Despite the I Bond’s appeal, investors shouldn’t ignore the sizable yield advantage for TIPS.
By David Enna, Tipswatch.com
We’ve just gotten through a year of “I Bond mania,” which has brought a lot of welcome attention to a little-known, rarely discussed, but very safe and sensible investment. Now I have a news alert: I Bonds are no longer the star of the inflation-protected universe. That role has shifted to Treasury Inflation-Protected Securities, with real yields now hitting decade-plus highs.
I like both investments, and I will continue to buy both. But because of this year’s surge in real yields, TIPS have become much more desirable. Combine that with a sense of urgency, because there is no way to know how long this advantage will last. Here are the numbers from Friday’s market close:
- I Bond: Current fixed rate of 0.4%, which equates to a real yield (above inflation) of 0.40%.
- 5-year TIPS: Current real yield of 1.71%, a yield advantage of 131 basis points over the I Bond.
- 10-year TIPS: Current real yield of 1.57%, a 117-basis-point advantage.
- 30-year TIPS: Current real yield of 1.63%, a 123-basis-point advantage.
Here is a chart showing how the advantage has shifted strongly to TIPS in the last half year:
Does this mean you should be rushing to sell your I Bonds to buy TIPS? Absolutely not. I Bonds have a key advantage over TIPS as a short-term investment, because their current interest rate is backwards-looking, based on past six-month inflation. The I Bond’s current inflation-adjusted variable rate is 6.48% annualized, for six months. That is too attractive to ditch.
For more on that, read this analysis: Short-term I Bond investors: Be patient with your exit strategy.
But as an investment you plan to buy and hold for 5 or more years, TIPS have a huge yield advantage over I Bonds. That shouldn’t be ignored. It is “normal” (historically, I mean) for the fixed rate of the I Bond to lag below the TIPS real yield. That’s okay, because I Bonds have a lot of other desirable features.
Advantages of I Bonds vs. TIPS
- Both I Bonds and TIPS protect you against unexpected inflation. If inflation in the next 30 years suddenly soars to 7%, 10%, 15%, your principal will increase by that amount because of the inflation-adjusted interest rate for I Bonds or inflation accruals for TIPS.
- I Bonds are a simple investment to buy and track, much simpler than a TIPS with a constantly changing market value and inflation accruals that update daily.
- I Bonds accurately track U.S. inflation but can never go down a cent in value if we hit a period of deflation. This isn’t true for TIPS, which lose some principal value after every month of deflation.
- I Bonds earn tax-deferred interest, while TIPS in a taxable account get hit by current taxes on both the coupon rate and the inflation adjustments in any year, even though the inflation accruals aren’t paid out until the TIPS matures or is sold.
- I Bonds can be used tax-free to pay for educational expenses, under some circumstances.
- I Bonds don’t trade on any secondary market and their value is never at risk if interest rates rise.
- I Bonds allow you fantastic flexibility. You can redeem them after one year, costing you three months of interest. Or redeem them after five years and pay no penalty, or just hold them for 30 years and cash out.
Disadvantages of I Bonds vs. TIPS
- As I noted above, I Bonds currently have a real yield well below the real yield of TIPS of all maturities.
- I Bonds can’t be purchased in a tax-deferred account. This can make raising money for an I Bond purchase difficult, especially for retired people with no regular income. TIPS can be purchased in a tax-deferred brokerage account, so raising the money can be done without tax consequences.
- I Bonds can’t be sold for a year, and there is a 3-month interest penalty for redemptions before 5 years. TIPS can be sold in the secondary market at any time, possibly at a loss or possibly at a gain.
- In times of very low inflation, your 6-month annualized return for I Bonds can drop to a very low level, even 0.0%. But I Bonds in this case may outperform TIPS, which would lose principal value in that scenario.
- Keep in mind, however, that even during times of deflation, a TIPS will continue to pay out its coupon rate. So a TIPS with a higher coupon rate has some added deflation protection. For example, the new TIPS issued in October has a coupon rate of 1.625%, so that is a buffer against annual deflation of at least 1.625%.
- I Bond purchases are capped at $10,000 per person per year. TIPS purchases are essentially unlimited. It takes a lot of years of investing to build a sizable allocation in I Bonds. With TIPS, you can do that in a day.
