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rationalwalk (< 20)

Series I Bond Composite Rate Falls to Zero

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May 01, 2009 – Comments (1)

Series I Bond Composite Rate Falls to Zero

By Ravi Nagarajan
Published on May 1, 2009 at 11:08 am

The Bureau of the Public Debt has announced an earnings rate of 0% for Series I Bonds issued between May 1, 2009 and October 31, 2009.  The fixed rate (also known as the real return) of new Series I Bonds will be 0.10%.  However, because the CPI-U inflation index fell at an annualized rate of 5.56% over the past six months, the earnings rate will be zero.  The earnings rate can never fall below zero on Series I Bonds.

Series I Bond Features

Series I Bonds were introduced in 1998 to provide a way for individual investors to easily protect themselves against inflation.  Series I Bonds carry a fixed rate that is set at the time of issue.  The fixed rate refers to the “real return” that the purchaser will earn over the life of the bond.  Series I Bonds also earn an inflation adjustment that is set every six months (on May 1 and November 1) that is based on the CPI-U inflation index.  The earnings rate is derived based on the fixed rate of return and the inflation adjustment and can never fall below zero.

The terms of Series I Bonds provide many interesting features for individual investors.  They are easy to purchase in small increments and do not require paying any commissions.  After the first twelve months, they can be redeemed at any time although there is a three month interest penalty for any bond redeemed prior to five years.  Perhaps the most compelling feature is the fact that interest earned on I Bonds is tax deferred.  This means that investors can accrue interest on the bonds for up to thirty years without paying income taxes on the interest that has been earned.  One major limitation of I Bonds is the annual purchase limit of $5,000.  This limit used to be $30,000 but was reduced recently.

Better Options Available Today

Over the past several years, the real rate offered on I Bonds has decreased significantly.  The chart that appears below tracks the real, or “fixed” return, available to I Bond purchasers over the past decade.  The rate has varied from 0% to 3.6% over this period and has steadily declined in recent years.

 

At the current fixed rate of 0.1%, there is little reason for investors to purchase I Series Savings Bonds given the alternative of purchasing Treasury Inflation Protected Securities (TIPS) at auction through Treasury Direct.  Treasury Direct offers investors the ability to participate in regular auctions without paying any commissions.  The Treasury holds regular auctions for TIPS of  various maturities.  TIPS may also be purchased on the secondary market through a broker.

For example, an investor who is considering the purchase of an I Bond today at a 0.10% fixed rate with an intended holding period of five years may instead consider the TIPS issue maturing on April 15, 2014 which carries a current real yield of 1.09%.  One important point to consider when purchasing TIPS on the secondary market is that in the event of deflation, the accrued principal balance can decrease.  This can be an issue for TIPS that have been outstanding for some time and have accumulated significant accrued principal due to inflation adjustments.  To avoid the risk of deflation reducing the accrued principal accumulated on an existing bond, one can purchase TIPS at auction.  Purchasers at auction have the additional protection of knowing that accrued principal can never fall below the original principal of the security.

One other point to consider when purchasing TIPS instead of I Bonds is that any inflation adjustment to accrued principal is taxable in the year that the inflation adjustment is made even though no cash is paid to the investor during the year.  Also, interest on TIPS are taxed every year.  In contrast, I Bonds are tax deferred securities which can carry important advantages over long holding periods.

For more information on TIPS, Treasury Direct has provided a list of frequently asked questions.

1 Comments – Post Your Own

#1) On May 01, 2009 at 11:37 AM, rationalwalk (< 20) wrote:

For some reason the chart didn't get into the post here.  To see the chart, go to my blog post:

 

http://www.rationalwalk.com/?p=1284

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