There haven’t been many safe investments that can beat inflation except for the I bond, but even that safety net may soon not be so powerful in fighting inflation.
Indeed, the record high interest rate of 9.62% on I bonds issued through October will drop on November 1 to 6.48%, a significantly lower level but still one of the best investments in the market, according to the experts.
The rate change is based on the change in the consumer price index (CPI) from March to September. The new rate is lower than the annual inflation rate of 8.2% in September, which means that when the rate is adjusted for inflation, you have a negative interest rate.
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What is an I-link and how do they work?
It’s a 30-year Treasury bond that protects you against inflation. It pays both a fixed interest rate and a rate that changes twice a year with inflation.
Interest is compounded semi-annually, which means that every 6 months a new interest rate is applied to a new principal value equal to the previous principal plus interest earned over the last 6 months. The value of the bond increases because it pays interest and because the principal value increases.
You can buy for $10,000 from the treasury and another $5,000 using your tax refund. You can cash them out after 12 months, but if you do so in less than 5 years, you lose the last 3 months of interest.
Do you pay taxes on I bonds?
You must pay federal income tax, but no state and local taxes on the I Bonds. You can either report each year’s income or wait to report all income when you redeem the bond.
If you use the money for qualified college expenses, you may not owe income tax.
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Why is the variable rate falling when inflation is still high?
The floating rate of bond I is based on the evolution of inflation over the last 6 months. In this case, the rate set on November 1 will be based on inflation from March to September.
“July and August slowed down a bit, which led to lower inflation,” said Ken Tumin, founder of bank account comparison site Depositaccounts.com.
The month-over-month CPI for July was unchanged from June and August rose 0.1%. In September, the monthly CPI accelerated again by 0.4%.
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What is the fixed rate and does it ever change?
The annual fixed rate is announced every May 1 and November 1 for all I Bonds issued over the next 6 months and remains at that rate for the life of the bond. It has been at 0% since November 1, 2019.
The Treasury could reduce the gap between the rate of inflation and the interest rate of I bonds by raising the fixed rate portion on November 1, but this is unlikely to make the actual or inflation-adjusted return positive. If the Treasury raises the fixed rate, it will likely be by a very small increment (think, tenths of a percentage point).
The last time it was above 1% was November 1, 2007.
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Is an I Bond always a good investment?
Yes, because other investments of similar quality, including savings accounts, treasury bills and certificates of deposit (CDs), offer even lower returns.
Online savings accounts offer just over 3% interest and CDs offer around 4% interest, “and those are the best, not the average,” Tumin said. Treasury bill yields are below 5%.
Also, remember that the current rate of 9.62% still applies to all bonds purchased through October 31. These bonds will gain 9.62% for six months, then drop to 6.48% for the next six months. That would make a one-year return of around 8.05%, which still isn’t bad.
Or “maybe the next 6 months of inflation will be below 9.62%, then the next 6 months below 6.5%,” Tumin said. “If that happens, you’ll have a real return for next year.”
Moreover, they never lose money because the real interest rate cannot drop below zero and the redemption value cannot decrease.
“The Treasury will always exchange an I bond for face value if the investor has held that security for 12 months,” John Rekenthaler, Morningstar’s vice president of research, wrote in a note last month. “In fact, I bonds have the maturity date desired by the investor.”
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When is the best time to buy an I Bond?
To lock in the record 9.62% rate for six months, buy I bonds by October 31. You’ll also earn full interest for the month of October on November 1, Tumin said.
But to be on the safe side, buy a little earlier because the Treasury will take a few days to process your purchase.
“I found that you should make sure the purchase is no later than the second to last business day of the month,” he said. “For this month, be sure to buy I Bonds by Friday, October 28.”
That advice is if you already have an open account with the Treasury with a confirmed bank account, he noted. Otherwise, give yourself even more time for your purchase.
As a general rule, “for maximum return, it’s best to buy I bonds near the end of the month and redeem them at the beginning of the month,” he said.
Medora Lee is a money, markets and personal finance reporter at USA TODAY. You can reach her at [email protected] and sign up for our free Daily Money newsletter for personal finance tips and business news Monday through Friday mornings.