April Series I Savings Bonds - Better Than CDs Due To Inflation Spike

The Bureau of Labor Statistics (BLS) released the March CPI-U numbers today, and with these numbers, the next I Bond inflation component can be computed.

Inflation as measured by the Consumer Price Index (CPI) increased 0.6% in March, which was slightly above expectations (0.5%). According to the BLS, this March 1-month increase was the largest rise since a 0.6% increase in August 2012. Core CPI (which excludes food and energy) increased 0.3% in March, also slightly above expectations (0.2%).

The year-over-year CPI gain was 2.6%, which according to CNBC, the gain was the highest since August 2018. The core CPI increased 1.6% year over year. The year-over-year surge was due to the CPI drop that occurred last March when the pandemic and the shutdowns began. Another high year-over-year rise is expected next month, but the Fed is expecting that this inflation increase will be temporary. The markets seem to agree. The 10-year Treasury yield has been falling today after the CPI data was released.

Based on September and March CPI-U numbers, the inflation component for the May I Bond should be 3.54% (annualized). This number is added on to the I Bond fixed rate (currently 0.00%) to derive the I Bond composite rate. The current I Bond inflation component is 1.68%.

Due to this higher inflation component (3.54%), I Bonds purchased this month will be a good deal as compared to top 1-year CDs. We can’t be sure if I Bonds will be a good deal as compared to long-term CDs, but based on today’s very low long-term CD rates, I Bonds will likely compare well. Higher long-term CD rates will require higher inflation. Unlike CDs, higher inflation will directly impact I Bond rates.

The main problem with I Bonds as compared with CDs is their maximum purchase limitation. An individual can only purchase a maximum of $10,000 of I Bonds at Treasury Direct each year. An additional $5,000 (paper I Bond) can be purchased using your federal income tax refund.

The I Bond fixed rate fell from 0.20% to 0.00% last May. This will likely remain at 0.00% for the foreseeable future. That makes I Bonds purchased now less attractive than they used to be, but they are still attractive when compared with today’s CD rates.

You can see how often the I Bond fixed rate was 0.00% since the 2008 Financial Crisis in this TreasuryDirect page.

I Bond Rates of Return for April 2021 Purchase

If you buy I Bonds before May, your I Bond will have a fixed rate of 0.00% and an inflation component of 1.68%. This results in a composite rate of 1.68%. This rate will remain in effect for six months until October 1, 2021. 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 CPI News Release Archive. The CPI-U for September 2020 was 260.280. The March 2021 CPI-U was 264.877. This is an increase of 1.77%. The annualized version of this is 3.54%.

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 1.68%, and the composite rate is 1.68%. Here's an estimate of the return for the next year:

• 1.68% from April 2021 through September 2021
• 3.54% from October 2021 through March 2022
• 2.61% average without redemption from April 2021 through March 2022

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, 2021 (best not to wait to the last day), the redemption value of the I Bond on April 1, 2022 would be about 1.73% higher. For 11 months, this comes out to an annualized yield of about 1.88%.

Below is an estimated annualized return for I Bond redemption from April 1, 2022 to July 1, 2022. It is assumed you will buy the I Bond on April 30, 2021 which gives you almost an extra month of interest. This effectively reduces the 3-month penalty to 2 months.

• 1.88% - redeem on 4/1/22, 6mo of 1.68%, 3mo of 3.54%, and 3mo of 0% (penalty)
• 2.02% - redeem on 5/1/22, 6mo of 1.68%, 4mo of 3.54%, and 3mo of 0% (penalty)
• 2.14% - redeem on 6/1/22, 6mo of 1.68%, 5mo of 3.54%, and 3mo of 0% (penalty)
• 2.24% - redeem on 7/1/22, 6mo of 1.68%, 6mo of 3.54%, 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 2021

We won't know the I Bond fixed rate until May. I think the odds are very high that it will remain at 0.00%. If the fixed rate is 0.00%, the composite rate for an I Bond purchased in May will be 3.54%. You’ll get six months of 3.54% followed by six months of an unknown rate that won’t be known until mid October. The lowest it could be is zero. That would give a 12-month average rate of 1.77%, assuming there’s no redemption.

Compared to CD Rates

As you can see, the above rates are much higher than the top 1-year CD rates that are nationally available (currently 0.80% APY).

I Bonds have several favorable tax features as compared to CDs. First, interest from I Bonds is exempt from state income tax. I Bond interest isn’t exempt from federal tax, but you can defer federal income tax on I Bonds until you redeem them or until they reach their 30-year maturity. For CDs, you owe taxes each year even for long-term CDs.

As I mentioned above, the main problem with I Bonds as compared with CDs is their maximum purchase limitation. An individual can only purchase a maximum of $10,000 of I Bonds at Treasury Direct each year. An additional $5,000 (paper I Bond) can be purchased using your federal income tax refund.

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 May, 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 0.00%, 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 1.40%.

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.

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.