- I Bonds can only be purchased in electronic form at TreasuryDirect, a government site that has many critics. TIPS can be purchased at any major brokerage, often with zero commission and fees.
- I Bonds can’t be sold on the secondary market, meaning there is no way to capture a capital gain if interest rates fall substantially. TIPS can be traded for gain or loss.
- You cannot create a joint account at TreasuryDirect, so a couple would need to set up two accounts, one with I Bonds registered as Spouse 1 with Spouse 2, and the other, Spouse 2 with Spouse 1.
Why advantage TIPS?
We’ve gone through a decade-plus of extremely low interest rates, thanks to Federal Reserve interventions in the Treasury market. Real yields — meaning yields above inflation — were negative for much of this time. We have finally come out of this misery with a bang: Real yields for TIPS are now reaching levels we haven’t seen since 2008, in the case of the 5-year TIPS, and 2010 for the 10-year TIPS. At the same time, the market continues to price in fairly low future inflation, just 2.29% over the next 10 years, based on the last 10-year TIPS auction. That makes TIPS appealing versus nominal Treasurys.
I Bonds remain a great investment, in my opinion, and I will definitely be buying them up to the purchase limit in 2023. I Bonds are superior as a short-term investment of 1 to 2 years because of their backward-based interest rate and predictable return.
But TIPS right now are a superior longer-term investment, based solely on these historically attractive real yields. As I noted in a recent article, I was able to nab a 20-year TIPS with a real yield of 2.02% on the secondary market, and also filled 2030 and 2031 slots in my TIPS ladder with real yields just a bit over 1.5%. You can’t do this kind of investing with I Bonds, because of the $10,000 per person per year limit on purchases.
I imagine that a lot of I Bond faithful will disagree with my opinion, and I do understand that I Bonds are very attractive because of their simplicity, safety and rock-solid deflation protection. But TIPS are just a better investment in November 2022. Real yields of 1.5% are now available across the TIPS yield spectrum. Is that attractive? Just take a look at where we were a few months ago:
• Confused by I Bonds? Read my Q&A on I Bonds
• Let’s ‘try’ to clarify how an I Bond’s interest is calculated
• Inflation and I Bonds: Track the variable rate changes
• I Bond Manifesto: How this investment can work as an emergency fund
• Confused by TIPS? Read my Q&A on TIPS
• Upcoming schedule of TIPS auctions
* * *
Feel free to post comments or questions below. If it is your first-ever comment, it will have to wait for moderation. After that, your comments will automatically appear. Please stay on topic and avoid political tirades.
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 be purchased through the Treasury or other providers without fees, commissions or carrying charges. Please do your own research before investing.
Treasury Inflation-Protected Securities 
Pingback: I Bonds: A not-so-simple buying guide for 2023 | Treasury Inflation-Protected Securities
Pingback: 2022 in review: Scary year for inflation, better year for inflation protection | Treasury Inflation-Protected Securities
You often refer to Bloomberg to follow yields. Is there a guide to understanding that chart? What are the red and green numbers? I don’t see a cusip number so how do I find the right one?
All the Treasurys listed on the Bloomberg Current Yields page are the last one issued, now trading on the secondary market. So the 5-year TIPS you see listed now is the TIPS that will be reopened at Thursday’s auction. I pretty much ignore the red and green numbers.
I also refer to Trading Economics, which seems to be very timely.
https://tradingeconomics.com/united-states/government-bond-yield
Very much appreciate your site. I’ve never liked TIPS funds due to volatility (interest rate risk, etc.), and have always stuck to buying at auction and holding to maturity. Currently pondering filling holes in my ladder since i did not buy when auctions were unattractive (low or negative real yields, etc.). So i’m looking at buying on the open market (via Schwab platform). For example: US Treasury TIP 912810FR4, 2.375% 01/15/2025, YTM = 2.02 at accrued interest 348.01 and price 100.73438. This seems like a good deal to me. Am i missing something?
