Saturday, May 14, 2011

I Bonds

There’s been quite a buzz lately in investing blogs and forums about I Bonds. The reason? The annualized interest rate for I Bonds purchased from May through October 2011 is 4.6% for the first six months. I’ll explain the details below, but this means that you will get a minimum return of about 2.5% if you buy an I Bond in late May of 2011 and sell it on May 1, 2012. This is a guaranteed, risk-free return that is much higher than any short-term, safe investment or savings vehicle, except perhaps for a reward checking account, and the interest is free of state taxes. The return could be even higher, depending on inflation during the second six months.

I Bonds are inflation-linked savings bonds issued by the US Treasury. I Bond Interest consists of a fixed rate set at time of purchase, plus an inflation rate that is reset every 6 months based on the change in the Consumer Price Index (CPI-U). The fixed rate currently is 0%, and the inflation rate is 4.6%.

You cannot sell an I Bond for about 1 year after purchase, so you don’t want to buy one with money you’ll need in less than a year. If you buy an I Bond before the end of May, you’ll earn interest starting from May 1st, and you can sell your I Bond on May 1st of the following year. If you sell an I Bond in less than 5 years after purchase, you lose 3 months of interest, but with a fixed rate of 0%, you’ll only be losing the inflation component of the interest.

You can only buy a maximum of $10,000 worth of I Bonds in a single year—$5,000 in electronic form from TreasuryDirect, and $5,000 in paper form from a bank or using the online, mail-in Order for U.S. Savings Bonds form. The minimum I Bond purchase amount is $25 using TreasuryDirect, and $50 for paper I Bonds.

To buy I Bonds from TreasuryDirect, you must open a TreasuryDirect account, which is electronically linked to your checking or savings account. To open a TreasuryDirect account, navigate to, then click Open an Account. After completing the application, you’ll receive an email with your account number, and you will be mailed an Access Card, which is required to log on to your account. If you want to start earning interest in May, you should open your account now so you’ll receive your Access Card in time to complete your purchase before the end of May.

I used to have a TreasuryDirect account, but I had not held any I Bonds or other treasury securities in it for a few years, so it was closed. So today I spent about 5 minutes online opening a new account. As soon as I receive my Access Card (hopefully before the end of May), I’ll buy $5,000 of I Bonds through TreasuryDirect. I’ll also either use the online form or a local bank to buy another $5,000 in paper I Bonds.

If you buy the maximum $10,000 in I Bonds before the end of May 2011, you will earn $230 in interest as of October 31 (6 months of interest at 4.6% per year). The inflation rate for the next 6 months will be announced on November 1, and is based on the inflation over the preceding April through September. If the inflation rate announced in November is 0% or less, you will earn no interest from November 1 through April 30; in this worst case scenario, you will have earned $230 on your $10,000 for about 11 months (assuming you bought the I Bonds at the end of May), which comes out to about 2.5%. If the inflation rate for the second six months (announced in November) is greater than 0%, which I’m betting it will be, your return will be higher.

You may decide to continue to hold your I Bonds for more than a year, and perhaps buy even more next year, especially if the inflation rate is high. I Bonds pay interest for up to 30 years, and federal income tax on I Bond interest is deferred until you sell the bond (and as mentioned previously, there are no state taxes on I Bond interest). This makes I Bonds a great way to increase your tax-deferred space if you already are maxing out your IRA and 401k/403b contributions. Also, once the 1-year minimum holding period is up, you can consider I Bonds part of your emergency savings, since you can quickly liquidate them at any time (sacrificing 3 months’ interest if sold before 5 years).

Here are links to an article and another blogger’s post on I Bonds and the current 4.6% return—they may explain some things better than my post:

The TreasuryDirect web site explains I Bonds in great detail, starting at the I Savings Bonds page.

If you have money sitting in a taxable account (probably earning 1% or less before taxes) that you’re sure you won’t need for at least a year, and you don’t mind spending a little time filling out the forms to set up a TreasuryDirect account and/or buy some paper I Bonds, then consider buying some I Bonds soon. It won’t make you rich, but at least you have the option of making a little more interest in these times of low interest rates, and at least keeping up with inflation.

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