Buying I Bonds in 2015? No, wait!

 

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:

Inflation

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:

  1. The I Bond’s inflation-adjusted rate will be negative.
  2. 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.

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31 Responses to Buying I Bonds in 2015? No, wait!

  1. maynardGkeynes says:

    “So if you are holding I Bonds from years back that have a fixed rate of 1.4%, you’ll see a decline in that fixed rate”
    Not sure I get this — I thought the fixed rate was there for the life of the bond?

    • tipswatch says:

      The fixed rate remains, but the composite rate will be lowered by deflation, but cannot go below zero. In effect that can wipe out the fixed rate. The Bogleheads forum has an excellent example of the formula for the deflationary period in 2009:

      Given a Fixed rate = 0.10% and a Semiannual inflation rate = -2.78%

      Composite rate = [Fixed rate + (2 x Semiannual inflation rate) + (Fixed rate x Semiannual inflation rate)]
      Composite rate = [0.0010 + (2 × -0.0278) + (0.0010 × -0.0278)]
      Composite rate = [0.0010 + (-0.0556) + (-0.0000278)]
      Composite rate = [-0.0546278]
      Composite rate = -0.0546
      Composite rate = -5.46%
      Composite rate = 0.00% (Composite rates are never less than zero)

      http://www.bogleheads.org/wiki/I_savings_bonds

      • maynardGkeynes says:

        Then in way, if I understand correctly, I-bonds are arguably worse than TIPS in deflation. Compare a $1000 TIPS with a $1000 I-Bond, both with a 2% coupon. Assume -5% deflation. The TIPS pays a (2% X $950) = $19; The I-Bond pays $0. Of course, you avoid the immediate $50 principal loss with the I-Bond, but the loss on TIPS is (hopefully) temporary, because the principal loss is recovered when inflation picks up again. However, because you never make up the lost coupon on the I-Bond, the loss is permanent. Does that make sense?

    • Clara Hickey says:

      I thought so too, until I found my bonds purchased in 2003 & 2005 are earning 0.0%.
      Apparently the CPI-U Index is larger than my “guaranteed” rate. Subtract, and you get 0.0%. I had no idea that my “fixed” rate was anything buy fixed. It doesn’t feel like deflation to me. But who are we to question? Hopefully, the rate will change somewhat on Nov. 1st. I will certainly be watching.

  2. Kevin says:

    What is your opinion as to getting I Bonds from a tax return this year? File ASAP to get 0% fixed and six months of interest at 1.48% (followed by presumably six months of 0%) or file April 15, probably getting May I Bonds with presumably 0% inflation rate component with the hopes of maybe getting thrown a bone of something higher than 0% fixed. Does it even matter in the larger scheme of things with the small monetary amount and small interest rates involved?
    I’m leaning towards ASAP . . . if better opportunities exist for this money next year, the penalty of 3 months interest upon redemption would be $0. Thoughts?

    • tipswatch says:

      Kevin, I don’t do the tax return method, but if I were going to do it I would probably do it ASAP, as you note. Better to lock in the 1.48% for six months. Even if inflation rises later in the year, you’d get that bump a year from now.

  3. Joseph Keenan says:

    Very helpful, as usual, thank you.

  4. Len says:

    Hope you realize you are giving some of the best analysis around. Not that Wall Street and their minions would even acknowledge that I bonds or TIPS have any value in a retirement portfolio to start with. Thanks for your continuing efforts!

  5. Tom says:

    I am set up for the I bond via tax refund. (tax-loss harvested late last year). If I file for an extension and submit my tax forms 10/15, is there a chance of my refund getting the November 1 real rate and probably a positive inflation rate? If I file before then, I am almost sure of loaning the government $5K for six months for zero interest, same as if I do the extension.

  6. tipswatch says:

    Tom, I have no idea how the IRS dishes out these refunds. I know that getting six months with zero interest sounds horrible, but it’s not truly bad in the long term. If we have deflation over six months, you are still getting a positive ‘real’ return, since zero is higher than a negative number.

