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Why the New Batch of I Bonds Is a Better Investment
Bary, Andrew. Barron's (Online); New York [New York]. 11 May 2023.
Treasury I bonds now carry a lower six-month interest rate, but they just become a far better investment over the long run.
The fixed rate on I Bonds was set at 0.9% at the semiannual reset on May 1, its highest level in 15 years. That's up from a 0.4% fixed rate at the prior reset on Nov. 1, 2022 and zero percent from May 2020 through October 2022.
The result is that while the six-month rate on savings bonds purchased from May through October is 4.3% , down from 6.89% in November and 9.62% in May 2022, investors buying new savings bonds should do better in the long run due to the fixed-rate feature.
Treasury I bonds have two components. The first is an inflation feature that gives holders a rate that resets every six months based on the change in the consumer price index. The second is a fixed rate, which is set at issuance and remains in effect for the life of the bonds.
The current 4.30% rate that applies for the next six months is composed of the inflation component of 3.4% based on the change in the CPI index from September 2022 through March and the fixed rate of 0.9%. The Treasury uses the CPI that isn't seasonally adjusted, which closely tracks the better known headline figure that is seasonally adjusted,
Buyers of the juicy 9.62% bonds issued a year ago will be getting just 3.4% over the next six months because their bonds have a zero fixed rate.
Current buyers will get the 0.9% fixed rate plus whatever inflation runs over the life of bonds, which mature in 30 years.
"The kicker is the fixed-rate portion of the bonds," says George Gagliardi, a financial advisor who runs Coromandel Wealth Management in Lexington, Mass.
"Those who purchase I-bonds now will receive 4.3% for six months, and will get a yield for the next 29 years on their I-bonds that is always 0.9% higher than those who bought I-bonds a year ago. Thus, both components need to be considered to understand and evaluate I-bonds."
The Treasury sets the fixed interest rate based on the yield on Treasury inflation-protected securities or TIPs, which are linked to inflation and have original maturities of five, 10 and 30 years. These marketable securities are auctioned regularly like ordinary fixed-rate Treasury bills, notes and bonds.
The real, or inflation-adjusted, rate on TIPs is now in the 1.25% to 1.5% area, up from negative levels in early 2022.
While Treasury I bond yields aren't as high as those on TIPs, they have some advantages. There is no reinvestment risk on I bonds since the interest is added to the value of the bonds every six months.
And unlike with TIPs, I bondholders can defer paying income taxes on their accumulated interest until the bonds mature. This gives I bonds an IRA-like quality.
Many investors are less interested in I bonds now that money-market funds are paying 4.5% and Treasury bills are yielding over 5%. But those rates may not persist. In fact, the markets are anticipating sub 4% short rates in a year.
I bonds need to be bought through the TreasuryDirect website . Individuals are limited to $10,000 in annual purchases, but those with businesses structured as certain partnerships can get around that cap.
I bonds must be held for 12 months , and holders lose a quarter's interest if they redeem the bonds within five years. They mature in 30 years but can be redeemed before then.
Interest is exempt from state and local income taxes but is subject to federal income tax, which is the same as for Treasury notes and bonds. This makes I bond taxation more favorable than that for bank deposits, whose interest is subject to federal, state, and local income taxes.
Write to Andrew Bary at firstname.lastname@example.org
Credit: Andrew Bary