Every TIPS on the secondary market has a unique story, and unique benefits and challenges. But generally, the market sets a correct price. This TIPS that matures Jan 2025 is selling at a slight premium because its real yield (as of Friday) was a bit below its coupon rate of 2.375%. It has a massive inflation accrual of 57%, meaning you will be purchasing 57% extra principal at a premium price. It’s probably a fair deal, but just realize if you buy $10,000 par of this TIPS you will be paying about $15,819 for about $15,740 of principal. Some investors don’t like paying a premium for extra principal.
I’m 45. I’ve never actually built an emergency fund nor do I hold any bonds in my retirement accounts. I’ve been aggressive in stocks my whole career as I’ve had a combination of starting later and a lack of high earnings. The last couple of years has given quite a lot to think about!
If you had to start off, and build a solid foundation, with 10k and a 20-40 year horizon? I like the idea of something firewalled from my other accounts using TD. What offers the most flexibility for the widest set of conditions?
10k in I Bonds only?
5K I Bonds. 5k TIPS?
3K in 4/8/13 Bills. 2K in Tips. 5k in I Bonds?
Well, I think you’re asking about how to build a $10,000 “emergency fund?” I think the experts would say focus on liquidity first, which is mostly things like money market checking and savings accounts. Once you get 3-6 months of living expenses tucked away in emergency savings, then perhaps start a short-to-intermediate-term strategy in T-Bills and I-Bonds with the additional amounts over and above your initial emergency savings. With a monthly laddering strategy on the two, you can still have liquidity there also. Always be mindful of tax efficiency as well. I-Bonds are essentially tax-deferred, and T-Bills are exempt from State & Local taxes. I-Bonds can only be purchased at Treasury Direct. Other Treasurys available at Treasury Direct can also be purchased through a broker like Fidelity (my personal favorite). The great thing about Fidelity is that they offer an auto-roll feature on T-Bills, and that is very convenient with T-Bills always maturing so frequently, whereas Treasury Direct makes that more difficult. For TIPS, definitely house them in a tax-sheltered account, since the interest earned from the coupon and principal increases are taxed annually as ordinary income, both at the Federal & State levels. Same for CD’s. Sounds like you’re on the right track; diversity of duration and securities combined with tax efficiency, and hopefully that will provide the building block you’re seeking. *One final note: if you’re someone with lower earnings, then consider dividend stocks as an alternative as well. Qualified dividends could perhaps cost you zero in annual taxes if your total taxable income is less than $44,626 in 2023. If you plan to buy and hold, and can stomach the volatility of stocks (which it sounds like you can), then the tax savings coupled with capital returns could well outpace anything you’d earn in TIPS, T-Bills, & CD’s. I-Bonds are a no-brainer, though.
Appreciate the reply. From my reading you also can autoroll Treasuries at Treasury Direct for up to 2 years. As much as I like Fidelity, my family uses them, I don’t want another account unless I have to.
Interesting point on TIPS with tax and account placement. I’ll keep that in mind.
This thread will give you good input & feedback. You’ll have to be very transparent in order to get good information. Questions: (1) How much in retirement accounts? (2) How much in non-retirement accounts? (3) How much do you earn per year? (4) What are your debts (mortgage, loans, autos, etc.)? (5) Single, married, children?
That is just the basic information that anybody on this thread needs to give you really pertinent & actionable inputs that you can put to work.
Jason gave an excellent reply and advice. Your first priority should be to build an emergency fund (three to six months of future spending) in a very safe investment that can be converted to cash immediately. So … 4-week Treasurys purchased in TreasuryDirect could meet that need.
Anyone who invests consistently in I Bonds will build up a fantastic emergency fund, accessible without penalty after 5 years. But that’s not going to work for you immediately. Find a safe, liquid investment that you like and build up that emergency fund, then focus on building a TIPS or I Bond ladder.
I am not a financial adviser, just a journalist, so that’s just my opinion.
“I do understand that I Bonds are very attractive because of their simplicity…”
Indeed. While TIPS may be comparatively advantageous right now on a real yield basis, there is something to be said for simplicity. For many people the complexity of TIPS is a major disadvantage in comparison to the relative simplicity of I bonds.
Hi David, I was wondering how deep your knowledge is in TIPS ETFs; I have questions about the STIP ETF. Their site shows a real yield of ~2.5%, but we know the 5yr real yield is ~1.5%. Could it be that much higher? (their duration is shorter) Also, they usually make monthly payouts, but not always, right now on pause. Do you have any insight? Thank you, love the site!
