Treasury I bonds now carry a lower six-month interest rate, but they just become a much better long-term investment.
The fixed rate on I bonds was set at 0.9% at the half-yearly review on May 1, its highest level in 15 years. This represents an increase from the fixed rate of 0.4% at the previous reset on November 1, 2022 and zero% from May 2020 to October 2022.
The result is that if the six-month rate on savings bonds bought from May to October is 4.3%, compared to 6.89% in November and 9.62% in May 2022, investors who buy new bonds Savings should do better in the long run due to the fixed rate feature.
Treasury I bonds have two components. The first is an inflation function 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 fixed at issue and remains in effect for the duration of the bonds.
The current rate of 4.30% which applies for the next six months is made up of the inflation component of 3.4% based on the change in the CPI index from September 2022 to March and the fixed rate of 0.9 %. The Treasury uses the CPI which is not seasonally adjusted, which closely tracks the better known headline figure which is seasonally adjusted,
Buyers of the juicy 9.62% bonds issued a year ago will only get 3.4% over the next six months because their bonds have a zero fixed rate.
Current buyers will benefit from the fixed rate of 0.9% plus ongoing inflation over the life of the bonds, which mature in 30 years.
“The kicker is the fixed rate part of the bonds,” says George Gagliardi, a financial adviser who runs Coromandel Wealth Management in Lexington, Mass.
“Those who buy I bonds now will receive 4.3% for six months and earn a yield for the next 29 years on their I bonds that is still 0.9% higher than those who bought I bonds a year ago. Thus, both components must be considered to understand and evaluate I-bonds.”
The Treasury sets the fixed interest rate based on the yield of 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 regularly auctioned as treasury bills, notes and regular fixed rate bonds.
The real, or inflation-adjusted, rate for TIPS is now between 1.25% and 1.5%, up from negative levels in early 2022.
Although the yields of Treasury I bonds are not as high as those of TIPS, they have certain advantages. There is no reinvestment risk on I bonds, since interest is added to the value of the bonds every six months.
And unlike TIPS, holders of I bonds can defer paying tax on their accrued 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 Treasuries are yielding over 5%. But these rates may not persist. Indeed, the markets anticipate short rates below 4% in one year.
I Bonds must be purchased through the TreasuryDirect website. Individuals are limited to $10,000 in annual purchases, but those whose businesses are structured like certain partnerships can bypass this cap.
I bonds must be held for 12 months and holders lose one-quarter interest if they redeem the bonds within five years. They mature in 30 years but can be redeemed before that date.
Interest is exempt from state and local income taxes, but is subject to federal income tax, which is the same as treasury bills and bonds. This makes the taxation of I bonds more favorable than that of bank deposits, the interest on which is subject to federal, state, and local income taxes.
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