October Series I Savings Bonds Offer Better Returns Than 1-Year CDs

POSTED ON THURSDAY, OCTOBER 15, 2020 BY Ken Tumin

The Labor Department released the September Consumer Price Index (CPI) numbers on Tuesday, and with these numbers, the next Series I Savings Bond inflation component can be computed. This allows us to calculate the earnings for I Bonds purchased this month and redeemed from October 2021 to January 2022.

I Bonds purchased this October compare very favorably to the best 1-year CDs.

Even though I Bonds compare favorably to CDs, their value is limited by the low I Bond purchase limits. Maximum purchases per year and per social security number is $10,000 at TreasuryDirect and $5,000 in paper bonds purchased with IRS tax refunds.

Tuesday’s report showed that the CPI-U increased by 0.84% in the last six months (an annualized rate of 1.68%.) The 1.68% rate should be the I Bond inflation component that will be announced at the start of November. If an I Bond is purchased in October, you’ll get the current rate of 1.06% for six months before the 1.68% takes effect.

Overall, inflation remains low. In the last year, CPI increased 1.4%, and Core CPI (which excludes food and energy) increased 1.7%. Inflation fell when the pandemic first began in March. The CPI numbers for March, April and May were -0.4%, -0.8% and -0.1% respectively. Inflation then rebounded in the summer with large increases. The CPI numbers for June, July and August were 0.6%, 0.6% and 0.4% respectively. The September CPI number shows that inflation has settled down. Inflation is expected to remain low for some time until the economy experiences a strong and sustained recovery. According to the Fed’s latest economic projections, PCE inflation is forecast to remain under its 2% target through 2022.

Social Security Benefits Will Rise 1.3% in 2021

The September CPI report is used by the Social Security Administration to determine the cost of living adjustment for next year. Low inflation over the last year did impact the Social Security cost-of-living adjustment (COLA) for 2021. According to the new Social Security Fact Sheet:

Based on the increase in the Consumer Price Index (CPI-W) from the third quarter of 2019 through the third quarter of 2020, Social Security and Supplemental Security Income (SSI) beneficiaries will receive a 1.3 percent COLA for 2021.

Last year, the adjustment was 1.6%, and two years ago, it was 2.8%.. You can see the full history of Social Security COLAs here.

November I Bond Inflation Rate Should be 1.68%

I’ve done the calculations based on these latest CPI numbers, and the I Bond inflation component taking effect in November should be 1.68%. The I Bond inflation component is added on to the I Bond fixed rate to derive the I Bond composite rate. The fixed rate is currently 0%. We won’t know the November fixed rate until Monday, November 2nd.

If you buy I Bonds before the end of October, you can know the rate of return you'll receive if you redeem the I Bonds between October 2021 and January 2022. The interest rate for the first 6 months will be based on the current inflation component (1.06%). The next 6 months will be based on this new rate (1.68%). After that, it'll depend on future inflation numbers. The current fixed rate component of 0% will stay the same for the life of the bond. Below are the details of calculating the expected rate of return.

I Bond Rates of Return for October 2020 Purchase

From Treasury Direct I Savings Bonds FAQs:

the inflation rate announced in November is the change between the CPI-U figures from the preceding March and September.

All previous CPI-U numbers are available from this government webpage. The CPI-U for March 2020 was 258.115. Based on Tuesday’s release, September 2020 CPI-U was 260.280. This is an increase of 0.84%. The annualized version of this is 1.68%.

If you buy before November, 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 1.06%, and the composite rate is 1.06%. Here's an estimate of the return for the next year:

1.06% from October 2020 through March 2021
1.68% from April 2021 through September 2021

I Bonds increase in value on the first day of the month. So on November 1st, you'll earn the interest for the full month of October. 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 October 30, 2020, the value of the I Bond on October 1, 2021 would be about 0.95% higher. For 11 months, this comes out to an annualized yield of about 1.04%.

Below is an estimated annualized return for I Bond redemptions from October 1, 2021 to January 1, 2022. It is assumed you will buy the I Bond at the end of October 2020 which gives you almost an extra month of interest. This effectively reduces the 3-month penalty to 2 months.