I always take these yield numbers with a grain of salt. It’s usually better to look at 12-month trailing yield, or year-to-date total return. iShares reports the real yield at 2.48%, and that could be correct. There are a lot of shorter-term TIPS yielding 2%+ right now. But the shorter the term, the more skewed that real yield number gets. Vanguard’s VTIP, which is pretty much an identical fund, quotes a 30-day yield of 1.78%. Morningstar quotes 1.43% for STIP and 1.82% for VTIP. Anyway, these are both good funds with short duration. I own VTIP in an IRA account, and it is now the only TIPS fund I have.
I don’t understand why anyone would buy a TIPS ETF, which is subject to the same market volatility as any other ETF or stock. The purpose of bonds is wealth protection with a guaranteed return without any exposure to the vagaries of the market. I buy bonds (TIPS and otherwise) and hold them to maturity and don’t own any bond funds. Lately, I’ve been putting my spare change into 13- and 26-week Treasuries, although I did buy some 2-year Treasuries that will yield 4.375%, guaranteed.
“I don’t understand why anyone would buy a TIPS ETF,”…
I agree. I invested some in 2 tips etfs, expecting to reap what I had heard about tips and thinking it was keeping my funds safe as real tips do. I was sadly, very mistaken. I see no purpose in any tips etf other than the vanguard vtip -which hasn’t been nearly as volatile as the other one I tried. Now that I know about real tips, I don’t really see investing putting any more in them.
So in my case, they caught the uninformed with a name that suggested it was something is is NOT.
Same for me, Elizabeth. Last year, I invested in an intermediate-term TIPS ETF, SCHP, not understanding the rising interest rate impact on the ETF’s underlying holdings. It has taken a big beatdown this year, so I did a “horse trade” and exchanged it at a 10% loss for an intermediate-term corporate bond ETF that was down 17-18%, and in two months I’ve already got a 6% return on it. Hoping to break even soon. After learning that hard lesson, I’m now reserving corporates, munis, and high yield for ETF’s, and buying all my Treasurys individually (and I-Bonds, of course). By the way, I modeled out 10-year expected returns on a intermediate-term government ETF vs. buying them individually, and the total returns for individual bonds were about 0.50% higher than those of an ETF. That is considerable when you’re talking 3.5%-4% range for government securities over 10 years. I’m definitely checking out some individual TIPS now after reading this article. Thanks David!
I think TIPS ETFs have a place in the investment world, but I have always said they shouldn’t be considered a core bond fund. They are focused on a single, esoteric investment with only 50 issues currently trading. As a long-term investment they are probably going to do fine, but short-term volatility can be wicked, as we have seen this year. I do think owning individual TIPS held to maturity, along with I Bonds on the side, is the better way to deal with the potential dangers of inflation.
How are the TIPS inflation adjustments taxed in an ETF? I’m trying to think about how that would still be taxable in an ETF like it is when you hold individual TIPS since it’s phantom income.
These TIPS funds pay out the inflation adjustments as current income (usually with a lag of a month or two) and so they are taxable in the current year. This is just like almost every bond fund. But with the TIPS funds it is less “phantom” because you could take the distributions instead of reinvesting them.
Interesting…but where would the cash be coming from that the fund pays out in the form of a distribution since the fund isn’t actually receiving the cash itself?
I have tried to figure this out before, and never found a detailed answer.
They have to sell some holdings. From SCHP prospectus:
Special federal income tax rules apply to the inflation-indexed bonds. Generally, all stated interest on such bonds is taken into income by a fund under its regular method of accounting for interest income. The amount of a positive inflation adjustment, which results in an increase in the inflation-adjusted principal amount of the bond, is treated as OID. The OID is included in a fund’s gross income ratably during the period ending with the maturity of the bond, under the general OID inclusion rules. The amount of a fund’s OID in a taxable year with respect to a bond will increase a fund’s taxable income for such year without a corresponding receipt of cash, until the bond matures. As a result, as noted above, a fund may need to raise cash by selling portfolio investments, which may occur at a time when the adviser would not have chosen to sell such securities and which may result in capital gains to a fund and additional capital gains distributions to fund shareholders.
