High Inflation Pushing Series I Savings Bond Rates to Record Levels

The Labor Department released the September Consumer Price Index (CPI) numbers this morning, and they show that inflation is continuing to run hot. The CPI on a year-over-year basis increased 5.4% in September, which was above the 5.3% forecast by economists. Core CPI, which excludes energy and food, was up 4.0% on a year-over-year basis, which was inline with expectations. Many factors have been forcing up inflation including supply chain issues, worker shortages and rising energy costs. The Fed has been saying that this year’s high inflation will be transitory. Each new month of high CPI numbers have been raising doubts about this claim.

With the September CPI numbers, the next Series I Savings Bond inflation component can be computed. This allows us to calculate the earnings for I Bonds purchased this month and redeemed from October 2022 to January 2023.

Due to high inflation this year, I Bonds purchased this October offer much higher rates than the best 1-year CDs.

Even though I Bonds compare very favorably to CDs, their value is limited by the low I Bond purchase limits. Maximum purchases per year and per social security number is $10,000 at TreasuryDirect and $5,000 in paper bonds purchased with IRS tax refunds.

Today’s report showed that the CPI-U increased by 3.56% in the last six months (an annualized rate of 7.12%.) The 7.12% rate should be the I Bond inflation component that will be announced at the start of November. This will be the highest I Bond inflation rate since the I Bond program began in 1998. Before this year, the highest rate had been 5.70% in November 2005. If an I Bond is purchased in October, you’ll get the current rate of 3.54% for six months before the 7.12% takes effect.

Social Security Benefits Will Rise 5.9% in 2022

The September CPI report is used by the Social Security Administration to determine the cost of living adjustment for next year. High inflation this year did have a major impact on the Social Security cost-of-living adjustment (COLA) for 2022. According to the new Social Security Fact Sheet:

Based on the increase in the Consumer Price Index (CPI-W) from the third quarter of 2020 through the third quarter of 2021, Social Security and Supplemental Security Income (SSI) beneficiaries will receive a 5.9 percent COLA for 2022.

Last year, the adjustment was 1.3%, and two years ago, it was 1.6%. You can see the full history of Social Security COLAs here.

November I Bond Inflation Rate Should be 7.12%

I’ve done the calculations based on these latest CPI numbers, and the I Bond inflation component taking effect in November should be 7.12%. The I Bond inflation component is added on to the I Bond fixed rate to derive the I Bond composite rate. The fixed rate is currently 0%. We won’t know the November fixed rate until Monday, November 1st.

If you buy I Bonds before the end of October, you can know the rate of return you’ll receive if you redeem the I Bonds between October 2022 and January 2023. The interest rate for the first 6 months will be based on the current inflation component (3.54%). The next 6 months will be based on this new rate (7.12%). After that, it’ll depend on future inflation numbers. The current fixed rate component of 0% will stay the same for the life of the bond. Below are the details of calculating the expected rate of return.

I Bond Rates of Return for October 2021 Purchase

From Treasury Direct I Savings Bonds FAQs:

the inflation rate announced in November is the change between the CPI-U figures from the preceding March and September.

All previous CPI-U numbers are available from this government webpage. The CPI-U for March 2021 was 264.877. Based on today’s release, September 2021 CPI-U was 274.310. This is an increase of 3.56%. The annualized version of this is 7.12%.

If you buy before November, you’ll receive the current I-Bond fixed rate of 0% for the life of the I Bond. The inflation component will be added to this rate and will change every 6 months. The current inflation component is 3.54%, and the composite rate is 3.54%. Here’s an estimate of the return for the next year:

  • 3.54% from October 2021 through March 2022
  • 7.12% from April 2022 through September 2022

I Bonds increase in value on the first day of the month. So on November 1st, you’ll earn the interest for the full month of October. So for maximum return, it’s best to buy I Bonds near the end of the month and redeem them early in the month.

If you redeem an I Bond before 5 years, you lose the last 3 months of interest. So based on this and the above numbers, if you buy an I Bond on October 29, 2021, the value of the I Bond on October 1, 2022 would be about 3.55% higher. For 11 months, this comes out to an annualized yield of about 3.87%.

Below is an estimated annualized return for I Bond redemptions from October 1, 2022 to January 1, 2023. It is assumed you will buy the I Bond at the end of October 2021 which gives you almost an extra month of interest. This effectively reduces the 3-month penalty to 2 months.

