I Buy, I Sell

Richard Connor

SERIES I SAVINGS bonds have garnered a lot of press over the past year. Thanks to higher inflation, these bonds have become a lot more attractive. Although savings bonds have historically been a go-to gift for birthdays, baptisms and bar mitzvahs, they’re more complicated than you might think. I bonds have a number of features that can confuse the average investor, me included.

Series I savings bonds, or I bonds, are designed to protect an investor from losing money to inflation. Each bond’s return has two components: a fixed rate of interest and an inflation rate. The latter is based on the Consumer Price Index CPI-U, it changes every six months and the change affects both newly purchased bonds and those that were bought earlier. Meanwhile, the fixed rate is set when you purchase the bond and it stays the same for the 30-year life of the bond you own. The fixed rate had been at 0% until Nov. 1, 2022, when it was raised to 0.4%. On May 1, the fixed rate increased again, to 0.9%.

The inflation rate that drives I bond returns is revised every six months, on May 1 and Nov. 1. When your bond is credited with that inflation rate depends on when you bought it. For example, if you purchased a bond in January, the inflation rate would be the rate announced the previous Nov. 1. Your January-issued bond’s inflation rate then changes every six months, in July and January, based on the inflation adjustment announced the prior May 1 and Nov. 1. Got that?

The combined rate for bonds bought between May 1 and Oct. 31 is 4.3%. This is the sum of the 0.9% annual fixed rate plus two times the semiannual inflation rate of 1.69%, or 3.38% annually. The actual formula is a bit more complicated, but this is close enough. For comparison, today’s 4.3% is less than half of May 2022’s meaty 9.62%

This is an area of confusion for many people. Each I bond has a six-month interest-rate period that starts on the first day of the month that the bond was bought. That bond’s rate will be the composite rate in effect on the date of purchase, and it will last for six months. When the Treasury resets the inflation adjustment on May 1 and Nov. 1, those changes won’t necessarily apply immediately to your existing bonds.

For example, I purchased several I bonds in mid-April as birthday gifts. My TreasuryDirect account shows that those bonds have an April 1 issue date. They have a composite interest rate of 6.89%—a 0.4% fixed rate plus an annualized 6.49% inflation adjustment, which was announced on Nov. 1. The bonds will continue to earn that 0.4% fixed rate for the next 30 years. The inflation adjustment, however, will change every six months, on Oct. 1 and April 1.

Another confusing aspect of I bonds: how and when interest is earned. New I bonds begin earning interest on the first day of the month you purchase the bond. That means that, even if you purchase a bond at the end of the month, you’ll receive interest for that entire month.

The way that interest is added to your I bond, however, is a bit complicated. The interest earned in any month is credited to your account on the first day of the following month. The implication: It makes sense to wait until the beginning of a month to sell a savings bond to make sure you’ve received the previous month’s interest.

Interest on an I bond compounds, but not like a traditional savings account. With a traditional savings account that compounds daily, each day’s interest is added to the principal, and the following day’s interest is calculated on the principal plus the accumulated interest.

With an I bond, the accumulated interest is compounded semiannually. This means that every six months after the month of issue, the accumulated interest is added to the principal to establish a new principal value. This is also the date when the new composite interest rate is set for your bond. The new, larger principal then earns interest at the new composite rate for the next six months.

To find the current value of your bonds, check your TreasuryDirect account or use the website’s Savings Bond Calculator. To make this even more confusing, the value of any bonds that are less than five years old doesn’t include the latest three months of interest, reflecting the three-month interest penalty for early withdrawal that applies during those first five years. This suggests that, for new bonds, you won’t see any interest show up in your account until the beginning of month No. 5.

A recent article by Harry Sit of The Finance Buff describes a clever strategy for replacing existing I bonds that have a 0% or low fixed rate with newer bonds with the 0.9% fixed rate. This assumes you plan to hold bonds for the long term. Any bonds purchased between May 2020 and October 2022 have a 0% fixed rate.

You can’t sell savings bonds in the first 12 months after you’ve bought them. But once you reach the 12-month mark, you could sell your 0% bonds and use the proceeds to purchase new bonds with today’s 0.9% fixed rate. Sit’s strategy involves waiting until at least three months after May 1, so that the three-month interest penalty you pay would be the three months when your bond is earning today’s lower 3.38% “variable” rate—the annualized inflation adjustment for the current six month period. Three months of interest at that rate is about 0.85%. With the sales proceeds reinvested at today’s new fixed rate of 0.9%, you would break even after a year.

Keep in mind that, depending on which month you bought your savings bond, you might not enter the new, low inflation-adjustment period until much later this year—and thus you shouldn’t necessarily rush to sell your low-rate I bonds this summer. Harry Sit’s article has more details. Also keep in mind that buying a new bond starts a new 12-month “no sell” period, plus the purchase would count toward the $10,000 annual purchase limit. You would also be liable for taxes owed on the interest received from the redeemed bond.

There’s a final bit of timing involving I bonds. Earnings from I bonds are subject to federal income taxes, but not state or local taxes. You have a choice of recognizing the bond’s income for federal tax purposes in the year you earn it or, alternatively, you could wait until you sell the bond to report the income. Most folks opt for the latter, so they benefit from the tax-deferral.

Richard Connor is a semi-retired aerospace engineer with a keen interest in finance. He enjoys a wide variety of other interests, including chasing grandkids, space, sports, travel, winemaking and reading. Follow Rick on Twitter @RConnor609 and check out his earlier articles.

Want to receive our twice-weekly newsletter? Sign up now.

Browse Articles

Notify of
Oldest Most Voted
Inline Feedbacks
View all comments

Free Newsletter