Bill Gross ex-Pimco has written recently about buying 0-5 year TIPS etf. Buying individual TIPS seems easy enough, but there must be a reason someone like Gross chooses etfs.
One reason I prefer individual bonds is because they mature. Bond funds that keep the same duration, never mature. In rising rates, that causes persistent losses.
“Combine that with a sense of urgency, because there is no way to know how long this advantage will last. ”
Last week was a wake-up call for delaying purchases of TIPS waiting for an optimal rate. One fine day the TIPS yields will drop and stay there.
I fell into this trap when 5 year TIPS yields hit 1.98% for a brief time. Instead of buying them, I talked myself into waiting for the mythical 2% yield.
What an idiot! The next day something or other happened and the rates dropped dramatically. I won the Forrest Gump award that day.
There’s been some interesting developments of late with “bondlike” instruments.
During the FED’s rate run-up this year, Treasury rates were running ahead of both brokered and direct CD’s.
Just recently, brokered CD’s have been running ahead of both Treasuries and direct CD’s.
This last week there was a 4.99% 5 year direct CD available for a couple of days. That’s better than Treasuries and matched brokered CD’s.
In the past, when direct CD’s passed brokered CD’s it was a sign that the tide was changing. Right now, the best direct CD out there is 4.97%.
Currently, the breakeven rate between a 5 year TIPS and the 5 year nominal Treasury is 2.42%. Anything under 2.50% seems like a good deal.
However, the breakeven rate between that 4.97% direct CD is 3.28%. So, does that mean TIPS are “expensive” versus that direct CD?
After suffering thru 2 years of inflation, I’m really not a big fan of any fixed rate instrument. Although getting around 5% does looks attractive.
After suffering thru 2 years of negative TIPS yields, 5 year TIPS with yields just shy of 2% still look like the better deal to me.
Of course, this all comes down to what you’re financial goals are. Mine are simply to preserve purchasing power after getting beat-up by inflation.
So, until TIPS fall into negative territory, I’ll probably just keep converting maturing CD’s into TIPS. And, iBonds next year for spare change.
I am amazed how the author here consistently looks at the strategies and perspective with these investments the same as I do, down to the smallest degree – I certainly can’t say that about friends and family I know! TIPs and I Bonds have been the primary source of investment and income for my family since 2007, and they have paid down to the penny as I forecast in advance – a major advantage over other investments when you need to fix a level income stream, with COLA adjustments automatically attached!
I do have one question that I have not been able to find online: if one has TIPs in a retirement account – as we have with half of our batch – and they mature and you take out the money as a withdrawal for income (or even sell some to do so), does it lose its status of being exempt from state and local taxes by being regular income from an IRA, rather than selling the bond directly in a taxable account, with the broker reporting it to the IRS as such?
Thanks for your much-needed clarification!
Yes, a TIPS held in a traditional tax-deferred account loses its exemption from state income taxes, because all withdrawals from a traditional IRA are taxable as income. But of course that only applies to withdrawals, there is no tax event when the TIPS matures or is sold, as long as the proceeds remain in the IRA. (However, some states don’t tax IRA distributions, see here: https://www.aarp.org/money/taxes/info-2020/states-that-dont-tax-retirement-distributions.html)
Thank you so much for your important information here in your response, and throughout your website. I’ve got a huge batch of April 15, 2023 TIPs waiting to mature when the rates top out (hopefully), and then its time to go long!
Hi. I own VAIPX in my Vanguard account (there’s a limit as to how much in TIPs is allowed in a VG managed account). It’s down significantly YTD, I assume because of the rise of interest rates. Can you comment on the usefulness of owning a TIPs fund for the long run?
VAIPX is a very good TIPS fund, with an expense ratio of just 0.1%. But because it owns the full range of maturities, it has a duration of 6.7, causing it to get hammered this year as real yields exploded 250+ basis points higher. That rise in real yields overwhelmed the inflation accruals, which have been running at about 7.7% over the last year. So you have a total YTD return of -12.5%, bad, but still better than the overall bond market at about -13.6%. I prefer investing 1) in individual TIPS held to maturity, and then 2) in shorter-duration TIPS funds like VTIP. But going forward VAIPX should improve when the Fed stalls the rate increases.