  • 3.87% (11mo) redeem on 10/1/22, 6mo of 3.54%, 3mo of 7.12%, and 3mo of 0% (penalty)
  • 4.14% (12mo) redeem on 11/1/22, 6mo of 3.54%, 4mo of 7.12%, and 3mo of 0% (penalty)
  • 4.37% (13mo) redeem on 12/1/22, 6mo of 3.54%, 5mo of 7.12%, and 3mo of 0% (penalty)
  • 4.57% (14mo) redeem on 01/1/23, 6mo of 3.54%, 6mo of 7.12%, and 3mo of 0% (penalty)

The highest guaranteed rate would be an annualized return of 4.57% for about 14 months.

Note, it’s best not to wait until the last day of the month to buy I Bonds at Treasury Direct. In 2011 I described my experiment in seeing how late in the month I could buy an I Bond. I found you should make sure the purchase is no later than the second to last business day of the month. For this month, make sure you purchase I Bonds no later than Thursday, October 28th.

If you decide not to redeem your I Bond in 2022 or 2023, you won’t lose the 3-month penalty. Thus, the annualized return after 12 months would be approximately 5.33% (the average of 3.54% and 7.12%). We’ll have to wait for the future I Bond inflation rates to calculate returns for anything later.

Compared to CD Rates

As you can see, the above rates are much higher than the top 1-year CD rates that are nationally available (currently 0.80% APY). In fact, the rates are much higher than any CD rate, regardless of maturity length (the highest CD rate is 1.50% APY for a 7-year term.)

Since interest from I Bonds is exempt from state income tax, the advantage of I Bonds is even higher in states that have state income tax. You still owe federal tax on I Bond interest, but you are allowed to defer taxes until you either redeem the I Bond or until it reaches its 30-year maturity date. This tax feature is another significant advantage over CDs (outside of retirement accounts) which require annual tax payments even if the CD has a multi-year term.

Unfortunately, an exact comparison between I Bonds and long-term CDs is not possible. The reason is that the I Bond inflation rate changes every six months. For this short period of time from now to before November, we know the I Bond inflation rate for 12 months. We can only guess about the I Bond inflation rate after that. The best we can do is to make an estimate of the future inflation rates.

For the last 23 years of the I Bond program, the I Bond inflation component rate has averaged around 2%. If the high inflation that we’re seeing this year proves not to be transitory, this average is likely to increase. In that case I Bonds, even with a zero fixed rate, will likely return more than CDs for quite awhile. It may take a return to CDs with yields over 3% before it becomes a close match.

Deciding to Sell or Keep Older I Bonds

If you have older I Bonds, you probably have I Bond fixed rates much higher than 0%, and if you’re fortunate enough to have purchased I Bonds before 2001, you probably have fixed rates over 3.00%. So those I Bonds are especially great deals in today’s environment.

As an example, an I Bond purchased in May 2000 has a fixed rate of 3.60% (the highest I Bond fixed rate). In November, that I Bond will have a composite rate of return of 10.85%. This will last from November through April 2022.

Remember the $10,000 Annual Purchase Limit

The primary downside with I Bonds is the annual purchase limit. An individual can only buy up to $10,000 in electronic I Bonds at TreasuryDirect. An additional $5,000 in paper I Bonds can be purchased using your federal income tax refund. The limits apply to calendar years.

There are ways to buy more I Bonds. Harry Sit of The Finance Buff has a useful review of how a married couple could buy up to $65,000 in I Bonds in one calendar year by using business accounts and trust accounts.

I Bond Features

Below is a summary of the I Bond features. More information is available at this Treasury I Bond page:

  • Can’t be redeemed within 12 months of issue date
  • Lose 3 months interest if redeemed within 5 years
  • Interest is composed of fixed and inflation-based rate
  • Fixed rate remains for life of bond
  • Inflation-based rate changes every 6 months after issue date
  • New rates announced every six months on November and May 1st
  • Federal tax can be deferred on interest until the bond is redeemed
  • Interest is exempt from state and local tax
  • Some or all interest is tax exempt when used for educational expenses
  • $10,000 maximum of I Bond purchases per year. An additional $5,000 (paper I Bond) can be purchased using your federal income tax refund. (Total was $60,000 before 2008. The change was announced on December 2007.)

For more details about the purchase limit, please refer to the Treasury Direct’s FAQ on the new purchase limit.

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