Update: The official announcement states that effective November 1st, the new fixed rate on Series I savings bonds is 0.0%, down from the previous 0.1%. The variable inflation-indexed rate is 1.48% (as was predicted). Thus, buying a new I Bond between November 2014 through April 2015 will earn a composite rate of 1.48% for the first six months, and after that 0% plus the current inflation-indexed rate updated every 6 months.
Original post below:
Savings bonds offer a unique opportunity for individuals to buy an investment that is closed to large institutional investors. Compare the rates on these savings bonds to what you’re earning on your FDIC-insured bank deposits or even your TIPS and bond mutual funds, and you may find them a good addition to your portfolio.
Since inflation-linked savings bonds (“I bonds”) are based on CPI numbers announced two weeks earlier, we can make predictions about upcoming savings bond rates before their official announcement. This also allows us the opportunity to know exactly what a current bond purchase will yield over the next 12 months, instead of just 6 months.
New Inflation Rate
March 2014 CPI-U was 236.293. September 2014 CPI-U was 238.031, for a semi-annual increase of 0.74%. Using the official formula, the variable component of interest rate for the next 6 month cycle will be approximately 1.48%. The new fixed rate won’t be announced until November 1st (speculation below). 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 different.
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 October
If you buy before the end of October, the fixed rate portion of I-Bonds will be 0.1%. You will be guaranteed the current variable interest rate of 1.84% for the next 6 months, for a total rate of 0.1 + 1.84 = 1.94%. For the 6 months after that, the total rate will be 0.1 + 1.48 = 1.58%. Let’s say we hold for the minimum of one year and pay the 3-month interest penalty. If you buy on October 31st, 2014 and sell on October 1st, 2015, you’ll earn a ~1.49% annualized return for an 11-month holding period, for which the interest is also exempt from state income taxes. That is better than any 1-year bank CD that I can find right now, keeping in mind the liquidity concerns and the purchase limits. If you hold for longer, you’ll be getting the full 1.76% over the first year.
Given the combination of current low rates and the fact that you lose the last 3 months of interest (again, for holding less than 5 years), it might be better to wait long enough to grab 12 full months of interest by holding for 15 months (14 buying late). If you buy on October 31st and hold until January 1st, 2016, you’d achieve an annualized return of ~1.51% over 14 months. (Check my math.)
Buying in November
If you wait until November, you’ll give up the opportunity to lock in the 0.1% fixed rate from April. Instead, you will get 1.48% plus an unknown fixed rate for the first 6 months. The next 6 months will be the sum of the same unknown fixed rate plus an unknown rate based on future inflation. If there is high inflation for the next 6-month period, buying in October may get you a higher rate sooner. My best guess for the fixed rate is that it will be somewhere between 0.0% and 0.2%.
As for my decision, I already maxed out my contribution limits for 2014 back in April to lock on the 0.2% fixed rate.
Existing I-Bonds
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. Even at a low or even zero fixed rate, your existing savings bonds are paying more than current savings accounts and will continue to be hedged against inflation, so weigh carefully whether or not to redeem them.
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 with 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. I’m keeping all of mine for the foreseeable future, due to their tax deferral possibilities and other unique advantages.
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possible typos/suggestions:
OLD: If you buy on October 31st and hold until January 1st, 2015
SUGG: If you buy on October 31st and hold until January 1st, 2016
OLD: If you wait until November, you’ll give up the opportunity to lock in the 0.2% fixed rate from April.
SUGG: If you wait until November, you’ll give up the opportunity to lock in the 0.1% fixed rate from 01-May-2014.
OLD: My best guess for the fixed rate is that it will be somewhere between 0.0% and 0.2%.
SUGG: My best guess for the fixed rate is that it will be somewhere between 0.0% and 0.1%.
OLD: As for my decision, I already maxed out my contribution limits for 2014 back in April to lock on the 0.2% fixed rate.