Great post and great opportunity. I would emphasize that TIPS. should be purchased in a deferred tax account, whereas I bonds can only be purchased in a taxable account via Treasury direct.
Regular bonds, ie. Treasuries, corporate, etc. and dividend stocks are best for those in need of cash flow such as retirees.
A disadvantage for I Bonds are the estate problems that they can cause. If there is no co-owner or beneficiary named, probate is an issue. Even for co-owner spouses there can be problems, especially when the amount of accrued interest is high due to many years of ownership. Surviving spouses could be faced with higher taxes (due to losing joint filing status after the year of death), and even triggering IRMAA surcharges to Medicare costs. All of these issues would be worth a separate Tipswatch.com article.
That is not so much a problem with I Bonds themselves as it is a failure to do proper estate planning, and that can apply as much to TIPs or, for that matter, to any other other investment and savings products. For instance, one can have an unlimited number of beneficiaries for investments held by one or more trusts.
The accrued interest issue applicable to I Bonds can also be planned for. It may make sense for some long term owners to spread out redemptions over several years to avoid landing in a high tax bracket in a redemption year because of excessive accumulated interest. For some it may even make sense at some point to elect to report interest annually, especially older owners with beneficiaries who are already in high tax brackets. The question is who should bear the tax burden, and when.
My only quibble is that I disagree with disadvantage #5 as it relates to I Bonds. The $10,000 limit is a misnomer if you employ a spousal gifting strategy.
A year ago when the I Bond composite rate was 7.12%, the first time it ticked up in earnest and gained mainstream attention, you and your spouse could have purchased $20,000 of I Bonds in December. In addition, you could’ve purchased an unlimited amount of $10,000 I Bonds as spousal gifts and tucked them away in your TD gift box, as long as you were willing to deliver them one year at a time in $10,000 increments after that.
Let’s say you purchased $80, 000 in gift I Bonds at that time, which you can also do in a day, $40,000 by each spouse. You now own $100,000 of I Bonds, all of which would’ve earned 7.12% annualized for 6 months, 9,68% annualized for the subsequent 6 months, and 6.48% annualized for the next 6 months. Here’s what your I Bond ladder would look like by year:
2021 – 100,000 purchased, $10,000 owned per spouse
2022 – 20,000 delivered between spouses, $20,000 owned per spouse
2023 – 20,000 delivered between spouses, $30,000 owned per spouse
2024 – $20,000 delivered between spouses, $40,000 owned per spouse
2025 – $20,000 delivered between spouses, $50,000 owned per spouse.
You can sell as you go, hold as long as you want, buy more along the way without limit and delay the deliveries, or buy more after the deliveries.
You could’ve bought 100,000 of five year TIPS back in December 2021 instead of I Bonds, but I think you’d have been much better off with the I Bonds capturing those high yields on all $100,000.
All true — looking into the past — but do you think the gifting strategy continues to be as attractive in November 2022 with the variable rate dropping to 6.48% and the future rate uncertain? I think it is still an option, but less of a home run.
Great question and I agree it’s not a slam dunk like it was a year ago. Last year we were in a rising interest rate environment. This year we are in a declining interest rate environment, so it is less attractive, but not entirely unattractive either given that the current I Bond rate of 6.89% annualized (with a 0.4% fixed rate) is still a better return over the next 6 months than any other fixed rate option out there (because it is backward-looking as you stated).
If you ignore both the year over year inflation rate of 7.7% (double that backward looming time frame) and the July and August inflation rates of 0.0% and 0.1%, and focus on the 0.4% rate each of the last two months, inflation projects to be running at an annual rate of 4.8%. With the Fed continuing to raise rates, it could come down even further, although we don’t know the future for certain.
For these reasons, I wouldn’t go all-in with the I Bond gifting strategy this year like I did last year, but my current strategy is to wait until mid-April to consider buying more I Bonds vs. delivering gift I bonds sitting in my gift box. In the meantime , I have a $20,000 T-bill maturing in April. If I’m right and the annualized I Bond rate comes in at 4.8%, I will buy another round of I Bonds to capture the 6.89% (with the 0.4% fixed portion) and the following 4.8% which combined will give me a return of 5.845% for the subsequent 12 months from April 2023 to April 2024, and delay the gift I Bond delivery for one more year. Then after that, I anticipate delivering I Bond gifts in future years and perhaps redeeming the I Bonds with 0% fixed rates first depending on what inflation is doing.
