## Friday, June 10, 2011

### I Bonds: Part 2

I received a couple of questions about Series I Savings Bonds (I Bonds) since my last post. One of the questions was about interest rates, and the other was whether or not I Bonds were only a good deal if bought in May 2011. I’ll address these questions in this post, and also will cover a few additional I Bond topics; e.g., I Bond registration (forms of ownership), more on annual purchase limits, and purchasing I Bonds for a minor child or living trust. As always, if you have questions, please post a comment or email me at KevinOnInvesting@gmail.com.

Interest Rates

Interest rates are usually expressed as annualized (per year) rates. If you are earning 1% on \$100 you’ll earn \$1.00 in interest in 1 year. If you withdraw your money after 6 months, you’ll earn half a year’s interest—\$0.50 or 0.5%. The annualized interest rate on I Bonds purchased in May through October 2011 is 4.6%, but that rate applies only for 6 months, so during that 6 months you’ll earn 1/2 of the full year rate or 2.3%. This is referred to as the semi-annual interest rate.

The rate that applies for the second 6 months is unknown at this time, and will depend on the inflation rate for the 6 months ending September 30. In the last post I looked at the worst case scenario of 0% inflation (or less—the I Bond rate never goes below 0%, even if inflation is negative) for the second 6 months. Let’s look at another example to help understand how to calculate the full year interest rate.

Say inflation is 3% annualized for the 6 months through September. This is the rate that will be used to calculate the interest rate for the second 6 months for I Bonds purchased from May through October 2011. Divide by 2 to get the semi-annual interest rate of 1.5%, since this rate will apply for only the second 6 months, not a full year. Your return for the full year depends on whether you redeem the I Bond or continue to hold it, because if an I Bond is sold within 5 years of purchase, you lose the interest for the last 3 months; this is an early withdrawal penalty.

If you continue to hold the I Bond, your return for the first full year will be the sum of the two semi-annual interest rates: 2.3% + 1.5% = 3.8%.

If you redeem the I Bond in as soon as possible, 12 months after you bought it (the first month counts as a full month regardless of when you buy the bond during that month), your semi-annual interest rate for the second 6 months is cut in half, because you lose the interest for the last 3 months. This cuts your semi-annual interest rate for the second 6 months from 1.5% to 0.75%. In this case you earn 2.3% for the first 6 months and 0.75% for the second 6 months, which gives you a total 1 year return of 2.3% + 0.75% = 3.05%.

These examples shows how any inflation rate greater than 0% for the second 6 months will increase your return from the minimum guaranteed 1-year return of 2.3%, whether you redeem the I Bond or continue to hold it.

Note that your annualized return will be slightly higher if you buy the I Bond later in the month, since you’ll earn interest from the beginning of the month in which you buy it. For example, if you buy an I Bond on June 30, 2011, and redeem it on the June 1, 2012, you’ll earn 12 months interest in 11 months. To calculate your annualized rate for this scenario, divide your actual rate by 11 (giving you the monthly rate) then multiply by 12 (giving you the annualized rate). In our example, this would yield 3.05% / 11 X 12 = 3.33%.

Is it Too Late to Take Advantage of This Great Deal?

You get the same deal if you buy an I Bond any time before November 1, 2011. You get the 4.6% annualized (2.3% semi-annual) interest rate for the first 6 months, and the interest rate for the second 6 months is based on the 6-month inflation rate as of the end of September 2011. Assuming your are reading this before mid-October 2011, you still have time to get this deal. The only thing you missed out on is starting to get this nice rate as early as possible (May 2011).

You may be able to buy paper I Bonds from your local bank, so you may want to check into that as an alternative to using the online mail-in form.

The online mail-in form used to purchase paper I Bonds also can be used to purchase series EE savings bonds (not discussed here), so be sure to enter the quantity in the I Bonds section of the form.

Minimum Purchase Amounts, Denominations

The minimum I Bond purchase amount using Treasury Direct is \$25, and you can purchase them in increments of a penny. Paper I Bonds are available in various denominations from \$50 to \$5,000.

With proper identification you should be able to redeem paper I Bonds of \$1,000 or less at any bank. If you want to purchase more than \$1,000 of paper I Bonds, consider purchasing multiple bonds in denominations of \$1,000 or less (this also gives you more flexibility in your redemptions). For example, to purchase the maximum annual amount, instead of purchasing one \$5,000 bond, you might purchase five \$1,000 bonds.

Annual Purchase Limits

In my last post I mentioned that you are limited to purchasing \$5,000 worth of I Bonds electronically and \$5,000 in paper form annually, for a total of \$10,000 per year. I didn’t mention that you also can buy these same amounts for your living trust, and if you want, for each of your children (or anyone else for that matter). So, a couple with 2 children and a living trust could purchase a total of \$50,000 of I Bonds per year: \$10,000 for each spouse, \$10,000 for their living trust, and \$10,000 for each child.

To purchase electronic I Bonds for your living trust, you open a separate entity account at Treasury Direct.

To purchase paper I Bonds for your living trust, you use form PD F 5374-1, SERIES I ORDER FOR U.S. SAVINGS BONDS TO BE REGISTERED IN NAME OF FIDUCIARY, and mail it to the Federal Reserve Bank that services your part of the country, which you can find by entering your zip code into the Treasury Retail Securities Site Locator. You can order this form from the Purchase Forms section of the Savings Bond Forms Ordering page on the Treasury Direct web site.

