Treasury also maintains EE Bond’s doubling period at 20 years
By David Enna, Tipwatch.com
The U.S. Treasury just announced the May to October 2021 terms for U.S. Series I Bonds and EE Bonds, and … as we expected, there were no surprises. Both of these Savings Bonds remain exceptional investments in our current low-interest-rate market.
Here are details from the Treasury’s announcement:
“The composite rate for Series I Savings Bonds is a combination of a fixed rate, which applies for the 30-year life of the bond, and the semiannual inflation rate. The 3.54% composite rate for I bonds bought from May 2021 through October 2021 applies for the first six months after the issue date. The composite rate combines a 0.00% fixed rate of return with the 3.54% annualized rate of inflation as measured by the Consumer Price Index for all Urban Consumers (CPI-U). The CPI-U increased from 260.280 in September 2020 to 264.877 in March 2021, a six-month change of 1.77%.”
Here is my translation:
- An I Bond earns interest based on combining a fixed rate and a semi-annual inflation rate. The fixed rate – which will continue at 0.0% – will never change. So I Bonds purchased from May 3 to October 30 will carry a fixed rate of 0.0% through the 30-year potential life of the bond.
- The inflation-adjusted rate (also called the variable rate) changes every six months to reflect the running rate of non-seasonally adjusted inflation. That rate is currently set at 3.54% annualized. It will update again on November 1, 2021, based on U.S. inflation from March to September 2021.
- The combination of the fixed rate and inflation-adjusted rate creates the I Bonds’ composite interest rate, which was 1.68% but now rises to 3.54%. An I Bond bought today will earn 3.54% (annualized) for six months and then get a new composite rate every six months for its 30-year term.
It’s important to note, however, that all I Bonds — no matter when they were issued — will get that 3.54% inflation-adjusted rate for six months, on top of any existing fixed rate. So an I Bond purchased in April will receive 1.68% for six months, and then 3.54% for six months.
Here is the formula the Treasury used to determine the I Bond’s new composite rate:
|The composite rate for I bonds issued from May 2021 through October 2021, is 3.54%|
|Here’s how we set that composite rate:|
|Semiannual inflation rate||1.77%|
|Composite rate = [fixed rate + (2 x semiannual inflation rate) + (fixed rate x semiannual inflation rate)]||[0.0000 + (2 x 0.0177) + (0.0000 x 0.0177)]|
|Composite rate||[0.0000 + 0.0354 + 0.0000000]|
None of this was a surprise, but the new terms do mean I Bonds become a very attractive investment, earning at least 1.77% over the next year, and probably much higher. That compares to 0.05% for a 1-year Treasury and maybe 0.60% for a best-in-nation 1-year bank CD. In other words, in a worst-case scenario I Bonds will return close to triple the earnings of the next-best very safe investment. The actual return will likely be much higher than 2% over the next 12 months.
(An I Bond has to be held one year before it can be redeemed, but an investor can purchase the I Bond near the end of a month and get full credit for the month. That means an I Bond can be, effectively, an 11-month investment. I Bonds redeemed from 1 to 5 years face a penalty of three months interest; after 5 years there is no penalty.)
The fixed rate of an I Bond is equivalent to the “real yield” of a Treasury Inflation-Protected Security. It tells you how much the I Bond will yield above the official U.S. inflation rate. Right now, an I Bond will exactly match U.S. inflation.
I track the correlation between the I Bonds’ fixed rate and the current real yields of 5-year and 10-year TIPS. In the past, a 10-year TIPS generally yields about 50-75 basis points higher than an I Bond. In our current market, the equation has swung wildly in favor of the I Bond, with the I Bond having a 171 basis-point advantage over a 5-year TIPS and an 76 basis-point advantage over a 10-year TIPS. Given these market conditions, there was no way the Treasury was going to raise the I Bond’s fixed rate.
Here are the fixed rate versus TIPS yields going back to 2008. As an interesting aside, notice that the 10-year TIPS yield has risen 6 basis points over the last year, while the 5-year TIPS yield has shot 50-basis-points lower.
I have noticed a lot of chatter recently about I Bonds on financial forums. I expect this to be a very popular investment in 2021. I Bonds carry a purchase limit of $10,000 per person per year, and must be purchased electronically at TreasuryDirect. Investors also have the option of receiving up to $5,000 in paper I Bonds in lieu of a federal tax refund. Learn more about I Bonds.
Here are the Treasury’s terms announced Monday:
“Series EE bonds issued from May 2021 through October 2021 earn today’s announced rate of 0.10%. All Series EE bonds issued since May 2005 earn a fixed rate in the first 20 years after issue. At 20 years, the bonds will be worth at least two times their purchase price. The bonds will continue to earn interest at their original fixed rate for an additional 10 years unless new terms and conditions are announced before the final 10-year period begins.”
And here is my translation:
- The EE Bonds’ fixed rate remains at 0.1%, where it has been since November 2015. Awful, right? (Check out your current money market savings rate, somewhere around 0.05%, or less.) But the EE Bonds’ fixed rate is irrelevant because…
- An EE Bond held for 20 years immediately doubles in value, creating an investment with a compounded return of 3.5%, tax-deferred. So, if you invest $10,000 at age 40, you can collect $20,000 at age 60, with $10,000 of that total becoming taxable.
- After the doubling in value at 20 years, the EE Bond reverts to earning 0.1% for another 10 years.
Retaining this 20-year doubling is a big deal. The Treasury has changed this holding period several times in the past, so there was a real possibility the terms could change in 2021, with the 20-year nominal Treasury currently yielding 2.19%, well below the EE Bond’s potential of 3.5%
What this means: You should only invest in EE Bonds if you are absolutely certain you can hold them for 20 years. They are an ideal “bridge” investment for someone around age 40, who can build an annual stream of income starting at age 60, potentially delaying Social Security benefits until age 70.
The EE Bond will also outperform an I Bond if inflation averages less than 3.5% a year over the next 20 years. I think that is a fairly strong possibility. For anyone with a secure 20-year timeline for investment, an EE Bond is extremely attractive.
A combination of I Bonds and EE Bonds also makes sense, providing both inflation protection and strong deflation protection. But EE Bonds only make sense for an investor committed to holding them for 20 years.
I will be writing more about I Bonds and EE Bonds in coming weeks, since interest will be high in these investments (and TIPS aren’t particularly attractive right now). If you have questions, let me know.
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David Enna is a financial journalist, not a financial adviser. He is not selling or profiting from any investment discussed. The investments he discusses can purchased through the Treasury or other providers without fees, commissions or carrying charges. Please do your own research before investing.