1.04% (11mo) redeem on 10/1/21, 6mo of 1.06%, 3mo of 1.68%, and 3mo of 0% (penalty)
1.09% (12mo) redeem on 11/1/21, 6mo of 1.06%, 4mo of 1.68%, and 3mo of 0% (penalty)
1.14% (13mo) redeem on 12/1/21, 6mo of 1.06%, 5mo of 1.68%, and 3mo of 0% (penalty)
1.18% (14mo) redeem on 01/1/22, 6mo of 1.06%, 6mo of 1.68%, and 3mo of 0% (penalty)

The highest guaranteed rate would be an annualized return of 1.18% for about 14 months. Note, it's best not to wait until the last day of the month to buy I Bonds at Treasury Direct. In 2011 I described my experiment in seeing how late in the month I could buy an I Bond. I found you should make sure the purchase is no later than the second to last business day of the month.

If you decide not to redeem your I Bond in 2021 or 2022, you won’t lose the 3-month penalty. Thus, the annualized return after 12 months would be approximately 1.37% (the average of 1.06% and 1.68%). We’ll have to wait for the future I Bond inflation rates to calculate returns for anything later.

Compared to CD Rates

As you can see, the above rates are a little higher than the top 1-year CD rates that are nationally available (currently 1.05% APY). Since interest from I Bonds is exempt from state income tax, the advantage of I Bonds is even higher in states that have state income tax.

Unfortunately, an exact comparison between I Bonds and long-term CDs is not possible. The reason is that the I Bond inflation rate changes every six months. For this short period of time from now to before November, we know the I Bond inflation rate for 12 months. We can only guess about the I Bond inflation rate after that. The best we can do is to make an estimate of the future inflation rates.

One way to estimate future inflation rates is to use the historical average. In 2014 I calculated the average I Bond inflation rate since the I Bond program began in September 1998. That average was 2.57%. This takes into account the period in 2009 when the I Bond inflation rate was negative. Since the composite rate can never be negative, I used zero for this period in calculating the average.

The recent history of inflation has a much lower average. I calculated the average I Bond inflation rate since 2014, and the average was only 1.64%.

If the I Bond inflation rate averages 1.64% over the next 5 years and you add that to the current fixed rate of 0%, an I Bond purchased today may have a 5-year average rate close to 1.64%.

Currently, the top nationally-available 5-year CDs have yields of only 1.50%.

Deciding to Sell or Keep Older I Bonds

If you have older I Bonds, you probably have I Bond fixed rates much higher than 0%, and if you're fortunate enough to have purchased I Bonds before 2001, you probably have fixed rates over 3.00%. So those I Bonds are especially good deals in today's environment.

Remember the $10,000 Annual Purchase Limit

Don’t forget that the annual purchase limit is $10,000 (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).

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 the 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. An additional $5,000 (paper I Bond) can be purchased using your federal income tax refund. (Total was $60,000 before 2008. The change was announced on December 2007.)

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

CuriousDave | Oct 20, 2020 | Comment #7

The penalty of loss of three months of interest on redemption of Series I bonds can be significantly mitigated because of the strange way the Treasury computes monthly interest. Regardless of the day of the month on which the bonds are either purchased or redeemed, interest is credited for the full month. A bond purchased on October 21st will earn the same amount of interest for all of October as a bond purchased on October 1st. Similarly, a bond redeemed on November 1st will earn the same full month of interest as a bond redeemed on November 30th. So, depending on actual date of purchase and redemption, it may be possible to reduce the 3 month penalty down to as little as a month and change. For those who do not wish to hold these bonds for longer than a year or so, with careful timing most of the loss of interest because of early redemption after a relatively short term may be avoided.

GreenDream | Oct 20, 2020 | Comment #8

"avoided" is the wrong word. You aren't avoiding it, you are still losing out on 3 months worth of interest. What you are doing is mitigating it. Since you didn't hold the money in the bonds for the majority of two of the months you held the bond, the loss is less painful (you can use that money for other things during that nearly two months worth of time) but it's still a loss of money you'd otherwise have accrued had you not cashed in early.

