Inflation News: October I Bonds Will Return More than Top 1-Year CDs

POSTED ON MONDAY, OCTOBER 16, 2017 BY Ken Tumin

The Labor Department released the September Consumer Price Index (CPI) numbers on Friday, 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 2018 to January 2019. Sometimes I Bonds compare favorably to 1-year CDs, and that is the case this time. The rise in gas prices after the hurricanes caused the CPI to surge. Friday’s report showed that the CPI-U increased by 1.24% in the last six months (an annualized rate of 2.48%.) The 2.48% 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 1.96% for six months before the 2.48% takes effect. The result is a good deal when compared with current 12-month CD rates. I’ll explain the details below. But don’t forget 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.

Before I review the details of my I Bond rate calculations, Friday’s inflation report is also important for other reasons. It’s used by the Social Security Administration to determine the cost of living adjustment in 2018. Also, inflation is a major factor in the Fed’s decision on rates.

Social Security Benefits Will Rise 2.0% in 2018.

The recent hurricane-induced surge in inflation gave a boost to the Social Security cost-of-living adjustment (COLA) for 2018. According to ssa.gov, “Monthly Social Security and Supplemental Security Income (SSI) benefits for more than 66 million Americans will increase 2.0 percent in 2018.” That’s the highest level since 2012. Last year, the adjustment was only 0.3% and in 2016, it was 0%.

Impact on the Fed’s Rate Decision

The Fed cares more about core CPI which excludes volatile food and energy prices. Core CPI increased only 0.1% in September. Over the last 12 months, core CPI increased 1.7%. The Fed’s main focus is on the personal consumption expenditures (PCE) price index excluding food and energy. The Fed’s target for the PCE is 2%. Since the Fed began increasing rates, the PCE has fallen from just under 2% to 1.3%. So the latest inflation data probably won’t have much impact on the Fed.

November I Bond Inflation Rate Should be 2.48%

I’ve done the calculations based on these latest CPI numbers, and the I Bond inflation component taking effect in November should be 2.48%. 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%, and it probably won’t change much if at all in November. We won’t know the November fixed rate until Wednesday, November 1st.

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 2018 and January 2019. The interest rate for the first 6 months will be based on the current inflation component (1.96%). The next 6 months will be based on this new rate (2.48%). 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 2017 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 2017 was 243.801. Based on Friday’s release, September 2017 CPI-U was 246.819. This is an increase of 1.24%. The annualized version of this is 2.48%.

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 1.96%, and the composite rate is 1.96%. Here's an estimate of the return for the next year:

1.96% from October 2017 through March 2018
2.48% from April 2018 through September 2018

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 31, 2017, the value of the I Bond on October 1, 2018 would be about 1.60% higher. For 11 months, this comes out to an annualized yield of about 1.75%.

Below is an estimated annualized return for I Bond redemptions from October 1, 2018 to January 1, 2019. It is assumed you will buy the I Bond at the end of October 2017 which gives you almost an extra month of interest. This effectively reduces the 3-month penalty to 2 months.

1.75% (11mo) redeem on 10/1/18, 6mo of 1.96%, 3mo of 2.48%, and 3mo of 0% (penalty)
1.81% (12mo) redeem on 11/1/18, 6mo of 1.96%, 4mo of 2.48%, and 3mo of 0% (penalty)
1.86% (13mo) redeem on 12/1/18, 6mo of 1.96%, 5mo of 2.48%, and 3mo of 0% (penalty)
1.90% (14mo) redeem on 01/1/19, 6mo of 1.96%, 6mo of 2.48%, and 3mo of 0% (penalty)

The highest guaranteed rate would be an annualized return of 1.90% 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.

Compared to CD Rates

As you can see, the above rates are just above the best 1-year CD rates that are nationally available. If you have to worry about state income tax, the I Bond becomes even a better deal since I Bonds are exempt from 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.

If the I Bond inflation rate average 2.57% over the next 5 years, an I Bond purchased today will compare favorably to 5-year CDs purchased today. The best 5-year CD rate that’s nationally available is currently 2.60% APY at Mountain America Credit Union.

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 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.

Kaight | Oct 17, 2017 | Comment #12

For anyone living in NY, or in CA, or in IL, these things are a no-brainer, even with the low dollar limits.

For folks in TX, FL, WA and a couple other states . . . . not so much.

scottj | Oct 17, 2017 | Comment #13

I'm just trying to use as many ways as possible to put money in things that don't report as yearly income. This way i can look poor and maximize my tax credits to help pay for health insurance, getting $580 a month now.

