Savings I Bonds are a low-risk investment backed by the US Treasury that pay out a variable interest rate linked to inflation. You could own them as a replacement for cash reserves (they are liquid after 12 months) or bonds in your portfolio. New inflation numbers were just announced at BLS.gov, which allows us to make an early prediction of May 2017 savings bond rates a couple of weeks before the official announcement on the 1st. This also allows us the opportunity to know exactly what a April 2017 savings bond purchase will yield over the next 12 months, instead of just 6 months.
New Inflation Rate
September 2016 CPI-U was 241.428. March 2017 CPI-U was 243.801, for a semi-annual increase of 0.98%. Using the official formula, the variable component of interest rate for the next 6 month cycle will be approximately 1.96%. You add the fixed and variable rates to get the total interest rate. If you have an older savings bond, your fixed rate may be very different than one from recent years.
Purchase and Redemption Timing Reminder
You can’t redeem until 12 months have gone by, and any redemptions within 5 years incur an interest penalty of the last 3 months of interest. A known “trick” with I-Bonds is that if you buy at the end of the month, you’ll still get all the interest for the entire month as if you bought it in the beginning of the month. It’s best to give yourself a few business days of buffer time though, since if you wait too long your effective purchase date may be bumped into the next month.
Buying in April 2017
If you buy before the end of April, the fixed rate portion of I-Bonds will be 0.0%. You will be guaranteed the current variable interest rate of 2.76% for the next 6 months, for a total 0.00 + 2.76 = 2.76%. For the 6 months after that, the total rate will be 0.00 + 1.96 = 1.96%.
Let’s say we hold for the minimum of one year and pay the 3-month interest penalty. If you theoretically buy on April 30th, 2017 and sell on April 1, 2018, you’ll earn a ~2.04% annualized return for an 11-month holding period, for which the interest is also exempt from state income taxes. If you held for three months longer, you’d be looking at a ~2.02% annualized return for a 14-month holding period. Compare with the current highest 1-year bank CD rates of roughly 1.5% and online savings accounts rates of roughly 1%.
Buying in May 2017
If you wait until May, you will get 1.98% plus an unknown fixed rate for the first 6 months. The fixed rate is likely to be either zero or 0.1%. Every six months, your rate will adjust to the fixed rate plus a variable rate based on inflation. If inflation picks up, you’ll get a hiked rate earlier than versus buying in April.
The primary reason to wait until May is that the current fixed rate is zero and it has a small chance of going up in May. I would personally rather lock in the solid 12-month return by buying in April rather than chase a possible 0.1% long-term bump. I plan on buying my annual limit this week, and I intend to hold these indefinitely for the reasons listed below.
Existing I-Bonds and Unique Features
If you have an existing I-Bond, the rates reset every 6 months depending on your purchase month. Your bond rate = your specific fixed rate + variable rate (minimum floor of 0%). Due to their annual purchase limits, you should still consider their unique advantages before redeeming them. These include ongoing tax deferral, exemption from state income taxes, and being a hedge against inflation (and even a bit of a hedge against deflation).
Annual Purchase Limits
The annual purchase limit is now $10,000 in online I-bonds per Social Security Number. For a couple, that’s $20,000 per year. Buy online at TreasuryDirect.gov, after making sure you’re okay with their security protocols and user-friendliness. You can also buy an additional $5,000 in paper bonds using your tax refund (see IRS Form 8888). If you have children, you may be able to buy additional savings bonds by using a minor’s Social Security Number.
For more background, see the rest of my posts on savings bonds.
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Credit card funding?
I’m afraid buying savings bonds with a credit card hasn’t been an option for many years now.
Hi Jon, if we buy the i bonds in april 2017, does that “lock” us in the composite 2.76% rate for the next 6 months as your post mentions? From May thru Oct 2017, as the variable rate may dip to 1.96%, wouldnt the composite rate on an april 2017 i bond investment drop also? thx!
Yes, if your purchase date is in April 2017, you will get 2.76% for 6 months locked-in and then 1.96% for six months locked-in. All I Bonds don’t all earn the same interest rate at the same time, it all depending on your purchase month and it changes in 6 month cycles. Buying in April keeps on the cycle starting at 2.76%, then 1.96%, then ??. Buying in May will be on the next cycle starting 1.96%, then ??. Eventually, all savings bonds will earn fixed rate + ?? but it may differ by 6 months.
This is the best explanation I’ve seen of how savings bonds work as far as timing purchases. Thanks!
How do you decide when to sell them?
If you are using them as cash replacement, you can sell if the interest rates are too low for your tastes even given the possible future upside or other unique characteristics.
Personally, I have not sold any and use them as long-term holdings. They are tax-deferred and I can either sell them down the line when my income tax rate is low or use them towards college expenses.
I apologize if I’m being ignorant, but with the 3% CDs and HY checking accounts around lately, I’m struggling to understand why these are a good idea, even with the tax deferred interest (of a whopping ~$200). The future use on education expenses is also phased out for higher earners. Can anyone convince me to bite before it’s too late in the month?
I have found HY account usually have all kind of annoying requirements like minimum debit card purcashes per month, etc. And are you seeing 3% CDs for 12 months? These become liquid after 12 months.
DirtyLilRat, Please tell us who is offering 3% CDs! The highest I’ve seen lately is 2.3%, and that’s with a 5 year commitment. I-bonds can be cashed in after 1 year (with a 3 month interest penalty) up to 30 years, and there’s no state taxes on the interest, and they aren’t federally taxed until you redeem them, and their rate goes up when inflation goes up. How about you convincing me that a specific CD is better? 😉
See below for a recent CD promo. If you withdraw after one year, you’ve still earned 1.50% APY after paying the penalty. After 2 years, you’ll have earned 2.25% APY. After 3 years, you’ll have earned 2.51% APY. At all these intervals, you are ahead of nearly all the top rates from other banks and credit unions.
https://www.mymoneyblog.com/andrews-federal-credit-union-certificiate-deal.html
The federal tax deferral and state tax exemption on the i-bond is only on the interest earned. It’s so insignificant.
If you are using them as cash replacement, you can sell if the interest rates are too low for your tastes even given the possible future upside or other unique characteristics.
Personally, I have not sold any and use them as long-term holdings. They are tax-deferred and I can either sell them down the line when my income tax rate is low or use them towards college expenses.
Thanks again for your blog, posts like these are very helpful.
Jonathan,
Great blog. I purchased I-bonds in 4/14. I just checked and I earned a total of 3.6% based on “current value”. That is about 1.2% annual. However, the history composite rate is about 2% for the last three years. I cannot see any history of interest earnings, except “current value”. Where did the money go?
I currently have over $15K in investment interest carryover that I can apply toward any interest I earn on investments each year, thus not pay taxes on the investment interest gains until that carryover amount is depleted.
I Purchased US savings bonds back in the early 90’s. Their current value is $10,024, of which $4800 is earned interest.
I am thinking of cashing in these bonds before the end of the year because I am afraid that the investment interest carryover ability in the tax code will be removed by the new trump tax plan.
If that deduction is removed I would have to pay tax on the $4800 gain in the future when i do cash in the bonds.
Any advice would be greatly appreciated.
Thanks,
Doug