- Jan. 8, 2016 update:
Buying Series I Savings Bonds from the US Treasury is usually a no-brainer decision. Because individuals are limited to purchasing $10,000 a year in I Bonds from TreasuryDirect (plus $5,000 in paper bonds as a tax refund), many investors jump aboard each January to buy the limit.
I Bonds might seem boring and ultra-conservative, but their status as both a super-safe and inflation-protected investment makes them highly desirable as a way to push money forward into retirement years. A lot of very rich people buy I Bonds to the limit each year and scheme to get that extra $5,000 as a tax refund. Here are some of the reasons why:
- There are no fees, no commissions, no carrying costs.
- The principal balance is 99.999999% safe.
- Interest earned is added to the principal balance until the I Bond is cashed out.
- Federal income taxes are deferred until the I Bond is cashed out.
- There are no state income taxes on interest earned.
- The I Bond can be sold after one year with a minor penalty (3 months’ interest).
- The I Bond can be sold after five years with no penalty.
- The I Bond can be held for 30 years, earning at least the rate of inflation the entire time.
So why wait this year? I Bonds earn interest based on a combination of a fixed rate and an inflation-adjusted rate. Understanding how these rates work is key to timing your purchase of I Bonds in 2015, because unusual factors are at work this year.
The fixed rate is subject to change every May 1 and Nov. 1, but the fixed rate at the time of the purchase stays with that I Bond forever. The fixed rate is currently 0.0%. While the Treasury doesn’t disclose how it determines the fixed rate, it appears likely to remain at 0.0% at the next adjustment on May 1.
The inflation-adjusted rate also changes every May 1 and Nov. 1, but it affects all I Bonds, no matter when they were purchased. The inflation-adjusted rate is currently 1.48% annualized. That means if you purchase an I Bond before May 1, you will receive six months of interest at that 1.48% rate.
The May 1 adjustment to the inflation-adjusted rate will be based on the change in non-seasonally adjusted CPI-U from September 2014 to March 2015. We are three months into this period, and so far the CPI-U index is down 1.36%. That is negative 1.36%. I track these numbers on my Inflation and I Bonds page. Here is the trend:
The trend is pointing toward a negative number for the May 1 inflation-adjusted rate for I Bonds. That has only happened once before in the 17-year history of I Bonds, in May 2009 when the rate dropped to -2.78%.
Good news, bad news. One of the good things about I Bonds is that your accumulated principal can never go down. This isn’t true of Treasury Inflation-Protected Securities, which will lose accumulated principal during times of deflation. If the May 1 adjustment goes negative, these two things will happen:
- The I Bond’s inflation-adjusted rate will be negative.
- The I Bond’s fixed rate will remain, but the composite rate will be lowered by the amount of the negative inflation, but not below zero.
So if you are holding I Bonds from years back that have a fixed rate of 1.4%, you could see the fixed rate wiped out by the negative inflation-adjusted rate. But the overall rate will not drop below zero.
Buy an I Bond today? If you buy an I Bond today, you will earn six months of interest at the annualized rate of 1.48%, which combines the fixed rate of 0.0% and the inflation-adjusted rate of 1.48%. Then, after six months, the May 1 adjustment will kick in, and you will (probably) earn 0.0% for six months. Your fixed rate will be unaffected since it is already zero. In effect you will be buying a one-year CD earning 0.74%, which you can then cash in with zero penalty.
Buy an I Bond after May 1 but before Nov. 1? Most likely, you will earn a fixed rate of 0.0% and an inflation-adjusted rate of 0.0% for six months. There really would be no reason to buy I Bonds under that scenario.
It’s possible the Treasury could surprise us and add a small fixed rate – say 0.1% – to make buying I Bonds a little more appealing. I’d say that is unlikely, but if it happened, I would be highly likely to buy I Bonds then, because the fixed rate carries with the investment for 30 years.
(But don’t get your hopes up. The last time the inflation-rate went negative, in May 2009, the Treasury dropped the fixed rate from 0.7% to 0.1%.)
Buy an I Bond after Nov. 1? This looks like the most appealing option. Wait. The fixed rate could rise above 0.0%. The inflation-adjusted rate could rise into a positive number. You could earn something more than 0.0% for six months. Waiting makes the most sense.
Or, this year, buy EE Bonds. If I Bonds continue paying 0.0%, EE Bonds would be an attractive alternative, if you can hold them for 20 years. EE Bonds carry a fixed rate – currently 0.1% – that changes each May 1 and Nov. 1. That looks horrible, but EE Bonds are in effect issued at half their future value. If you hold them 20 years, they will immediately double in price, and that creates an effective interest rate of 3.5%. A 30-year Treasury is yielding only 2.39%.
EE Bonds are a great deal, as long as you can hold them for 20 years. Of course, they are not inflation-protected, so I’d suggest them as an alternative – not a replacement – for I Bonds and TIPS.