I Bonds Interest Rates

I Bonds Interest Rates

I Bonds are financial instruments issued by the US Treasury that are meant to give investors low risk and high liquidity, while effectively protecting them against inflation-related value erosion. This Buzzle article will tell you all about the I bonds interest rates and other related information.
If you were researching low risk investments with liquidity on the higher side, and the interest rates enough to keep the investment growing despite inflation, you must have come across the term 'I Bonds'. These interest rates are high enough to retain investment growth values, despite the value erosion faced due to inflation. It is this factor that draws investors into investing in this, over other instruments like EE/E Series Bonds and TIPS (Treasury-Inflation Protected Securities). Let us begin by first updating our Series I Savings Bond, or just plain 'I Bond' info.

Basics

The US Treasury came up with an 'I Savings Program' in September 1998, with the purpose of creating instruments that protect bond investors from inflation erosion. I Bonds are considered as long-term investments in the market, and the interest rates for them are declared twice a year, every year, specifically on the 1st of May and November. They are issued with certain specific rules, and one of the most important one from an investor's point of view is the one that says, 'an I Bond can never lose value, and hence, it can never carry a 0% interest'.

Features
  • These bonds start earning their interests from the very first day of their issuing months. They are accrual-type financial instruments, and their interest accrues on them and is only encashed when the bond is liquidated or redeemed. When the bond matures, it is worth the face value, plus the interest accrued on it over the investment period.
  • They can be redeemed or liquidated anytime after the compulsory lock in period of 12 months. But if they are redeemed anytime before they are 5 years old, the three most recent month's interest is deducted from the amount that you will earn from them. This forfeited amount forms the only penalty for liquidating an I Bond before 5 years are up.
  • They are always sold at face value, i.e., they are never issued at a discount or a premium. The bond price (price at which you buy the bond) equals the denominations, i.e., USD 100 will get you a USD 100 I Bond.
  • Like most US Treasury instruments, these bonds can grow in value for a maximum of 30 years. The earnings on them are inflation indexed, and so do not undergo abnormal value changes due to the adverse effects of inflation over this time span. They post their final interest earnings on the last day of the final maturity month, after which they stop earning any interest.
  • Entities eligible to invest in this scheme are individuals, corporations, public and private organizations, and even fiduciaries. As an individual, you can own an 'I Bond' only if you have a Social Security Number, and even minors have this privilege.
  • All interest earned on them is taxable under the Federal Income Tax laws, but this tax can be deferred until the bond is either redeemed or liquidated. Special tax benefits under the Education Savings Bond Program can be availed as well if the bond holder qualifies for them.
  • As they are backed by the US Government, they carry negligible risk of default. Due to this very reason, they are preferred over stocks, corporate bonds, and other equity instruments.
  • In an effort to guarantee a real return to investors, they adjust their interest rates every 6 months, according to the latest inflation figures provided by the CPI-U.
Interest Rates

The only way that I Bonds can guarantee a real income is by incorporating the inflation rates somehow into their interest rate calculation formula. Hence, it is nothing but a combination of two separate rates - a fixed interest rate and a variable inflation rate. Let us learn more about the two components before we move on to the interest rate calculation formula.

Fixed Component

The fixed rate component is announced twice every year (May and November), and is a rate that is fixed for the life of any and all I Bonds issued during the 6 months after the announcement. For example, for any bond issued between November 2009 and April 2010, the fixed rate (which will not change during the entire life of the I Bond) is 0.30%. This rate is to change on 1st of May 2010 and will apply to all bonds issued for 6 months after the announcement. The Secretary of the Treasury or the Secretary's designee usually determines this fixed rate, and it is always greater than 0 even in deflationary conditions.

Inflation Component

This rate is also announced every May and November, and is based on the inflation figure changes provided by the CPI-U (Consumer Price Index for all Urban Companies). This rate may or may not be above 0%, as it depends on the condition of the economy. In deflationary times, this rate may be negative, and the only complication in I Bond Interest rates comes due to this factor. If the deflationary rate is higher than the fixed rate or offsets, the interest rate comes to 0%. As this is not possible as per the conceptual terms, in the event that such a thing happens, the redemption value of this agreement is considered to be the one that it had in the previous month. Semiannual inflation rates are used for the purpose of calculation of the composite interest rates.

Composite Rates

There is a fixed formula for the calculation of the composite rate, and it includes both, the fixed and the inflation components mentioned above. The formula is as follows:

Composite rate = [Fixed rate + (2 x Semiannual inflation rate) + (Fixed rate x Semiannual inflation rate)]

Various online websites make this calculation easier by providing online savings bond calculators. Bond calculators help in calculating the exact I Bond investment values by taking the prevailing and current I Bonds interest rates into account. Hope you have understood this concept better through this article.

Disclaimer: This article is for reference purposes only and does not directly recommend any specific financial course of action.
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