SUGG: As for my decision, I already maxed out my contribution limits for 2014 back in April to lock on the 0.2% fixed rate from 01-Nov-2013 (before the fixed rate changed to 0.1% on 01-May-2014).
Thanks, I always have some typos since I copy and paste my old savings bond posts and update them. Arrggh!
Does anyone know when the 402(g) limits for 2015 will be announced?
(FYI: some typo’s in the “Buying in November” section showing fixed rate as .2%. It should be .1% as noted in the “Buying in October” section. 0.2% was for last years Nov-Apr period.)
Thanks!
If you currently own a 0.0% fixed rate I-Bond that you’ve held for more than a year but less than 5 years, wouldn’t it make sense to redeem them now (and take the 90 day interest penalty) and use the proceeds to reinvest in I-Bonds that have fixed rates of >0.0%?
Perhaps (I haven’t done the math to calculate breakeven time given the 3 month penalty) but only if you have limited funds and aren’t maxing out your contributions already every year.
Jonathan – I would be interested in seeing you (or someone who has crunched the numbers) write up the calculation of how long it takes to recoup the three-month interest lost from selling an I-bond earning 0% fixed rate and buying one earning x% fixed (where x is either 0.1 or 0.2). The only discussion I can find is on Bogleheads: http://www.bogleheads.org/forum/viewtopic.php?f=10&t=125709 By mtwoy >> Fri Nov 01, 2013 12:27 pm: “By my estimates (and someone should definitely check my math), it would take 18 months with the new 0.2% fixed rate to recoup the penalty of 3 months interest at 1.18% for selling I Bonds held less than 5 years to buy new bonds.” I don’t know how mtwoy came up with 18 months.
I think I figured out the Boglehead example. Don’t ask me how I derived this. NM = 3 x IR / FR, where NM is the number of months it takes to recoup the 3-month penalty on selling an I-bond early. IR is the inflation rate of the existing bond earning zero percent fixed that you are thinking of selling. FR is the fixed rate of the new I-Bond you are thinking of buying. Note that this formula assumes you don’t pay any taxes on selling your I-bond. So for a 2% inflation rate I-bond earning 0% fixed, selling early to exchange it for an I-bond earning 0.1, 0.2, and 0.3% fixed rate respectively; it takes 60, 30, 20 months respectively to recoup the penalty. 1.5% I-bond exchanged for 0.1, 0.2, 0.3% fixed rate takes 45, 23, 15 months respectively. 1.0% I-bond exchanged for 0.1, 0.2, 0.3% fixed rate takes 30, 15, 10 months respectively. 0.5% I-bond exchanged for 0.1, 0.2, 0.3% fixed rate takes 15, 8, 5 months respectively. Long story short, this strategy makes sense if the I-bond you are selling is earning a very low inflation interest rate and the I-bond you are exchanging for earns a high fixed rate.
http://www.treasurydirect.gov/news/pressroom/pressroom_comeeandi1114.htm
1.48 inflation rate confirmed. Fixed rate is zero. So much for trying to calculate if it makes sense to sell an old zero percent fixed rate bond to get one with a non-zero fixed rate. I’m glad I bought a bunch of 0.2% fixed rate Ibonds when I did.
Yup, back to zero fixed land. What a weird interest rate world that I’m also happy about my 0.2% bonds. 🙂
Thank goodness I bought these back in 2003/2004 when the fixed rate portion was much higher than it is now, and you could buy up to $30,000 worth.
CPI-U rates came out today. May 2015 I-Bond variable rate will be -1.60%. This wipes out the puny 0.1% and 0.2% fixed rates of last year. Basically, your I-Bonds will earn zero percent for six months (when that starts depends on the purchase date). Bummer. This is why not all of my savings are in I-bonds.
Thanks Robert. This is why I basically have been in T-bills, short term notes, savings bonds I bought mostly more than 8 years ago, municipal bond funds I dollar cost averaged since 2002) and TIPS I bought mostly 8 years ago in my non-retirement part of my portfolio. I am very finicky on these low rates. Looks like my T-bills are a better deal.