I-Bonds: Buying in October vs. November (Part 1)

Well, there goes another Saturday devoted to watching college football. Now back to the issue at hand – Should I buy I-Bonds now or later? I’m definitely buying some, since the higher rate, low risk, and 1-year minimum hold time matches my Mid-Term goal needs very well. As I and others have mentioned, as long as you buy sometime during the month, you get interest for the entire month. So if you buy at the very end of the month (I’ll call this ‘buying late’), you can view it as getting 12 months of interest in only 11 months. So, we should buy either at the end of October or the end of November. There is a difference, so let’s compare:

Buying in October
If you buy in October, because you lock in your known fixed rate (1.2%), you’ll know exactly what your interest rates will be for the next 12 months. For the 1st six months, you’ll add the current variable rate:

10/05 to 3/06: Fixed + Variable = 1.2% + 3.6% = 4.8%

For the next 6 months, you’ll get your locked-in fixed rate again plus the upcoming new variable rate:

3/06 to 9/06: Fixed + Variable = 1.2% + 5.72% = 6.92%

So over the first 12 months, you’ll get a average annual rate of 5.86%, beating all current 1-year bank CDs.

But, there are some added complications. The bad? If you cash out your I-bond in less than 5 years, you lose your last 3 months of interest as a penalty. The good? Your earnings are exempt from local and state taxes. Let’s work through this too.

Penalty Issues
Cashing out after 12 months (or 11 buying late) will lose you 3 months at 6.92%, which will bring your annual return down to 4.125% (or 4.5% buying late), still beating out 1-year bank CDs.

Another alternative is to cash out after 15 months (or 14 buying late), so you will lose 3 months of unknown interest, but keep that last 6 months of 6.92% goodness. That will earn you an annualized rate of 4.688% (or 5.02% buying late). Better rate, slightly longer holding time.

Tax Exemption Issues
If you pay income tax rate on city, county, or state levels then your I-bonds are boosted more since savings bond earnings are exempt from them. If you assume a Federal tax rate of 28% and a State tax rate of 10%, that 5.02% rate turns into the equivalent of a 14-month CD paying 5.83% APR. The best 1-year CDs I could find only pay around 4.6%!

Long post, so in the next post I’ll look into what you get if you wait until the end of November. Unfortunately, that involves a lot of guessing.