Low CD rates mean savings bonds are still a good option
The return on inflation-adjusted savings bonds is going to be a bit lower over the next six months.
But Series I Savings Bonds will continue to pay a better return than most certificates of deposit. And they certainly will outpace money market or savings accounts at banks or credit unions.
The U.S. Treasury this morning set the total return on I Bonds for the next six months at 2.2%.
That rate is down from the 3.06% that Treasury has been paying on Series I Bonds since Nov. 1. The six months before that it was 4.6%.
The total return on Series I Bonds is calculated by adding the inflation rate, which changes every six months, and a fixed rate that is based on when your bond was purchased and does not change for as long as you own the bond.
The Treasury announced today the fixed rate on all I Bonds sold through the end of October will be 0%.
That's really not a surprise. The fixed rate has been zero since November 2010.
So the inflation rate is the total earnings rate for I Bonds sold from now until Nov. 1.
That rate, calculated by changes in the Consumer Price Index, shows the annualized inflation rate over the past six months was 2.2%.
Here's how Treasury figures the inflation component.
The CPI-U for September 2011 was 226.889 and the CPI-U for March 2012 was 229.392. That represents an increase of 1.10%. To get the annualized rate, you multiply by two.
It’s not good news to hear that the return on I Bonds, perhaps one of the only ways to earn a safe yield these days, is going down.
But it is still a much better deal than you'll get from even the top-paying CDs.
The best nationally available 12-month CD rates pay just 1.15% APY.
Even top nationally available 5-year CD rates pay less than you'll earn with an I Bond. The best rate is 1.91% APY.
We should also point out that savings bonds also have several tax advantages over CDs:
- You don't have to pay tax on the interest you earn until the bonds are redeemed. With CDs, you're taxed on the interest in the year it's earned.
- The interest earned on savings bonds is exempt from state and local income taxes. That's a big plus for residents of states that levy a hefty tax on investment income, such as California and New York.
- The interest can even be exempt from federal income taxes if the bonds are used to pay for eligible college expenses. (See IRS Publication 970, Tax Benefits for Education.)
You can buy savings bonds at TreasuryDirect and have them issued electronically to your account.
With the start of 2012, the Treasury Department also stopped issuing paper bonds. The only exception is that you can buy up to $5,000 in paper bonds using your tax refund by filing IRS Form 8888.
Electronically, you can buy as much as $10,000 in Series I Bonds and another $10,000 in Series EE bonds (although the interest rate on EE Bonds is significantly lower).
All Series I Bonds and Series EE Bonds purchased electronically are issued at face value. So if you pay $1,000 for a bond, it is immediately worth that much.
Paper Series EE bonds are issued at half their face value. You will pay $500 for a $1,000 bond, but it will not be worth its face value until it matures.
If you redeem Series I Bonds within the first five years, you'll forfeit the three most recent months' worth of interest. After five years, there is no early-withdrawal penalty.