Savings Bond holders: Your I Bond interest rate could drop to 0.0% on May 1

I Bonds

We are supposed to be in a year of rising interest rates, but so far that hasn’t been true. And holders of I Savings Bonds could be in for a bit of of a ‘shock’ on May 1, when the inflation-adjusted interest rate is re-set for all I Bonds.

With two months left to go, inflation data are pointing to a negative number for the inflation-adjusted interest rate on I Bonds. That could change once the February and March data are in, of course, but right right now we are looking at a -0.1% inflation-adjusted rate.

I Bonds pay a combination of two interest rates:

  • The fixed rate, currently 0.2% for as long as you hold the bond, up to 30 years – will never change. So if you bought an I Bond in 2013 with a zero fixed rate, it will continue to have a zero fixed rate. Purchases through April 30, 2014, will have a fixed rate of 0.20%. I Bonds I bought back in 2000 still carry a fixed rate of 3.4% and will continue to do so through 2030.
  • The inflation-adjusted rate changes each six months to reflect the running rate of inflation. That rate is currently set at 1.18% annualized. It will adjust again on May 1, 2014, for all I Bonds, no matter when they were purchased.

To understand how that inflation-adjusted rate is set, take a look at the last adjustment, on Nov. 1. To set the rate for November through April, the Treasury looks at the CPI-U inflation index from the end of March to the end of September. Here is the formula:

End of September 234.149 / End of March 232.773 = 1.0059, or .59%, the current six-month rate, which translates into an annual rate of 1.18%.

The Treasury uses the non-seasonally adjusted CPI-U, and that has been trending negative since the end of September.

End of Month Inflation index Monthly non- adjusted inflation
Sept. 2013 234.149 0.12%
Oct. 2013 233.546 -0.26%
Nov. 2013 233.069 -0.20%
Dec. 2013 233.049 -0.01%
Jan. 2014 233.916 0.37%
Feb. 2014 ?? ??
Mar. 2014 ?? ??

If the Treasury were setting the I Bond inflation-adjusted rate today, it would use this formula:

End of January 233.916 / End of September 234.149  = .999, or -0.1%.

Will the rate end up negative after the full six months? I would guess not, since higher heating fuel costs are likely to give February and March numbers a little boost. That is what happened in January with the .37% non-seasonally adjusted rate of inflation.

What happens if the rate goes negative?

An I Bond can never pay less than 0.0% interest and the accrued principal balance will never go down. (This is an advantage I Bonds have over TIPS in deflationary times. The principal balance of a TIPS does go down, but never below the original purchase.)

If the I Bond inflation-adjustment is set below zero, it is subtracted from the base fixed rate to determine the net interest of those six months. That number cannot go below zero.

For an I Bond purchased in 2014 and paying a base rate of 0.2%, an inflation-adjusted rate of -0.1% would result in a combined rate of 0.1% for six months. For I Bonds with a zero base rate, the combined rate would be 0.0% for six months.

The I Bond inflation-adjusted rate has gone negative only once, from May to November 2009, when it was set at a whopping -2.78%. During those six months, unless you bought your I Bonds before October 2001, you were earning zero interest.

Check out historical I Bond fixed rates and inflation-adjusted rates.

Should you dump I Bonds paying 0.0%?

If your strategy is to buy I Bonds up to the limit each year _ $10,000 per person at Treasury Direct and up to $5,000 in paper I Bonds as a tax refund – I would definitely urge you to ride out the six months at zero interest. Because of the purchase limits, you need to hold I Bonds until you need the cash.

Other folks who stay below the purchase limit could sell their I Bonds with a zero base rate and purchase again after Nov. 1, when the inflation-adjusted rate will be re-set, probably higher. The risk is whether the Treasury will continue the 0.2% base rate, which it set in November 2013 after three years at 0.0%.

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6 Responses to Savings Bond holders: Your I Bond interest rate could drop to 0.0% on May 1

  1. Ed says:

    Something to consider … Very low interest rates have been a coexister with perception of economy in serious trouble. Lately is espoused ‘things are getting better”! Lowering the I-bond rate would impress oppositely! And be the latest change for the next 6 mo.!!!

  2. tipswatch says:

    Ed, I would say low interest rates are controlled by the Federal Reserve, and that’s about it. Low inflation is harder to figure. There are possibly lots of reasons, and low interest rates are one of them. It means savers are earning practically nothing on their money. That certainly doesn’t encourage spending.

    Also, young people go to college, building large debt to do so. When they graduate, the jobs aren’t there and they must pay back the debt. There is little money left over to spend. They aren’t buying houses, or new cars, even if they have jobs.

    People who have jobs get 1.5% annual increases in pay, but not a lot more.

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  4. Mel says:

    Well let’s look at the menu. Bank CD 5 years 2% (fully taxable)
    T Note 5 years 1.5% (no state tax)
    TIPS 5 years – .25% (no state tax)
    I Bond 5 years .2% (no state tax)

    Given that the stated goal of the Federal Reserve is 2% inflation, doesn’t seem like much of a decision really. Can’t do anything with the 5,000 in paper bonds because you can’t repurchase those. I’m just inclined to sit tight myself.
    Granted that unemployment is still quite high, I often wonder if those people who quietly accept a cost of living adjustment from their employer equal to the inflation rate slept through high school math class. Federal tax of 25%, state tax of 4%, Social Security tax of 6.2%. End up with roughly 2/3 of the rise in the cost of living- look I’m making less than I did last year.

  5. Jimbo says:

    After reviewing the paltry yields on TIPS and iBonds last year, I started wondering why I was even bothering with them. One look at the current CD rates refreshed my memory. Here’s some of the best rates from DepositAccounts.com:

    1 Year CD = 1.16%
    3 Year CD = 1.61%
    5 Year CD = 2.12%

    The 1 year CD rate pretty much matches the current iBond rate of 1.18%.
    The 3 year CD rate is close to the trailing 12 month TIPS inflation rate of 1.6%.
    The 5 year CD beats both iBonds and a 5 TIPS by about 1%.

    When you consider the inflation protection, both iBonds and TIPS are still an OK place to park some money. I’ll probably pop for 10K of iBonds now and wait and see how things play-out this year before purchasing the other 10K.

    To get the equivalent yield of a 5 year CD in TIPS you have to go out to 2025. That’s 11 years!
    With the 10 year Treasuries sinking like a rock this week and TIPS yields with them, I haven’t been very motivated to buy more.

    In fact, I’ve sold a few this year. Due to the timing of my purchases, the inflation factor took a dive on several of the bonds that I bought making them go negative in book value. However, due to the interest rates taking a dive, the market value on them went up 6% to 10% (annualized).

    If the interest rates keep going down and I can realize further outsized gains, I’ll probably sell more. It will probably be a lot harder to rationalize selling TIPS that are increasing in book value now that the inflation factor will be on the rise again.

    Overall, I’ve been meeting my goal of at least breaking even with inflation. However, it isn’t as easy as it used to be. Back in the good old days a three-month CD would do the trick. Now you have to go out 3 years.

    Last year, I was worried that purchasing TIPS too quickly would increase my exposure to interest rate risk. That’s when the 10 year Treasuries briefly topped 3%. Today it was down to 2.66%! Like you said at the outset of your article, 2014 was supposed to be a year of rising rates.

    What a wacky world we live in…

    Jimbo

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