I had a long discussion with my Aunt on Mother’s Day. The topic: interest rates. Specifically, the lack of interest on savings accounts [1] right now.
She was trying to figure out where to stash some of her money to get the best return, without any risk. With pitiful rates on CDs and bank accounts, it’s time to revisit savings bonds!
Due to inflation, the rates on I-Bonds [2] jumped up this month, which makes I-bonds much more attractive than both savings accounts and short term CDs.
Current I-Bond Rates
Current I-Bond Rates for bonds purchased in May 2011: 4.6%
The rate is made up of the following rates:
- Fixed Rate: 0%
- Variable Inflation Rate: 4.6%
Updates
I-bond composite rates for bonds purchased in:
- November 2011: 3.06%
- May 2012: 2.2%
- The next update will be in November 2012.
The fixed rate will stay the same for the life of the bond; the inflation rate of the I-bond changes twice a year on May 1 and November 1.
Inflation Rate
The inflation portion of the I-bond rate is based on the Consumer Price Index for all Urban Consumers (CPI-U).
We won’t know what the inflation rate will be for the second half of the year, so it’s impossible to calculate the return for the entire 11 months. However, the bond cannot lose value from month to month, so the minimum interest rate is 0%, even when there is deflation.
I-Bond Tips and Tricks
The basics of purchasing I-Bonds are covered in Everything You Need to Know About Buying I Bonds [3], but there are a few more tips and tricks to consider:
When to purchase: I-bonds should be purchased at the end of the month to maximize returns. If you purchase I-bonds at the end of the month, it’s as if you owned the bond for the entire month. Just be careful about an online purchase on May 31, as the transaction may not be credited until June.
How much to purchase: The maximum you can buy in I-bonds per year through Treasury Direct [4] is now $10,000. However, you can also buy another $5,000 in paper bonds per year. Update: You can no longer buy paper savings bonds [5] unless you are using a tax refund. These are individual limits; each person in your family can make the minimum purchase per year.
Redemption. You can redeem savings bonds [6] after a 1 year minimum holding period, so it’s not as liquid as a savings account. However, with an end of month purchase, it effectively reduces the minimum holding period to 11 months.
Factoring in penalties. You will lose 3 months of interest if you redeem the bond before 5 years. However, even after forfeiting the 3 months of interest, you’ll still be able to get a higher return than other current interest rates.
Look up old bonds. I used to stockpile I-bonds back in the day when you could purchase them with cash rewards credit cards [7] …. I’ve long since sold those bonds, but I’m tempted go look up how much they’d be earning now, since the fixed rates were much higher. If you made similar purchases and held onto those bonds, it looks like you’ll be seeing rates around 7-8% right now!
I-Bond Rate Formula
For those of you interested in the math, here is the official formula for computing the I-bond composite rate:
Composite I-Bond Rate = Fixed rate + (2 x Semiannual inflation rate) + (Fixed rate x Semiannual inflation rate)]
The current semiannual inflation rate is 2.3%, so the calculation looks like this:
Composite rate = [0.0000 + (2 x 0.0230) + (0.0000 x 0.0230)]
Composite rate = 4.60%
I-Bond Highlights
Some of the attractions of I-bonds (in addition to their current interest rate) are centered around the tax treatment of I-bonds:
- Interest is tax deferred until redemption.
- Interest is exempt from state (and local) taxes.
- Interest is tax exempt when used to pay for college or roll into a 529 plan [8].
In addition, children can own I-bonds; our kids each have a stash of bonds they’ve received as presents.