Interest rates

I Bonds Explained: Why interest rates will hit an all-time high

One of the safest investments to protect your money from inflation is about to get even more attractive.

The annualized yield on Series I savings bonds, also known as I bonds, will rise to at least 9.62% in May – a record high, making the government bond an even more attractive way for ordinary Americans to protect their savings against record inflation. .

Since November, the interest rate on I bonds has been 7.12%. Every six months, in November and May, the US Treasury sets a new “floating” interest rate based on the previous six months of inflation.

By design, experts say I bonds are one of the safest ways to hedge against inflation.

David Enna, founder of the financial site ADVICE Watch (short for Treasury Inflation Protected Securities), has a proven track record of accurately predicting I bond rates, including the current rate of 7.12%. As Enna explains, it’s not about using a crystal ball. Rather, it’s a simple matter of math — and knowing where to look.

While the Treasury won’t officially announce the new floating rate until May 2, the Labor Department has already released all of the inflation data that the Treasury uses to calculate it.

“When last month’s inflation report – either in April or October – comes out,” says Enna, “you can tell what the rate will be weeks before they announce it.”

On Tuesday, the Labor Department released its latest inflation report, indicating that the inflation rate hit 8.5% in March, the final piece of the puzzle.

With that, we now know that the inflation rate between September 2021 and March 2022 was 4.81%. Thus, the 6-month variable rate of I bonds will be 4.81%. (Multiply that by 2 to get the annualized rate of 9.62%.)

“The floating rate of 7.12% was already a record for the I Bond, which was first issued in September 1998,” Enna wrote in a TIPS Watch report on Tuesday. “So the new rate of 9.62% is going to crash through that record.”

Compare that to the average return on a savings account right now: 0.06%, according to the FDIC. The best commercial bank savings accounts and certificates of deposit (CDs) offer annual returns 10 to 12 times that (0.5% to 0.75%), but those rates are still a far cry from 9.62% .

“To add insult to injury, the lack of interest [from savings accounts] is subject to income tax,” Zvi Bodie, an economist and professor emeritus at Boston University, told Money. Interest earned on I-bonds, on the other hand, is tax-deferred until cashed.

Investing in I bonds: advantages and disadvantages

In times of high inflation, I bonds sound like a no-brainer. That’s exactly what they’re designed to protect against, after all.

In addition to being a safe hedge against inflation, they offer tax advantages. Interest earned on I Bonds is exempt from state and local taxes, and you will only pay federal taxes on the interest when you cash it. Another tax benefit? You can even avoid paying federal income taxes on I Bonds if you use them for graduate school feessuch as tuition and fees for most colleges, universities or vocational schools.

Another unique feature of I bonds is the way interest accrues. The Treasury Department says you’ll always get a full month’s worth of interest, whether you buy your I bond on the first or last business day of the month.

Similarly, you can buy an I bond on the last business day of April and still lock in a full six months of the 7.12% annualized rate before it changes in May. (Keep in mind that since it’s only for six months, the rate is effectively 3.56%.) After six months, interest is compounded, added to the principal value of your bonds, and then the new rate will automatically rise to 9.62. % (i.e. a half-yearly rate of 4.81%).

Hypothetically, if you were to buy I bonds today, you can confidently predict your return for next year by combining these two six-month rates for a 12-month guaranteed rate of 8.37%.

However, there are some big caveats. For one thing, I bonds cannot be cashed in the first year. (There is an exception for emergencies.) Similarly, if I Bonds are redeemed within five years of purchase, you will miss the last three months of interest.

You are also limited in the amount you can invest annually – $10,000 per person for e-Bonds I; and $5,000 of I-only paper bonds purchasable when you file your federal taxes. (Update April 15: To purchase paper versions of I Bonds, you must elect to use your tax refund when filing with IRS Form 8888. The average refund is around $3,200 this year, so most people are unlikely to be able to afford the maximum amount.)

Given this, financial experts say I bonds can be viewed as an inflation-protected savings account rather than a large, lucrative long-term investment.

  • Variable interest rate of 9.62% from May (currently 7.12%)
  • Designed to protect savings from inflation
  • Tax deferred interest
  • Interest exempt from national and local taxes
  • Exempt from federal taxes if used for graduate school expenses
  • Fairly liquid investment
  • Maturity 30 years
  • Backed by the full trust of the U.S. government
  • Limited potential for real gains
  • Annual purchase limit of $15,000 per person
  • Cannot be cashed within one year (notwithstanding urgency)
  • Three-month interest penalty for collection within five years
  • Not as liquid as a regular savings account
  • Must open an account with Clunky TreasuryDirect.gov
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How I Bond Interest Rates Work

In addition to the floating rate mentioned above, I bonds have a separate “fixed” rate. This second rate will remain the same throughout the life of the bond and will determine the overall bond yield I, sometimes referred to as the “composite rate”.

The fixed rate is announced on the same schedule: the first business day of November and May. Since 2020, the fixed rate has been 0%, and it hasn’t exceeded 1% since before the Great Recession.

The Treasury Department confirmed to Money that the fixed rate can never drop below zero — and neither can the combined rate, for that matter. This means that the money you invest in I bonds will not lose value, no matter how bad inflation is. (No stock can promise that, and if the interest in your savings account is below inflation as usual, then the money sitting there is effectively losing value year after year.)

In May, the composite interest rate for I bonds will be at least 9.62%. Although unlikely, it could be higher if the Treasury also announces a fixed rate above 0%, which would push the composite rate above 9.62%.

Here is an overview of the fixed rate:

  • Fixed rate, as the name suggests, is locked in for the life of the I – 30 year bond or the date you sell it, whichever comes first.
  • The fixed rate is determined on the date of purchase. If you buy an I bond with a fixed rate of 0%, that will never change. (But the variable rate can and will change, depending on inflation.)
  • Historically, the fixed rate has varied from 0% to 3.6%. It has been stuck at 0% since 2020.

Together, these two rates preserve the purchasing power of your savings and, in some cases, increase it.

For example, people who bought I bonds between May and October 2000 locked in a fixed rate of 3.6% – the highest ever – until 2030.

When the variable rate changes next month, these investors will benefit from a combination of these two historically high rates. While their fixed rate remains at 3.6%, their variable rate will reach 9.62% at an annualized rate.

The combined price? A whopping 13.39%.

Clarification: This article was updated on April 15, to clarify that paper versions of I-bonds can only be purchased with your tax refund.

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