Series I Savings Bonds are issued by the U.S. Treasury. They currently earn about 7% at an annualized rate through April 2022, are backed by the full faith and credit of the U.S. government and their redemption value cannot decline. We’ll start with the catches –
The Catches:
- You may only purchase $10,000 annually per Social Security number in a calendar year.
- I Bonds are purchased directly from the U.S. Treasury via the TreasuryDirect website. Neither we (Red Tortoise) nor you can purchase them via Schwab, other brokerage firms or financial institutions.
- You must hold them for at least one year.
- If redeemed before five years, you lose the previous three months’ interest.
- The current rate is 7.12% annualized through April 2022. After that the rate will be different as explained below.
- Income is subject to Federal income tax, but not state and local income taxes. Using the money for higher education may allow you to avoid paying federal income tax on your interest.
There are many benefits of owning I Bonds along with additional requirements. Visit the U.S. Government I Bond website for a complete description and explanation of the program.
The interest on an I bond is a combination of
- A fixed rate of return which remains the same throughout the life of the I bond. Currently that rate is 0%.
- A rate based on the CPI-U (the non seasonally adjusted Consumer Price Index for all Urban Consumers for all items, including food and energy). The rate is calculated twice a year (March compared to September of the same year and September compared with the March of the following year). Over the six months ending September 2021 the CPI rose 3.56% which is over 7% annualized. This is the rate which will be credited through April 2022. The interest rate can’t go below zero and the redemption value of your I bonds can’t decline.
As a worst case illustration, consider purchasing this savings bond at the end of November and holding it for a year. You will earn the current 7.12% annualized rate for the first 5 months at which time the rate resets. After that even if you earn nothing for the remaining 7 months, you will have earned about 2.9% which is higher than what you can earn on one-year CDs.
Our expectation is that a Series I savings bond purchased at the end of November will earn more than 2.9%. The 2.9% return assumes that there is no interest earned from May through November 2022 which would occur if there was no inflation from September 2021 through March 2022. If prices rise from September 2021 through March 2022 (they have already risen 0.83% in October), the return will exceed the 2.9%. If you cash in the bond after one year (e.g. December 1, 2022) you will forego the last 3 months of interest.
This may seem too good to be true. Why are these savings bonds relatively attractive? Historically and theoretically, people expect interest rates to exceed the inflation rate. The real rate is the amount of interest above the inflation rate one earns on risk-free (e.g. Treasury) securities. In the past, if inflation were 3%, people would expect interest rates to be closer to 4% (a 1% real rate) than to 2% (a negative real rate). Today we can observe negative real rates in the market for Treasury Inflation Protected Securities (TIPS). But savings bonds do not allow for a negative real rate so their return is higher.
Disclaimer: In addition to the other disclaimers on this site, this post is not an investment recommendation. It is intended to bring attention to one opportunity. Its suitability depends on many factors and it may not be appropriate for you.