A Simple Guide to Series I Savings Bonds (I-Bonds)

by Xin Lu on 22 April 2008 10 comments

After the recent interest rate cuts by the Federal Reserve many of my bank and money market interest rates plummeted.  Now the best yield I have is on my Series I Savings Bonds issued by the United States Treasury.  These bonds are also known as I-Bonds and their yields fluctuate according to inflation.  Currently, the yield is 4.28% and that beats all of my other cash investments.  Here is some information on the interest rate on I-Bonds and the advantages of owning these bonds.

The yield on I-Bonds changes every May 1st and November 1st.  The composite interest rate is based on a fixed rate and a variable portion that fluctuates with the semiannual inflation rate.  The formula used for the yield is:

[Fixed rate + (2 x Semiannual inflation rate) + (Fixed rate x Semiannual inflation rate)]

The fixed rate is currently 1.20%, but it is expected to drop on May 1st.  However, the inflation rate has gone up so the variable rate will be higher than before. If you lock into the current fix rate, it is expected that the next composite rate would be above 6%.

You have to hold an I-Bond for a year before you can cash out, and if you cash in your I-Bonds before five years you will lose 3 months of interest. However you can take advantage of the bond's interest accrual rules to lose only 1 month of interest. It is a bond that gives you the whole month's interest no matter which day you purchase or sell it.  As an example, you can buy the bond on April 30th this year and sell it on May 1st next year.  Your holding time is one year, and you are supposed to lose three months of interest, but you actually only lose one month and two days' interest because you actually held the bonds for only one day in the two months you performed the transactions.  If you choose not to sell the bonds they will continue to earn interest for 30 years.

There are several advantages to owning I-Bonds.  First, taxes on these bonds are deferred so you can choose to pay them only when you sell them.  Second, local and income taxes are not charged on all Treasury Bonds so in a high tax state like California the effective yield is even higher.  Third, you can reasonably predict what the next interest rate would be according to the CPI reports.  Finally, it is a relatively safe investment because it is backed by the United States Treasury.

Currently you can only buy $5000 of I-Bonds online per year through http://treasurydirect.gov, but you can also buy $5000 of paper notes through a bank.  There should be no transaction fees to buy I-Bonds and as long as the US Government does not fail completely you are guaranteed to get your money back.  The current I-Bonds yield is definitely better than any CD or savings account out there, but if you make a purchase make sure you do not mind leaving your money with the government for at least a year.

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Guest's picture
Shane

So you're saying I can buy these bonds, and keep them for one day and get the interest for almost an entire year? That can't be right. Right?

Philip Brewer's picture

It's not quite that good. You have to hold an I Bond for a year, and if you cash it in after less than 5 years, you pay a penalty of three month's interest.

However, if you buy it on the last day of a month, you still earn the interest for that whole month.  And, if you cash it in on the first day of a month, you earn the interest for that whole month as well.  That can really cushion the 3-month interest penalty, if you have to cash it in before 5 years are up.

And, as Xin says, the current interest rate is awesome.  Even after taking the interest rate penalty into account, it beats any other safe investment out there.

You might want to buy before the end of this month, though.  I don't expect the fixed part of the rate to stay this good.

Guest's picture
Guest

The limit is 5,000 for each SS#. So even though the interest rate is great, at the end of 5 years you will have made 1,500 minus Fed and State taxes. In the overall scheme of things, if you just eliminated only one 4 dollar Star Bucks coffee a day after five years you will have saved 5,200 with no taxes and not tying up 5,000 dollars which you could invest in the stock market, or as a down payment for a house, or you could pay off your 20% credit card and save an additional 5,000 dollars in interest over the next 5 years and still have your 5,000 dollars from your Starbucks savings.
You see, when dealing with these small amounts of money, I bonds are not the greatest deal.

Guest's picture
Gary

Can I-Bonds be purchased as an IRA investment? I could not find this answer on the treasurydirect.gov website.

Xin Lu's picture
Xin Lu

Yeah, it's pretty unfortunate that they cut the limit to $5000 per social security number. When I first purchased them in 2005 the limit was $30000 per person per year. I guess too many people bought them or something.  Though, I wouldn't say that $5000 is a small amount of money, and the risk of putting your money in the stock market is exponentially greater than buying I-bonds.  You should treat I-Bonds more like a savings account or 1 year CD.

Philip Brewer's picture

There are separate limits for I Bonds that you buy electronically and actual paper I Bonds that you buy from the bank.  You can buy $5000 in each form for a total of $10,000:

http://www.treasurydirect.gov/news/pressroom/pressroom_reducedpurchaseli...

Xin Lu's picture
Xin Lu

Gary, if your investment firm offers the option of buying I-Bonds then you can have it in your account.  I know some firms charge a ridiculous fee for purchasing bonds, though. 

Guest's picture
Michelle

I am still dealing with trying to find someone to authorize my electronic account, but the Treasury did tell me that you can get paper bonds by postal mail as follows:

--------------------------

If you are wanting a paper bond and you are unable to find a bank in your area that sells them, you may order them by mail from your servicing Federal Reserve Bank.

You would first need to order the purchase forms by mail (they can't be downloaded because they are in triplicate). This can be done at our website below:

http://www.treasurydirect.gov/forms.htm

Click on "Savings Bond Forms" under Forms for Individual/Personal Use and then click "Purchase Forms" under the Form Categories heading. You will need a PD F 5263 for Series EE bonds or a PD F 5374 for Series I bonds.

Once you have the forms, fill them out and mail them along with your check to your servicing Federal Reserve Bank. You can find out the address at the link below:

http://www.treasurydirect.gov/FC/FCGateway?site=indiv&app=sav

Enter your zip code and click on "Locate."

Guest's picture
chandler_loki

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Guest's picture
robi

Just got off the phone with TreasuryDirect.

You cannot convert paper bonds until one calendar year after purchase (not on their FAQ's)

I cannot figure out the rational behind allowing an online purchase of $5000, and a paper purchase of $5000, but requiring the paper to stay paper for one year.

Outside of some little weird rules like this, this is one goverment agency that has it's act together.

I'm a long time bond buyer, and trust me, these may be boring but they make a good balance to equities.