US Treasury Series I Bonds
US Treasury Series I bonds are inflation indexed savings bonds and provide a good alternative for protecting the value of your capital in rising interest rate environments. The Bureau of the Public Debt is the only seller of these bonds so you are unlikely to learn about them through your bank or broker.
Current interest rate on i Bond purchased from May 1, 2013 to October 31, 2013: 1.18%
Series I bonds are issued by the U.S. Treasury at face value and have a maximum duration of 30 years. These bonds can be sold any time after five years without penalty, and between one and five years after purchase with a loss of the most recent three months interest.
Series I bonds are now issued in both paper and electronic format. The US Treasury now limits purchases to $10,000 per individual in electronic format through TreasuryDirect.gov, and allows a purchase in paper format up to $5,000 provided it is purchased with an IRS tax refund check.
The interest rate on Series I bonds is reset biannually - in each May and November. The rate at any time is determined by adding a fixed rate set at the issuance of the bonds and variable rate that resets on each reset date.
I Bond Fixed Rate Component
The first component is a fixed rate. On May 1, 2013, the Treasury elected to continue with a fixed rate component of 0.00% for bonds purchased through October 31, 2013 (this component decreased from 0.20% to 0% on November 1, 2010, and is dramatically below the 2006-2008 range between 1.2% and 1.4% and its range for the early part of the Century which was as high as 3.60%). The fixed rate applies to all bonds purchased in the defined six-month period and does not change during the life of the bond. Hence, bonds purchased from May 1, 2013 to October 30, 2013 will always have a 0% fixed component.
I Bond Variable Rate Component
The second component is a variable rate calculated on the basis of the change in the Consumer Price Index for Urban Consumers (CPI-U) during a six-month period ending one month before the rate setting date. The variable component is determined by multiplying the actual six-month CPI-U change by two. The six-CPI-U change in CPI-U for the period ending March 30, 2013 was 0.59% (the rate move from 231.407 in October 2012 to 232.773 in March 2013, a 0.59% move). As a result, the variable rate for all outstanding Series I bonds (previously purchased and new purchases) is 1.18% from May 1, 2013 to October 31, 2013.
Information on the history of the fixed and variable components of Series I Bonds is available here.
Opportunity to Maximize Series I Bond Performance and Outperform 1 year CDs
You can maximize your Series I bond performance by making all applicable purchases at the end of the month and sales at beginning (since interest accrues by the month, and is not calculated daily). Many observers have pointed out that a purchase of Series I bonds is now superior to a purchase of a one year CD if you were to sell in one year on the first possible date and accept the 3 months of interest forfeiture. Because the purchase amounts are limited to $10,000 in electronic format per individual - plus an additional $5,000 in paper with an IRS refund check - most people will find that the time associated with the transaction is not worth the very small gain. Rather, Series I bonds should principally be thought of as a place to park money that you will not need for at least 5 years and that you want to be sure keeps at pace with inflation.
Tax Status of I Bonds
While Series I bonds are state and local tax free (and federal tax deferred), they are not as liquid as other state and local tax free instruments.
Series I Bonds can be used for education and college expenses. All interest earned on Series I Bonds is Federal tax exempt if the money is used for college tuition within 12 months of the Series I Bond being redeemed.
What to Look for with I Bonds
One significant advantage of Series I bonds, when held over long periods, is that they are state and local tax-free and federal tax is deferred until redemption.
Since interest on Series I bonds is calculated on the basis of the month in which they are purchased (and not the day), there is an advantage to purchasing these bonds at the end of the month and selling at the beginning of the month.
Series I bonds provide strong protection against inflation that shows up in the CPI-U (conversely, these are not good instruments to own in a deflationary or disinflationary environments, especially one accompanied by high short term interest rates).
Unlike Treasury Inflation Protected Securities (TIPS), interest payment on these bonds change and the principal is not adjusted. Therefore, these bonds will not depreciate in value in a deflationary environment; rather, your rate will be reset to the lower rate.
Avoiding I Bond Pitfalls
The biggest pitfall is the lack of liquidity in these bonds. These bonds cannot be sold within less than 1 year of purchase, and are therefore substantially less liquid than online savings accounts and money market funds. Moreover, there is a forfeiture of three months' interest if you sell between one and five years of purchase.
If you opt for paper, as opposed to electronic bonds, they should not be lost (they, however, are not bearer bonds). They are most easily redeemable by being physically presented to a savings and loan institution. Most online banks will not redeem these bonds for you.
Buying I Bonds
I Bonds can be purchased by all US citizens and US residents, including minors (who may own directly in their own name). I Bonds may also be purchased by US civilian employees regardless of nationality or residence. I Bonds may be purchased in electronic formats from TreasuryDirect and they are bought at face value. Individuals can purchase up to $10,000 in electronic format each year and $5,000 in paper format with an IRS refund check. US citizens need to provide your social security number which the Treasury uses to track electronic bonds and to be sure that you do not exceed purchase limitation restrictions.