  7. Pingback: TIPS versus I Bonds during deflationary times | Treasury Inflation-Protected Securities

  8. Ed says:

    I have NOT read these Comments thoroughly, but I have one point to add. I see lots of small real yields, some of them with a negative sign — VERY aggravating! But remember the inflation protection provided until maturity! History includes sometimes high inflation — and in addition to politicians making it happen, some people likely strive to do a dirty bomb at a major port …, etc.

  9. BigDaddyRich says:

    Sorry I’m late to the comments on this post. I’m buying a set of I Bonds in the last week of April, right before the new interest rates take effect, so, technically, I’ll have six months with the current interest rate. I say technically because Treasury doesn’t apply interest to new savings bonds until after the first four months, due to the interest penalty they impose if you redeem the bonds before holding them for five years. So if I’m correct, I’ll earn the current interest on my bonds in September and October, and then get the new rate in November — when, hopefully, a higher fixed rate will be added.

  10. tipswatch says:

    Big Daddy, if you buy in April you will get the full six months at 1.48%, and then you will get the next six months at the next inflation-adjusted rate, probably 0.0%. The fixed rate will remain at 0.0% for the entire time you own the I Bond. It will never change.

    • BigDaddyRich says:

      Let me clarify: when I said “I’ll earn the current interest on my bonds in September and October, and then get the new rate in November — when, hopefully, a higher fixed rate will be added,” what I meant is that I hope Treasury will increase the fixed rate for I Bonds sold during the six-month period beginning November 1.

  11. tipswatch says:

    OK, Big Daddy, you can buy a portion in April, and then another portion in November. Not a bad strategy. But those I Bonds you buy in April will earn the full 1.48% for six months, don’t worry about that. If you sell them after one year and before five years, your penalty will be at the current composite interest rate.

  12. Tiger Intheboat says:

    Regarding EE bonds being sold at half their future value….Treasury Direct says:

    “Paper bonds were sold at half the face value; i.e., you paid $25 for a $50 bond.
    Electronic bonds purchased via TreasuryDirect are sold at face value; i.e., you pay $25 for a $25 bond.”

    Since paper EE bonds are discontinued at retail, does that mean that all we get is the fixed rate of interest, .1%?

  13. tipswatch says:

    Tiger, Treasury Direct says: “We no longer support buying paper bonds. If you bought bonds through your employer in the past, open a TreasuryDirect account and buy bonds.” But if you are holding paper EE bonds issued after 2005 you are guaranteed to get double the purchase price after 20 years. In effect, the same thing. Hold 20 years, get double your original purchase, which in effect is 3.5% a year.

    The fixed rate depends on when you bought the EE Bonds. For example, back in 2007, the fixed rate was 3.7%, which would actually double in value in less than 20 years.

    • Tiger Intheboat says:

      Sorry, I wasn’t clear. I was talking about new purchases of EE bonds, as a possible alternative to buying I bonds. If you buy new EE bonds today, from Treasury Direct, is it true that you no longer buy them at half the face value, and in effect only get the very low interest rate?

      • tipswatch says:

        If you bought an EE Bond today, you would get a fixed rate of 0.1% for the full term of the bond. However, when the EE Bond hits 20 years, it immediately doubles in value. This seems to me to be almost exactly the same as buying them at half value. Cashing out early would make it a bad investment, holding for 20 years makes it a good investment. Here is the wording from Treasury Direct:

        “Electronic bonds are sold at face value (not half of face value). They start to earn interest right away on the full face value. Treasury guarantees that for an electronic EE Bond with a June 2003 or later issue date, after 20 years, the redemption (cash-in) value will be at least twice the purchase price of the bond. If the redemption (cash-in) value is not at least twice the purchase price of the electronic bond as a result of applying the fixed rate of interest for those 20 years, Treasury will make a one-time adjustment at the 20 year anniversary of the bond’s issue date to make up the difference.”

