I Bond scenarios: Counting down to May 1, 2014

If you haven’t bought US Savings I Bonds up to the limit in 2014, you face an interesting decision: Buy right now, or wait until May 1, when the Treasury will reset the variable interest rate for all I Bonds and determine the fixed rate for bonds sold between May 1 and Oct. 31.

I Bonds pay a combination of two interest rates:

1. The inflation-adjusted rate, also called the variable 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. The starting date of the new interest rate depends on the month you bough the I Bond. Learn more here.

The Treasury uses the non-seasonally adjusted Consumer Price Index (CPI-U) to set this variable rate. The March inflation number was the last piece of data we needed to know the next variable rate. The inflation index at the end of March was 236.293, a 0.9156% increase over the 234.149 recorded at the end of September 2013. This will mean the new I Bond inflation-adjusted rate will go to an annual rate of 1.83% (or possibly 1.84%, depending on how the Treasury rounds the numbers) for six months beginning May 1.

2. The fixed rate, currently 0.2% for as long as you hold the I 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, have a fixed rate of 0.20%.

The Treasury will re-set the fixed rate on May 1 and there is no way to know for sure what it will be, except it won’t be less than 0.0%. When the Treasury set the 0.2% fixed rate on Nov. 1, 2013, it broke a three-year string of 0.0% fixed rates. That was a surprise.

On Nov. 1, 2013, a 10-year TIPS was yielding 0.50%. Today, it is yielding 0.52%, an increase of 2 basis points. That seems like a pretty strong argument for leaving the fixed rate where it is, at 0.20%. But the Treasury is mysterious. Here’s my wild guess:

 Fixed Rate on May 1 Percentage chance 0.00% 15.0% 0.10% 15.0% 0.20% 69.9% Higher than 0.20% 0.1%

I have wondered if the Treasury set the 0.20% fixed rate in November to offset the low inflation-adjusted rate, which was stuck at 1.18% annualized for 12 months. That rate will now be rising to 1.83%; does that eliminate the need to keep the fixed rate at 0.2%?

Because the fixed rate stays with an I Bond through its entire life, up to 30 years, it is a very desirable thing. So let’s get to the scenarios.

Purchase I Bonds before May 1

I am in this group because I bought my I Bond allocation in February (\$10,000 per person per year, at Treasury Direct). Buyers can also get \$5,000 in paper I Bonds in lieu of a tax refund, but I don’t use this strategy.

• Fixed rate 0.20%
• Variable rate 1.18% for six months, 1.83% for six months
• Combined rate of 1.38% for six months, 2.03% for six months
• Effective rate of 1.705% for 12 months

Purchase I Bonds between May 1 and Oct. 31

• Fixed rate unknown
• Variable rate of 1.83% for six months, unknown for six months
• Combined rate unknown
• Effective rate unknown

At lot isn’t known, because to look out a year for an I Bond purchased in May requires a second inflation adjustment on the variable rate, and that number won’t be known until mid-October. If you think inflation will be rising this year, you may want to wait.

If the fixed rate stays at 0.20%, waiting will look like a smart move. You’d get a combined interest rate of 2.03% for six months and bypass the six months at 1.38%. November’s new variable rate is not known, but that’s the same for all I Bond holders.

If the fixed rate drops to 0.0%, you’d still do OK in the first year, with the combined rate of 1.83% for six months. Even if the variable rate dropped to zero in November, you’d get a combined rate of 0.92% for 12 months.

If you plan to sell the I Bond after a year, no big deal. (You’d lose three months of interest, however.) But if you are holding the I Bond for 20 or 30 years, you want the highest possible fixed rate.

Purchase I Bonds between Nov. 1 and Dec. 31

• Fixed rate unknown
• Variable rate unknown
• Combined rate unknown
• Effective rate unknown

Why would you wait until Nov. 1 and face all these unknowns? You would if you believe interest rates and inflation will be rising in 2014. If that happens, you might get a higher fixed rate and higher variable rate than you could get in April or May.

The rates set in November will be in effect in January, when the I Bond purchase-limit  clock will reset. I will probably be buying again at the beginning of 2015, up to the limit. If rates rise this year, a savvy buyer could double up on the November to April I Bonds by purchasing them in December and then again in January.

Author of Tipswatch.com blog, David Enna is a long-time journalist based in Charlotte, N.C. A past winner of two Society of American Business Editors and Writers awards, he has written on real estate and home finance, and was a founding editor of The Charlotte Observer's website.
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8 Responses to I Bond scenarios: Counting down to May 1, 2014

1. R says:

Dave, I just thought of this …
Is the dollar amount of I-bonds sold in 6 mo. by UST possibly quite low relative to their total of TIPS in 6 mo.? If so, then they might use the fixed rate offered for some sort of messaging to the people/market …?

If your scenario pans out (and I suspect it will), I will definitely rethink my initial plan of waiting until November to purchase I Bonds. Hoping against hope the fixed rate will go up to at least 0.25%, but that’s doubtful after Yellin’s latest remarks (http://www.theguardian.com/business/2014/apr/16/federal-reserve-janet-yellen-job-market-still-needs-help). Would love to start buying EE Bonds on a regular basis as well.

3. tipswatch says:

Ed, I think two of those were pingbacks from past blogs, because this blog has updated information.

4. Ed says:

4 Responses to I Bond scenarios: Counting down to May 1, 2014
BUT only 2 are shown!

5. tipswatch says:

Thanks Fred. I have heard of one really interesting strategy: Prepare your taxes and determine the amount you owe or will receive as a refund. But instead of submitting, file for an extension and include a payment that will result in a \$5,000 refund. Then, after the IRS cashes your check, file your taxes and request the \$5,000 in paper I Bonds. Clever!

My strategy with I Bonds is to buy to the limit each year (\$20,000 for a couple) and never sell them until I need the cash. That size of investment works for me.

6. ormondroyd says:

Being such an enthusiast of the I bonds, why neglect the \$5000 you may purchase with a tax refund? Given the absurdly low rates available elsewhere I don’t mind “loaning” the government the money beginnning April 15th because the real (after inflation) return I could garner any where else amounts to virtually nothing. Care to elaborate on your strategy?

And as always, kudos for a job well done! Fred