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

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

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.


Comments
scottj
scottj   |     |   Comment #1
I have not bought my 2017 yet, is it better to wait till Nov to see if there is a change in fixed rate? Will I still get that 1.96% for 6 months and then 2.48%?
LRDX
LRDX   |     |   Comment #2
No, if you wait November, then you get the new rate for 6 months, then the next (announced in May) rate for another 6 (or 3, mo plus 3 mo 0% penalty rate if you redeem at 12 months)
alan1
alan1   |     |   Comment #3
If you wait until November, you will get an inflation component of 2.48% for the first six months (plus a possible fixed rate component). The inflation component for the subsequent six months is unknown. You will not be able compute it until
April 2018.

from Treasury Direct:

Fixed rate

You know the fixed rate of interest that you will get for your bond when you buy the bond. That fixed rate does not change during the life of the bond.

Treasury announces the fixed rate for I bonds every six months (on the first business day in May and on the first business day in November). That fixed rate then applies to all I bonds issued during the next six months.

The fixed rate is an annual rate. Compounding is semiannual.

Inflation rate

Unlike the fixed rate which does not change for the life of the bond, the inflation rate can and usually does change every six months.

We set the inflation rate every six months (on the first business day of May and on the first business day of November), based on changes in the non-seasonally adjusted Consumer Price Index for all Urban Consumers (CPI-U) for all items, including food and energy.

https://www.treasurydirect.gov/indiv/research/indepth/ibonds/res_ibonds_iratesandterms.htm#rate
scottj
scottj   |     |   Comment #4
I just can't wrap my head around this :(. Is there any downside till waiting to Nov to buy? I don't plan on ever redeeming early.
Mattp
Mattp   |     |   Comment #5
Isn't fixe rate a big deal as that is for the life of the bonds. Right now it is 0%. Can we predict based on recent auction data if fixed rate will change to say 0.1%. If that is the case then better to hold off until after the new raTe is announced to buy. What am I missing. If buying end of month has advantages then wIt till Nov 30th to buy right.
LRDX
LRDX   |     |   Comment #6
If you plan to hold them long term, you probably want to wait for the small chance the fixed rate will be higher, as you don't really care about the unknown inflation rate component.

If you want to hold them as a 12-15 mo CD, you probably want to get it now, as you don't want to risk a low 2nd rate, especially that this inflation surge seems temporary due to the hurricanes (although a low May rate is not that big issue due to the 0% 3-mo-penalty)
Nothing
Nothing   |     |   Comment #7
Buy now for 6 mo. @1.96 and in 6 months get 2.48 for 6 months and then redeem at month 15. Not a bad place to park a "little" money for 15 months
LRDX
LRDX   |     |   Comment #8
I already bought in January, the last before rate was also competitive (especially that I'm in a high state-tax state, and these are exempt of that), so I jumped in immediately for this year's $10k limit.

The new higher rate just instructs me to hold them for at least additional 6 months. And I'll buy more in Jan. Unless I need the money for some emergency.
mix
mix   |     |   Comment #9
I've never considered purchasing a savings bond before but I think I'll give it a try this month. Thanks for the article.
???
???   |     |   Comment #10
You want an "eye" I bond not a saving bond right? inflation bond
Lrdx
Lrdx   |     |   Comment #11
Same difference. These are called "Series I savings bonds". You can also buy series EE savings bonds, what is next to useless nowadays (0.1% fixed interest, but gets double its initial value in year 20 - effectively 3.53% interest for 20Y, with 98%+ of interest early withdrawal penalty). There are other savings bond series, but none of them have new issues.
mix
mix   |     |   Comment #21
It literally lists Series I and Series EE under the category "Savings Bonds" on the Treasury Direct website...
Kaight
Kaight   |     |   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
scottj   |     |   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
DOA   |     |   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
scottj   |     |   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
DOA   |     |   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
DOA   |     |   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
scottj   |     |   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
DOA   |     |   Comment #19
Thanks for the input. Glad you were covered. The short term plan has a $1 million limit.
scubabelle
scubabelle   |     |   Comment #20
scottj - Glad you are feeling better now :)
lou
lou   |     |   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
xyz   |     |   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
DOA   |     |   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
xyz   |     |   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
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