And BTW, it's only a month's worth that you can "knock off" the penalty, not two months as the payments on the 1st are always for the prior month. Basically you can only get one month's "free" interest, by buying in at the end of the month. Cashing out on the beginning of the final month doesn't get you anything other than what you already are due, but not waiting until the beginning of the month (or alternately holding beyond the beginning) when you cash out is you tossing away interest that you are otherwise already due, this is true whether you are cashing out early or holding for the long term.

CuriousDave | Oct 21, 2020 | Comment #9

Last year I redeemed some I Bonds after holding them for only 38 months. Although I did lose 3 months of interest, the accumulated interest included in the redemption proceeds, after subtracting the penalty, was more than I had computed by well over a month's worth, so I contacted the Treasury for an explanation. Here is the emailed response from Treasury Services:
"Bond earnings are added the first day of the month and includes interest for the current month. We calculate for each month not each day. It does not matter what day the bond was purchased to receive the interest. When you choose to redeem your I bonds you will receive the interest earned the 1st day of the month. In your example if you redeem a bond on October 1st you will receive the same interest if you redeemed October 2nd or even October 31st. Please be aware with I bonds you must hold the bond for 5 years to avoid any interest penalty for redeeming early." Thanks Treasury Services
Therefore, I am standing by my original comment. Btw, the first line of my comment was "The penalty of loss of three months of interest on redemption of Series I bonds can be significantly mitigated".

GreenDream | Oct 22, 2020 | Comment #10

And you ended it with "with careful timing most of the loss of interest because of early redemption after a relatively short term may be avoided". See that last word: avoided. That, as I pointed out is incorrect. You aren't avoiding anything, you are merely mitigating the loss not avoiding it. So while you started out correct with "mitigated:, you ended wrongly with "avoided".

GreenDream | Oct 22, 2020 | Comment #11

And BTW, just because you miscalculated the interest, doesn't make what you stated correct, it jut means you miscalculated the interest through your own misunderstanding about how it's calculated. But this is like arguing when the new decade starts on the 0 or the 1 year. No one ever convinces the other of their point.

The bottom line, as I see it, is that you can only avoid (used properly) a months worth of days for which no interest will be credited (due to interest for that month only being applied on the 1st) by buying at the end of the month, which in turn mitigates from the 3 month penalty. Whether you sell at the beginning or the end of the months makes no difference as you are getting that months interest regardless, so it mitigates nothing in regards to the interest penalty, but it does give you extra time to use that money outside of the bond for other stuff, which is a good thing but is a separate issue to the penalty.

Comments

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11 Comments.

Choice | Oct 16, 2020 | Comment #1

Thanks,Ken...Wow, did I miss this and I was not using the right months...shame on me! I think 1.06 for six months and then 1.68 for 6 months is not bad for a one year CD. I'm also inclined to look at April next year and see what the projected inflation rate is for the May 1 time period forward for six months.

calwatch | Oct 16, 2020 | Comment #2

I do think that on January 30 I will be making my annual $10,000 purchase.

JeffinEasternFL | Oct 16, 2020 | Comment #3

I miss the "paper" $30K and Treas Direct $30K EACH annual limits, ...I stocked up on BOTH early last decade (several $30K a year and several $60K years of buying), they will mature at/near $1M~ in guaranteed value! I certainly will hold 'em 30 years for sure! Too bad limit's just $10K now....even with a "0" fixed rate, they are attractive for "not so liquid" no risk monies!

buckeye61 | Oct 16, 2020 | Comment #4

With CD and Savings account rates stuck in a perpetual low rate cycle this has become an option that's looking more compelling. Obviously, it's more beneficial to higher earners in State's with high income tax rates, but with big online banks like Barclays offering a robust 0.30% for CD's from 12-60 months it's worth a closer look.

Choice | Oct 17, 2020 | Comment #5

Went all in for 2020 purchases today merely a parking lot for idle funds..we’ll see what happens in April...The Fed is the one spending...what is your point...our little amount will change the world axis? Really? ...more on the point where are you parking idle funds.

P_D | Oct 17, 2020 | Comment #6

$ Cap is too low to be of any interest to me.

With the way Washington spends my money like a drunken sailor, it's hard to understand why they wouldn't want me to also finance them for even more out of control spending. But so be it.