There haven’t been many safe investments that can beat inflation, except for the I bond, but even that safety net may soon not have such a strong impact on fighting inflation.
That’s because the record 9.62% interest rate on I bonds issued through October will drop on November 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 September’s annual inflation rate of 8.2%, which means that when the rate is adjusted for inflation, the interest rate is negative.
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What is an I bonus and how do they work?
It is a 30-year Treasury bond that protects you against inflation. It pays a fixed interest rate and a rate that changes twice a year with inflation.
The interest is compounded semiannually, which means that every 6 months a new interest rate is applied to a new principal value that is equal to the previous principal plus the interest earned in the last 6 months. The value of the bond grows because it earns 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 cash them out after 12 months, but if you cash in less than 5 years, you lose the last 3 months of interest.
Do they pay taxes on bonds I?
You must pay federal income taxes, but not state and local taxes on bonds I. You can report earnings each year or wait to report all earnings when you collect the bond.
If you use the money for qualified higher education expenses, you may not owe taxes on the earnings.
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Why is the variable rate going down when inflation is still high?
The variable rate of the I bond is based on the change in inflation in the last 6 months. In this case, the rate established on November 1 will be based on inflation from March to September.
“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.
The monthly CPI for July was unchanged from June and August increased by 0.1%. In September, the monthly CPI rose again by 0.4%.
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What is the fixed rate and does that ever change?
The fixed annual rate is announced each May 1 and November 1 for all I bonds issued during 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 on I bonds by increasing the fixed-rate portion on November 1, but that is unlikely to make the real or inflation-adjusted yield positive. If the Treasury raises the fixed rate, it will probably be for a very small increase (think tenths of a percentage point).
The last time it was above 1% was on November 1, 2007.
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Is a bond I still 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 a little over 3% interest and CDs offer about 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. Those bonds will earn 9.62% for six months and then change 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 inflation will be below 9.62% and then the next 6 months below 6.5%,” Tumin said. “If that happens, it will have real performance for next year.”
Also, they never lose money because the real interest rate cannot go below zero and the surrender value cannot go down.
“Treasury will always exchange an I bond at face value if the investor has owned that security for 12 months,” wrote John Rekenthaler, vice president of research at Morningstar, in a note last month. “Indeed, I bonds have any 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 before October 31. It 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 your purchase.
“I found that you have to make sure the purchase is no later than the penultimate business day of the month,” he said. “For this month, make sure you buy I bonds no later than Friday, October 28.”
This tip is if you already have an account set up at Hacienda with a confirmed bank account, he noted. Otherwise, allow yourself even more time for your purchase.
In general, “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 firstname.lastname@example.org and sign up for our free Daily Money newsletter for personal finance tips and business news Monday through Friday mornings.