate and November 2015 semi-annual inflation rate were 0%, you will receive an effective APY of at least 0.92% if the I bonds are purchased in May and redeemed after 12 months. Compared to today’s top savings rates, that rate is not too competitive.

Since interest is accrued every month regardless of when you purchased or redeemed the I bonds, it is a smart move to buy them closer to the end of the month and sell them at the beginning of the month — effectively decreasing the period of time that the money is locked in the bonds.

http://www.mybanktracker.com/news/2014/04/18/april-2014-series-savings-bonds-pay-120-apy-year/

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Comment #28 by Anonymous posted on
Anonymous
What does the 2015 rates cited have to do with actions now?  Should that be 2014?

2
Comment #29 by Shorebreak posted on
Shorebreak
Good eye. The author of the article made an error on the year. Thanks #28.

3
Comment #55 by Anonymous posted on
Anonymous
A Nov "2014" inflation rate of 0 percent in your example is not too realistic...as I recall recently it was 0 only right at the onset of the financial meltdown...AND the Fed wants some inflation since that drives people to help the economy by buying!  No one would buy anything if the inflation was zero or negative...see Japan as a recent example.

1
Comment #27 by Anonymous posted on
Anonymous
Hi, I'm from the government and here to help! I'd like you to purchase a variable rate bond based on rates we set every six months. Rates, I might add, that do not reflect your true purchasing power in any meaningful way...but that's another matter. We're going to beat (temporarily at least) your local CD rates, rates we all know are a result of the INDEPENDENT Fed funds rate set by impartial, god-fearing, liberty-loving experts who work for...the banks. Oops, I didn't meant to say that but it's in the ether so just ignore it.

One thing...you get great tax breaks from your state and local governments but we, the feds, can't afford that. So. here's your bond, here's our rate (for now) and here's your tax bill. Oh, and we're going to be hitched for the next 30 years! Are you getting that warm and fuzzy feeling?

3
Comment #34 by Anonymous posted on
Anonymous
Forget about it.  Don't even think about buying any kind of savings bonds.  As long as the FED is manipulating the interest rates, you can't win.  That's all there is to know.

5
Comment #37 by henry (anonymous) posted on
henry
What does #34 propose that is a better alternative?

4
Comment #43 by Anonymous posted on
Anonymous
A few of my benign comments were removed and I'm not sure why. In any case, I-bonds pay two rates: one fixed, the other variable based on CPI which does not measure true inflation but, rather, consumer prices based on BLS data. Since the government controls the measurement of "inflation" and they have a direct incentive to report a low number one can only assume the varying interest rate earned on i-bonds will be manipulated accordingly.
I-bonds are sold as a way to maintain pace with inflation but all they are designed to do is track CPI with a small teaser rate attached. When 10-year FDIC insured CD's can guarantee a 3.4% rate over the entire period I question the value of variable rate i-bonds, penalties notwithstanding. I do believe the day is coming when the feds will attempt to finance the debt through fixed rate bonds (aka insured CDs) sold directly to consumers via the Internet. Think of the money that would flow to Washington if a 1-year CD was floated at a measly 1.5%, available at the click of a button. At 2% the politicians would be giddy. Then, of course, they'd spend more than collected and we'd be right back on DA wondering where to put our hard-earned money.

2
Comment #44 by Anonymous posted on
Anonymous
I would never lock in a rate for 10 years

3
Comment #50 by Anonymous posted on
Anonymous
The main problem is the annual investment limitation of $20,000, coupled with the inability to invest the entire $20,000 all at once. If one has a CD for, say, $30,000 maturing now and the intention is to invest safely for 12 months, the I Bond does not work.

1
Comment #51 by Anonymous posted on
Anonymous
Spouses provide all kinds of assistance to at least raise the ante to $20K.  It is also "good" when scheduling the time to obtain your credit reports, i.e. in effect, every 2 months.  Try it you may like it.  :-)

1
Comment #53 by Anonymous posted on
Anonymous
The government tells us peasants that the inflation rate is very low. Great!  Of course......they don't count the cost of fuel,utilities,clothes,services,food and taxes. Other than that.......things are really cheap!!  Besides......who buys those things anyway!  Move along.....nothing to see here.

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