  14. Pingback: Buy I Bonds now, or wait until later in 2014? | Treasury Inflation-Protected Securities

  15. Tiger Intheboat says:

    Thanks, I didn’t see that on the site. I appreciate your help with this.

    Tiger

  16. Claire says:

    I checked my I bond values every half year (May and November) and am shocked to see this time I’m earning 0% from most of them (for those purchased in 2003). The ones I bought back in 2001 are earning a handsome 4.91%, but they are very low value bonds (just a few $50s and $100s). Should I cash them out and put them somewhere else that has better returns?

  17. tipswatch says:

    Claire, the I Bond’s variable rate of -1.60% (annualized) started on May 1 for I Bonds purchased in May. That rate, which lasts for six months, begins in the month you originally bought them. So this negative hit will roll out from now to November. My Savings Bond Wizard shows no bonds paying 0.0% today, but if I look at October, a bunch of them will drop to 0.0%. I Bonds I bought back in 2001 and before will have their fixed rates cut by 1.6%.

    Should you sell them? I would say no, especially any I Bonds you have with a fixed rate above 0.0%. Hold on to those until you really, really need the money. If you want to sell more recent I Bonds – held less than 5 years – hold them for six months of zero interest and then sell, so your penalty (six months’ interest) will be zero.

    But I have been recommending that people just hold their I Bonds and wait out this six months of zero interest. The only reason to sell I Bonds is if you need the money right now, such as to pay for a college education, or immediate expenses.

    • commonsensepersonalfinance says:

      Thanks tipswatch, for the recommendation. All my I bonds were purchased before 2004 so I guess I will hold onto them and wait out until the interest going up again! It’s just a little hard to swallow 0% pills…

  18. Frank says:

    A question about buying Ibonds when rates kick up: I have a number of bonds I’ve purchased over the past five years, many of which have a 0% fixed rate. If and when the fixed rate jumps up, say to 1%, could I sell ALL of my bonds (approximately $50,000 worth) and buy $50k of ibonds with a fixed rate of 1%? I understand the interest penalty for bonds sold prior to the five year holding period. What I’m not sure about is whether I can cash in $50k of ibonds and buy $50k in a single year (I’m thinking about the $10k limit on Ibonds – not sure if that only applies to new bond purchases or not).

  19. tipswatch says:

    Frank, you can only buy $10,000 per person of I Bonds per year (plus the possible tax refund ploy). It doesn’t matter how many you sell, you can only buy $10,000 per person per year. So the strategy would be to sell $10,000 and buy $10,000, and you’d have the same net amount of I Bonds, but you’d have a higher fixed rate on that $10,000.

  20. Betty says:

    So glad I found your site; was about to cash in my 2003 and 2005 bonds but now I won’t. Read somewhere that if bonds are used to pay for education there is no federal tax. May not be true, but if it is, wonder if I can use I-bonds to pay for my grand-kids college tuition. Any idea? Thnx. Grambybetty

  21. tipswatch says:

    Betty, If you have I Bonds from 2003 they are paying a fixed rate of 1.6 to 1.1 percent above inflation, depending on when you bought them. I Bonds purchased in 2005 are paying 1.2% to 1.0% above inflation. So you don’t want to sell those, unless you have a need.

    I am not an expert on using I Bonds for education, but I think they would need to be used for yourself or a dependent, not your grandchildren.

    https://www.treasurydirect.gov/forms/savpdp0051.pdf

    If there are ways around this, I don’t know them. Other folks may have some ideas.

    • maynardGkeynes says:

      If at all possible, I would keep hold the bonds until maturity. The rate is quite decent, you have inflation protection, you can defer the interest, and, in this world, the taxes you may have to pay in 2033 -35 too far away to make plans about. There may not be an income tax by then, there may be a flat tax (at lower rates), a VAT, a monarchy, a dictatorship of the proletariat, etc etc ( who knows?). You’ve got a bird in the hand….

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