You may be able to buy paper I Bonds for your trust at a local bank, but I was unable to do so at my local Wells Fargo bank, so I mailed the Fiduciary form and my check to the Federal Reserve Bank of Minneapolis, which services the western part of the country. The Fiduciary form doesn’t provide a mailing address, so I called the Federal Reserve Bank of Minneapolis and verified I could mail it to them.

You may redeem the I Bonds in the linked account before your child turns 18. Once your child turns 18 you cannot redeem the bonds yourself—you must transfer them to the child. When your child turns 18, he or she creates his or her own Treasury Direct account, then you de-link the child’s account from your account, and transfer the I Bonds into your child’s account.

You can purchase paper I Bonds for your child (or grandchild or anyone else) using the same online mail-in form you use to purchase them for yourself. If you prefer to be the formal custodian for your minor child’s bonds, you can use the Fiduciary form (same form used to buy bonds for a trust). You can obtain the Fiduciary form at the Purchase Forms section of the Savings Bond Forms Ordering page on the Treasury Direct web site.

Registration (forms of ownership)

Except when purchasing I Bonds for your living trust, you’ll probably want to name a co-owner (paper bonds), secondary owner (electronic bonds) or beneficiary for your I Bonds. This makes it easier for your heirs to access and sell the I Bonds in the event of your death, since with these forms of ownership the bonds are not subject to probate. Note however that a co-owner, secondary owner or beneficiary cannot be named with a living trust registration.

For precise descriptions of the different ways to register I Bonds, see the Register an EE or I Bond page at Treasury Direct.

For paper I Bonds, you can select a co-owner or beneficiary when you fill out the purchase form.

For electronic I Bonds it’s a little more complicated. When you create your Treasury Direct account, the registration initially available is Sole Owner (with you as the sole owner). To use Primary Owner (with Secondary Owner) or Beneficiary registrations, you must first create a new registration in your Treasury Direct account. After logging in to your account, select ManageDirect from the top menu bar, then under Manage My Account select Update my Registration List, then select Add Registration. Click either Primary Owner or Beneficiary, then enter the names and social security numbers for yourself and the secondary owner or beneficiary. If this is the registration you will normally use, click Make this my preferred registration.

If you register an electronic I Bond as Primary Owner (with Secondary Owner), you can grant transaction rights to the secondary owner if the secondary owner has a Treasury Direct account. This enables the secondary owner to redeem the I Bond without the knowledge or consent of the primary owner, similar to a co-owner of a paper I Bond.

Be sure to inform the co-owner, secondary owner or beneficiary about the I Bonds, either directly or through written instructions that are available to them upon your death. For paper I Bonds, you should keep a record of the bond serial numbers. For electronic I Bonds, keep a record of your Treasury Direct account number.

1. I disagree that you can purchase I bonds for both yourself and your living trust. According to Treasury Direct, the limit is applied per Tax ID Number. A living trust typically uses the social security number of one or its grantors as its Tax ID Number. Since the limit is applied to the Tax ID Number (in this case, the grantor's social security number), I believe that the trust is not allowed to purchase I bonds after the grantor has reached the limit. If you disagree, please explain why.

2. Anonymous,

Regarding purchase limits for a living trust and an individual whose SSN is used as the Tax ID for the trust, from the language used in most places, one would think that you could not double up on the limits by using a living trust, for the reason you stated. For example, here is the first Q&A from the Federal Reserve Banks web page on savings bond limits frequently asked questions (http://www.frbservices.org/help/savings_bond_limit.html#7):

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Q: What is the annual purchase limit for U.S. Savings Bonds?

A: Effective January 1, 2008, the annual (calendar year) purchase limit applying to Series EE and Series I savings bonds is \$5,000, issue price, for each series. The limit is applied per Social Security Number (SSN) or Taxpayer Identification Number (TIN). Individuals or entities may purchase up to \$5,000 worth of each series in paper form. In addition, individuals can buy up to the same amount of each series in TreasuryDirect online accounts, or a total of \$20,000 (issue price) in single ownership form per calendar year. Please note: Bonds purchased as gifts in the names of other people do not count against the bond purchaser’s own annual purchase limit, even if the purchaser’s SSN is used for the gift purchase.
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However, another Q&A on the same web page addresses the limits for trusts and individuals whose SSN is used as the TIN for the trust:

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Q: How does the limit apply to bonds purchased in the name of my trust?

A: You may purchase up to \$5,000, issue price, for each series in the name of your trust using the TIN assigned to the trust. The limit applies to the trust as a single entity. If an individual’s SSN is used to purchase bonds in the name of the trust, that individual may still purchase up to the annual limit of both series under his or her own name.
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From the first Q&A, you can infer that they are talking about the limits on savings bonds in each form (paper or electronic).

I've seen this discussed in various places, but it's nice to have an authoritative source (the Federal Reserve Bank) to reference. A trust seems to be an exception to the common language of "per series, per type, per SSN/TIN".

You can definitely open a Treasury Direct account for yourself as an individual and for your living trust using your SSN, and purchase the maximum annual limit in each account--I've done it.