There haven’t been many safe-haven investments that can beat inflation aside from the I-bond, but even that safety net soon can’t pack as much weight as an inflation-fighting force.
That’s because the record 9.62% yield on I-bonds issued through October will fall Nov. 1 to 6.48%, significantly lower but still one of the best investments out there, experts say.
The rate change is based on the change in the consumer price index (CPI) from March to September. The new rate is below the annual inflation rate of 8.2% in September, meaning that when the rate is adjusted for inflation, you̵[ads1]7;re looking at a negative interest rate.
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What is an I bond and how do they work?
It’s a 30-year government bond that protects you against inflation. It pays both a fixed interest rate and an interest rate that changes twice a year with inflation.
Interest is compounded half-yearly, which means that every 6 months a new interest rate is applied to a new principal equal to the previous principal plus the interest earned in the last 6 months. The bond’s value grows because it yields interest and because the principal value increases.
You can buy $10,000 from the Treasury and another $5,000 using your tax refund. You can redeem them after 12 months, but if you do so in less than 5 years, you lose the last 3 months of interest.
Do you pay tax on I-bonds?
You must pay federal income tax, but no state and local taxes on I-bonds. You can either report each year’s earnings or wait to report all earnings when you redeem the bond.
If you use the money for qualified higher education expenses, you cannot owe tax on the earnings.
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Why is the variable interest rate falling when inflation is still high?
The variable interest rate on the I-bond is based on the change in inflation over the last 6 months. In this case, the rate set on 1 November will be based on inflation from March to September.
“The months of July and August slowed down quite a bit resulting in a lower inflation reading,” said Ken Tumin, founder of bank account comparison site depositaccounts.com.
July month-over-month CPI 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 1 May and 1 November for all I bonds issued during the next 6 months and remains at this rate for the life of the bond. It has been at 0% since November 1, 2019.
Treasury can reduce the gap between the inflation rate and the I-bond rate by raising the fixed rate part on 1 November, but it is unlikely that the real or inflation-adjusted return will be positive. If the Treasury raises the fixed rate, it will likely be by a very small increase (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 still a good investment?
Yes, because other similar quality investments, including savings accounts, T-bills and certificates of deposit (CDs), offer even lower returns.
Online savings accounts offer a little more than 3% interest and CDs offer about 4% interest, “and those are the best ones, not the average ones,” Tumin said. The interest rate on treasury bills is below 5%.
Also, remember, the current rate of 9.62% still applies to all bonds purchased through October 31st. These bonds will earn 9.62% for six months, then switch to 6.48% for the next six months. That would make the one-year return around 8.05%, still not bad.
Or “maybe the next 6 months of inflation will be less than 9.62% and then the next 6 months below 6.5%,” Tumin said. “If that happens, you will have a real return in the next year.”
Also, they never lose money because the effective interest rate cannot go below zero and the surrender value cannot decrease.
“Treasury will always exchange an I-bond at par if the investor has held the security for 12 months,” John Rekenthaler, Morningstar’s vice president of research, wrote in a note last month. “In reality, I-bonds have the maturity date the investor wants.”
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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 will also earn the full interest for the month of October on November 1, Tumin said.
But to be sure, buy a little earlier because the treasury will take a couple of days to process the 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, make sure you buy I-bonds no later than Friday, October 28.”
This advice is if you already have an account set up with the Treasury with a verified bank account, he noted. Otherwise, give yourself even more time for the purchase.
In general, “for maximum returns, it’s best to buy I-bonds near the end of the month and redeem them early in the month,” he said.
Medora Lee is a USA TODAY money, markets and personal finance reporter. You can reach her at firstname.lastname@example.org and subscribe to our free Daily Money newsletter for personal finance tips and business news every Monday through Friday morning.