DOA | Oct 17, 2017 | Comment #14

Good idea. Do not forget about using deductible IRA contributions, deductible 401K contributions, and deductible Health Savings Account contributions to help reduce the income counted against getting the credits and subsidies. Take advantage of this is as long as you can because it looks like that gravy train is not going to last much longer.

scottj | Oct 17, 2017 | Comment #15

I retired 8 years ago at 48 so have no W2 income so can't do IRA and other things. Trump stopping subsidies only effects people who make more, us poor folks will continue to get our tax credits

DOA | Oct 17, 2017 | Comment #16

I hear you. I am in about the same ballpark as you. Fortunately, I will be on medicare next year in March 2018. Even for some of us poor folks that just make slightly over the qualifed income limit to receive the credits/subsidies still had much better and more affordable health insurance than what we ended up with Obamacare. Probably a point of no return or many years down the road.

DOA | Oct 17, 2017 | Comment #17

Scottj, just wonder what your opinion is on short term/catastrophic health insurance. I could cancel my expensive individual ACA qualified heath insurance and get 3 months less expensive short term health insurance (United Healthcare) starting this year on December and then go in Medicare March 2018. If I keep my individual insurance, I have two high deductibles to meet for the end of this year and then the next deductible will start over again beginning next year. If I get the short term plan, only one deductible to meet until I get on Medicare.

scottj | Oct 17, 2017 | Comment #18

For just 3 months I would stay on better insurance, I hate surprises and would want good coverage. I'm lucky that I live in MA, besides tax credits I get a plan that is subsidized by MA. I use to pay almost $2k a month for family plan that wasnt even that good. I now pay a little over $500 a month and is a great plan with zero deductibles which is great because I got very sick this summer and spent 72 days in ICU. Have almost $2.5 million in insurance claims and my total out of pocket has been $250 co payment for hospital. And to think was against Obama and Obamacare :)

DOA | Oct 17, 2017 | Comment #19

Thanks for the input. Glad you were covered. The short term plan has a $1 million limit.

scubabelle | Oct 18, 2017 | Comment #20

scottj - Glad you are feeling better now :)

lou | Oct 21, 2017 | Comment #23

Yikes, if I remember you're a relatively young guy. I hadn't seen you post for a long time, but never thought it was because you were sick. What happened to you that caused you to spend 72 days in ICU. Of course, you don't have to say but am curious what put you in the hospital for such a long time.

xyz | Oct 20, 2017 | Comment #22

DOA #17
Dont forget to think about Supplemental Insurance that covers the 20% fees not paid by Medicare if you think you might have expensive health problems down the road.
You have a short window of time at age 65 when you can get this coverage w/out having to go through denials because of pre-existing health conditions
Policies run about 2K plus per year.
Medicare Advantage plans may seem the better deal but they ARE RUN by the insurance companies.We've seen what 's going on with them.
I stick with the Government Medicare and just use a supplemental insurance company for the back-up payments

DOA | Oct 21, 2017 | Comment #24

I appreciate your input on this. I agree. Medicare Advantage Plans seem to work too much like Obamacare. So after being in Obamacare for 7 years, I am looking forward to getting better and less expensive health insurance and I will definitely be going the Medicare/Medigap/Part D route.

So what plan do you recommend on medigap? I want to get Plan F medigap, but it will not be offered anymore starting in year 2020. So I am wondering because of that issue, it might be a mistake to enroll in Plan F being concerned that the premiums might start to get out of hand when Plan F is no longer offered?

xyz | Oct 21, 2017 | Comment #25

Plan G ? Do the homework.
Check which plans are offered in your State/ County. All plans will go up, including Part B Medicare

Nothing | Oct 21, 2017 | Comment #26

I like my hmo...never a problem with doctor leaving. Also, with what I save I can go outside the plan, pay for tests and take to hmo and say, “see I told u I had this issue, now fix it!”

New topic...anyone watching what may happen to taxes next year and thinking to take more from ira this year b/c tax rates this year may be lower?

Bogie | Oct 21, 2017 | Comment #27

Some healthcare providers will not accept test results from other healthcare providers outside of their own network. But when it comes to monitoring your own health, it's still worth every dollar spent.

Nothing | Oct 21, 2017 | Comment #28

Bogie, not a question of hmo "accepting" the outside test...the test cannot be ignored since it puts "them" on notice "of something," and, yes, the hmo will do its own tests