Detroit Free Press Susan Tompor Column: Watch Out, the I Bond Rate is About to Dip Sharply

By Susan Tompor, Detroit Free Press

Apr. 3–Boy, I hate to break this bad news to I Bond savers, but get ready for puny rates.

Interest rates on Series I Bonds, the U.S. savings bonds pegged to inflation, are about to take a nosedive.

Ever imagine going from nearly 7% to less than 2%?

Well, that’s about to happen, said Dan Pederson, Detroit-based author of “Savings Bonds: When to Hold, When to Fold and Everything in Between” (Sage Creek Press, $19.95).

A hot commodity

I Bonds have been a hot spot.

I Bonds bought from November 2005 through April are getting an annualized rate of 6.73% for the first six months after their issue. During the six months before that, I Bonds also were popular because the annualized rate was 4.8%.

So I Bond sales have soared. About $4.6 billion went into I Bonds from October 2005 through February, the most recent numbers available, according to Stephen Meyerhardt, a spokesman for the Bureau of Public Debt in Washington, D.C.

By comparison, $900 million went into Series EE Bonds.

But what many savers are overlooking about I Bonds is that the current rate for new bonds is based on a 1% fixed rate, with an inflation adjustment built on top of that.

The fixed rate of 1% lasts for the 30-year life of the bond. But the inflation rate, based on the consumer price index for all urban consumers, is adjusted every six months.

New I Bond rates are announced every May 1 and Nov. 1.

The most-recent I Bond rate hit 6.73% because inflation was exceptionally strong last summer when energy prices surged.

The bad news?

Based on the inflation numbers available so far, Pederson is estimating that I Bonds could be paying around 1% to 2.6%. Yes, that’s the combined rate — the fixed rate plus the inflation rate.

Meyerhardt said the Treasury wouldn’t speculate on what the new I Bond rate will be when it is announced May 1. But he acknowledged that it certainly would be lower than that 6.73%.

The next inflation adjustment will be based on the consumer prices data for October 2005 through March.

We’ve still got one more inflation number to get for the month of March, which is expected to be released in mid-April. So if inflation were higher, the I Bond rate would move closer to 2.6% or higher, Pederson said.

It’s not hopeless

So what should savers do?

First, recognize that you can still get a 6.73% annualized rate for the next six months if you buy an I Bond before the end of this month. But you’d need to expect a lower rate based on inflation for the following six months.

And if you already have I Bonds, pay attention to when you bought your I Bonds. If you bought those bonds sometime between September 1998 and October 2001, you will want to hold onto those bonds.

I Bonds bought during those years start out with a fairly rich fixed rate of 3% or higher.

An I Bond issued in June 2000, for example, carries a fixed rate of 3.6%. So you’re getting any inflation adjustment on top of that 3.6%.

And understand that you cannot cash in an I Bond until after you’ve held it for one year.

So if you bought an I Bond last November or December, you’re going to have to wait until late this year to cash out anyway.

And if you do cash out before five years, you’re going to pay a penalty and lose three months of interest.

So are I Bonds a bad deal?

No, but they’re not some wild moneymaking machine, either.

Look at it this way, I Bonds bought between November 2005 and April 2006 would still be paying slightly more than 4% for a year, even after you factor in a low, estimated new rate.

And if you sold after a year, you could still be looking at a gain of 3.76% for the year, after paying the 3-month penalty. (That’s assuming the new rate ends up around 1.6%.)

Pederson notes that there is a chance the Treasury also could increase the 1% fixed rate for new I Bonds bought May 1 and after.

Even so, it’s good to realize now that the eye-popping I Bond rate that everybody’s been talking about is going away very soon. So whatever you do, don’t load up on I Bonds now thinking that you’re going to lock up more than 6.73% for the next year or more.

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