With current "high-yield savings" and CD rates barely hovering above 3% APY, and inflation rates marching on well above that, I've become increasingly concerned about protecting my savings (such as they are). As such, I've been looking seriously at Series I Savings bonds, which seem quite attractive, particularly as we approach the May 1 rate reset.
For anyone who was as unfamiliar with I bonds as I was, here's a rundown of some highlights:
- The earnings rate is comprised of 2 components: a fixed rate (good for the lifetime of the bond), and an inflation rate equal to the semiannual increase in the CPI-U (changes to the current inflation rate every 6 months). New rates are published every May 1 and November 1.
- I bonds earn interest for the entire month of purchase regardless of the actual date of purchase (i.e. a bond purchased April 30 earns interest as if it was purchased on April 1.) Interest for the previous month is posted on the first of the month, and is compounded semi-annually.
- I bonds have a minimum holding period of 1 year (from issue date) and stop earning interest after 30 years. If a bond is held for less than 5 years, the last 3 months of interest are forfeited.
- Interest is exempt from state and local income taxes, and is federal income tax-deferred until the bond is redeemed.
- When the bond is used for qualified education expenses, including rollover into an ESA or 529, the interest may be tax-exempt. (More information here)
- The current purchase limit (per Social Security Number) for I bonds is $5,000 in electronic bonds, plus $5,000 in paper bonds purchased from a financial institution.
The current (Nov 2007 - April 2008) rates are 1.2% fixed rate and 1.53% semiannual inflation rate, for a composite of 4.28%. Any I bond issued before May 1 will earn 4.28% for 6 months, then 1.2% + current inflation rate for each 6 month period after that.
Here's where it gets interesting. CPI data for March was just released today, and the new CPI-U is 213.528, an increase of 2.42% from the September 2007 CPI-U of 208.49. This means that the second 6 months for I bonds issued before May 1 will earn a composite rate of 6.07%. Thus, a 14-month holding strategy (buying on April 30, 2008 and selling on July 1, 2009; 12 months of interest after the 3 month penalty) earns an equivalent annual rate of 4.49%. With a state income tax, the I bond is even better! Assuming a 6% state income tax rate, the I bond equivalent yield jumps to 4.78%!
Now, it is likely that the inflation rate will drop in another 6 months, and/or rates on other savings vehicles will rise, making it unattractive to hold the bond beyond these first 14 months. However, a worst-case scenario of 4.49% APY for 14 months (with the potential for greater benefits depending on one's individual tax situation and how the rates change) is certainly worth serious consideration now. Just remember to purchase before May 1 to lock in these rates!
More information about I bonds can be found at TreasuryDirect.gov