- May 1 update: Treasury drops I Bond fixed rate to 0.1%
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|
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.
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%.