At least, that’s my plan at the moment.
Marc’s post focuses on the spousal gifting mechanism as a way of increasing total possible I Bond purchases each year.
Another is to just open multiple Treasury Direct accounts in both individual and trust names, since Treasury Direct considers an “entity” (e.g., trust) account to have its own separate I Bond purchasing limit even if the entity is registered (and reports any taxable income from I Bond redemptions) under the same Social Security number as the individual account.
My wife and I were aware of the gifting mechanism but considered it too cumbersome. Each of us has an individual Treasury Direct account, and each of us has an individual Treasury Direct trust account (naming the other as sole primary beneficiary). Those individual trusts were established solely for expanding our annual allowance of I Bonds, i.e., we don’t expect or intend to use the individual trusts for anything else. For actual estate planning purposes, we also have a joint trust, though we haven’t yet used it at Treasury Direct.
Counting two individual accounts, two individual trust accounts, a joint trust account, and up to $5,000 of federal income tax refund which can be received as paper I Bonds, that’s a potential total of $55,000 a year in I Bond purchases.
Whether we actually have that amount of spare cash in any given year is, of course, a different question. 🙂
Here is one of the comments you predicted: I think the deflation protection of Ibonds is under-appreciated. That protection becomes more valuable when inflation is volatile. If we have periods of deflation the real return of the current Ibond will be more than the 0.4% fixed rate. With only occasional 6-month deflationary periods (last I checked there were 2 since ibonds were introduced) this does not close the gap to TIPS. But if inflation is volatile, and deflationary periods happen more often, Ibonds provide protection. Add to that the tax-deferred compounding of inflation in Ibonds which further closes the gap in returns. For these reasons I like I bonds for the long-term (not short term)
One little understood fact about I Bonds is that they actually *benefit* versus inflation after a period of deflation. If inflation runs at -2% for six months, the I Bond earns 0.0%, so it has out-performed inflation by 2%. When inflation rises from that dip, the I Bond holder gets the full benefit of the increase, without taking any penalty on the decrease. This doesn’t happen often, though. Only twice since 1998 as you point out. Last time was when the variable rate was -1.60% at the May 2015 reset.
One other point: If we have a negative variable rate, it will potentially wipe out any fixed rate, creating a composite rate of 0.0% but no lower.
Yes, it’s the one investment in which the fixed rate isn’t guaranteed to return a fixed rate, another I Bond misnomer in that rare case along with the $10,000 annual limit.
if “fixed rate” is such a misnomer to you, what would you think a better name for it would be? Because, frankly, fixed rate is exactly what it is: a rate that is fixed for the life of the bond. The problem is you are confusing the fixed rate with the combined rate (which is a combination of that fixed rate with a variable rate, the end result of which is obviously going to be a rate that varies).
Hey John,
I’m just being a stickler but I’ll expand on my complaint even though it’s just an observation. I don’t want to call it anything else. I want it’s full definition and implied benefit to be realized by the recipient in all circumstances.
A fixed rate means the rate doesn’t change ✔️ AND you RECEIVE that fixed rate until maturity of the financial instrument ❌, which isn’t the case with an I Bond in deflationary times. I want the bond to return the fixed rate portion of the composite rate to the bond owner even if the inflation rate is negative. Instead of freezing the rate of return at 0% in this scenario, TD would freeze the rate of return at the fixed rate, which comports with the definition of an I Bond on the TD website:
“ With an I bond, you earn both a fixed rate of interest and a rate that changes with inflation.” — Treasury Direct
This is not true with deflation, and that’s annoying. They key word to me is “earn.” In the rare case when there’s no inflation, I should earn 0% AND I should earn the fixed rate, but I don’t. I can’t think of any other financial instrument that promises a fixed rate of return and then doesn’t actually pay it out to the customer.
Of course, I know why this is and I understand it’s their “house” rule for how the composite rate works in such times, as you indicated.
