- May 1 update: Treasury drops I Bond fixed rate to 0.1%
Four days into November, and I am still amazed that the U.S. Treasury added a 0.2% fixed base rate to its Savings I Bonds purchased from Nov. 1, 2013 to April 30, 2014. OK, it is true that 0.2% is going to earn you very little interest ($20 a year on a $10,000 investment, growing with inflation). But it was basically a gift from the Treasury, because it keeps I Bonds the super-hero of super safe investments.
The way I Bonds work. An I Bond is a security that earns interest based on combining a fixed rate and an inflation rate.
The fixed rate – now 0.2% for as long as you hold the bond, up to 30 years – will never change. So if you bought an I Bond earlier this year 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. (Although the effective start date of the new interest rate can vary depending on the month you bought the I Bond, a Treasury oddity.)
Why they are a great investment.
- First, I Bonds are the most conservative and most safe of all investments. Your principal is 99.9999999% safe and it will never decline, ever. If inflation falls to below zero, the inflation-adjusted rate will fall to zero, but not below zero. This is not true of TIPS, where accrued principal declines when deflation strikes. This means I Bonds are a superior investment to TIPS in times of deflation.
- I Bonds allow you fantastic flexibility. You can redeem them after one year, costing you three months of interest. Or redeem them after five years and pay no penalty, or just hold them for 30 years and cash out.
- I Bonds protect you against unexpected inflation. If inflation in the next 30 years suddenly soars to 7%, 10%, 15%, your principal will increase by that amount because of the inflation-adjusted interest rate.
- I Bonds allow you to defer federal income taxes until you redeem them, so you pay zero in taxes until they are sold. This is a big advantage over TIPS, which carry current-year income taxes for both the coupon rate and the inflation adjustment to principal. (Both TIPS and I Bonds are free of state income taxes, an advantage over bank CDs.)
- I Bonds are very simple to track as an investment. Just download the Savings Bond Wizard, update your information, and check it a couple times a year. This is another huge advantage over TIPS held at TreasuryDirect, which is a do-it-yourself proposition, even for downloading yearly tax forms. Want to track current value of your TIPS? Open up Excel and get to work. TreasuryDirect is not going to tell you.
So with all these I Bond advantages, how do they compare with other super-safe investments? I contend that that tax advantages alone make an I Bond paying a fixed rate of 0.2, plus inflation, preferable to all super-safe investments through 10-year maturities.
|I Bond||Treasury||TIPS||Bank CD|
|1 year||Inflation plus 0.2%*||0.09%||Inflation minus 1.16%||1.00%|
|5 years||Inflation plus 0.2%||1.35%||Inflation minus 0.59%||1.95%|
|10 years||Inflation plus 0.2%||2.59%||Inflation plus 0.45%||NA|
|30 years||Inflation plus 0.2%||3.68%||Inflation plus 1.35%||NA|
|* 3-month interest penalty|
The 10-year TIPS pays 0.45% plus inflation, only 25 basis points better than the I Bond. But if held in a taxable account, you’d owe taxes every year on both interest and the principal adjustment. Compare TIPS and I Bonds.
Conclusion. I Bonds outshine other super-safe investments in the short term, and their tax advantages make them attractive to hold for the long term. Because you can buy only $10,000 a year per person (plus your income tax refund, if you wish), I say continue to buy them to the max each year and sell them only if you need cash.
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Ed, any adjustment to CPI-U would affect both TIPS and I Bonds, since both use the same index. I’d say the likelihood of default on either is very, very small, but probably smaller for I Bonds since they are a ‘little guy’ investment. If the Treasury decides to default on Savings Bonds, the world as we know it will be ending.
Here is a ‘relative ugliness’ thought favoring I-bonds over TIPS. Suppose the UST chooses to default on its debt (including perhaps fooling with the CPI-U). Because of the maximum number of directly affected voters per dollar of debt, I reckon that savings bond holders are least likely to be shafted.