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
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.