“AND you RECEIVE that fixed rate until maturity of the financial instrument ”
And you *DO*. Again, you are confusing the fixed rate (which doesn’t change for the life of the bond – it stays the same until maturity) with the composite rate (which is a combination of the fixed and variable rates which can and does change as the variable rate changes).
” I want the bond to return the fixed rate portion of the composite rate to the bond owner even if the inflation rate is negative”
Then what you are asking for isn’t a fixed rate component of the composite rate, it is a floor on the composite rate equal to the fixed rate instead of the current 0% floor. Or alternately a 0% floor on the variable rate.
So, what we’ve just established is that “fixed rate” isn’t a misnomer, it’s you repeatedly confusing the fixed rate with the composite rate floor.
““ With an I bond, you earn both a fixed rate of interest and a rate that changes with inflation.” — Treasury Direct
This is not true with deflation, and that’s annoying”
Be glad that it’s “not true with deflation”, that floor of 0% prevents you from getting a negative composite rate. That’s a *good* thing.
On this “fixed rate debate.” The I Bond’s fixed rate is fixed, but is added to the variable rate to create the composite rate. If you add a positive number to a negative number, you may end up with 0.0%. That’s the way it works and I am fine with that.
Consider the way the Social Security COLA works, much more punitive. If we have a year with a negative CPI-W inflation rate, the next year’s COLA formula skips the negative year and goes back to the previous year to determine the future rate. So in other words, no benefit from the deflation. The result was that in both 2010 and 2011, there were 0.0% COLA increases, even though inflation was up in the second year.
At what point does the fixed rate go to zero during deflationary periods? For example, the current I-Bond has a 0.4% fixed rate. If the inflation/deflation rate is 0%, then the I-Bond will still have a 0.4% fixed rate and it will go to 0% only if the deflation rate is 0.4% or greater, correct?
That’s correct.
I was thinking… 5% of my portfolio is (thankfully) in I-Bonds now. Maybe that’s way more than enough to commit to that weak TreasuryDirect platform and “customer no-service”. Your article makes me think about buying a TIP on the secondary market maturing 7/15/26, which is the soonest one after my retirement date. I’m thinking the financial world may be different then, my personal outlook certainly will be, I’ve no idea how I’ll want to be allocated then (lots going on here at a personal & family level)
Thanks for another good comparative article, and thanks for the earlier aticles with instructions on how to buy I Bonds and short term T Bills. Question please—what is the “apple to apple” comparison on the return I would get (a.k.a. $$ in my pocket) on $10,000 I Bond and $10,000 in TIPS bought today and held for the the same 5yr period?
There is no way to know exact amounts, since it depends on future inflation. If you bought an I Bond today, you’d be assured of getting 6.89% annualized for six months (about $324) and then some return that is 0.4% above annualized October to March inflation, and then 0.4% above future inflation for five years. With a five-year TIPS, you’d potentially earn 1.7% a year above future inflation, but it’s all in the future, so who can say? “Apples to Apples” the TIPS should earn about $130 more a year than the I Bond after that first six-month period. But if deflation hits hard, it will earn less than $130 more.
Excellent summary, as usual. My situation demands attention to taxation with the TIPS dispensing coupons insufficient to cover the taxes on the coupon payments plus OID increments. Best to use a tax-deferred account to avoid headaches if possible.
Great comparison summary. I would point out that the Disadvantage #2 regarding not being able to purchase I bonds in a tax-deferred account, while true, is misleading. There is no need to! I bond interest is tax deferred until redemption just like an IRA or a 401k.
I agree, but the issue I was referring to is raising money to buy the I Bond. In a tax-deferred account, you can move money around to make a TIPS purchase, but not to buy an I Bond. That makes it easier to buy an TIPS without any tax consequences in raising the money.
That assumes raising the money is an issue. Since it’s a limit of $10k/year/entity, that could well fall within the amount of money one already has available to save/invest (unless one is struggling to pay the bills, in which case any money raising would first be aimed at paying the bills rather than buy the bonds) be it from their salary (if still working), RMDs (if in retirement), or other sources of taxable income that exceeds their yearly expenses.
In other words, unless one has no discretionary income to speak of, that “disadvantage” probably isn’t much of one for most ibond purchasers. IMO.
Excellent article, as always.