I bond rates poised to drop in May

The Treasury Department’s inflation-protected I bonds, which were wildly sought after last year, won’t be in such hot demand when the rate resets for purchases made from May to October.

Analysts expect the annualized yield for an I bond to sink to 3.79% for the period from May to October from the current 6.89%.

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“The huge surge in popularity of I bonds was triggered by six-month inflation-adjusted variable rates of 7.12%, 9.62%, and then 6.48% — at a time when other safe investments were paying something like 1% or less,” Dave Enna, founder of Tipswatch.com, a blog that tracks inflation-protected investments, told Yahoo Finance. “Now that has changed.”

Still, there’s time to buy these ultra-safe investments before the rate resets, experts say, but Americans should also consider the few downsides, especially as yields on other, similarly less risky investments improve.

What are I bonds?

I bonds are government-backed and guaranteed to keep pace with inflation because their return is tied to the Consumer Price Index, the government’s measure for consumer price growth.

Additionally, the interest is generally free from state and local taxes. You might also be able to completely or partially exclude savings bond interest from federal income tax when you pay qualified higher education expenses at an eligible institution or state tuition plan in the same calendar year you redeem eligible I bonds.

The bonds are sold in increments of $25 or more when you buy them electronically from the U.S. Treasury’s website, TreasuryDirect, with no fee. Paper bonds are sold in five denominations: $50, $100, $200, $500, and $1,000.

The I bond rate is made up of the fixed rate, which applies for the 30-year-life of the bond, and a semiannual inflation rate calculated from a formula based on the six-month change in the non-seasonally adjusted Consumer Price Index for all Urban Consumers (CPI-U) for all items.

New rates are set every May and November by the Treasury Department. Because of the twice-yearly adjustments, the date you buy your I bonds can have a significant impact on your returns.

For May, the I-bond inflation component is expected to be 3.38% annualized (or 1.69% semi-annualized). The fixed rate for May to October has not been set, but assuming it stays the same, the new combined annualized yield would be 3.79%.

“We are able to calculate this early from the latest data from the Bureau of Labor Statistics that came out on April 12,” Ken Tumin, a senior industry analyst at LendingTree and founder of DepositAccounts.com, told Yahoo Finance. “This is down from the current I-bond inflation rate of 6.48% that took effect last November.”

The case for buying I bonds in April

I-bonds purchased in April — before the rate reset in May — will still earn the annualized yield of 6.89% for six months. That’s the fifth-highest rate since the bond’s introduction in 1998, according to Treasury data.

And for the second six months, it’ll earn 3.79%, Tumin said. The 12-month average will be 5.34%, on par with today’s certificates of deposit (CDs) with yields at or just above 5% at online banks for terms of around one year.

“The highest online one-year CD yield is currently 5.25%. Several of the large online banks have yields over 5% on savings accounts,” Tumin said.

Treasury bills with maturities of three, four, and six months have also been yielding just above 5%, while the one-year Treasury bill has been yielding in the high-4% range.

So, buying in April is the best strategy to ensure that you’ll get six months of the high-inflation annuallized component of 6.48%, Tumin said.

“It will also guarantee that you get the 0.4% fixed rate, which is relatively high compared to many times in the last 15 years when the fixed rate was 0%,” he added.

While it’s possible that the fixed rate will rise in May, it’s still better to purchase I bonds in April.

“For example, if the fixed rate rises to 0.6%, it would take nine years for an I-bond purchased in May to exceed the total earnings of an I-bond purchased in April,” he said.

Due to inflation falling and the rise of yields on other zero-risk savings alternatives, the I bond no longer has a clear advantage in the short term, Tumin said. I-bonds bought in April, however, “offer respectable short-term yields,” he said.

Drawbacks to I bonds

Still, there are some downsides to consider. First is how much you can buy.

In general, you can only purchase up to $10,000 in I bonds each calendar year. There are a few ways to pump up that sum. For example, you can direct your federal tax refund to buy an additional $5,000 in I bonds.

Second is the penalties.

I bonds earn interest for 30 years, or until they’re cashed in, whichever comes first. You can cash in after one year. But if you cash before five years, you lose three months of interest. So if you cash in the I bond purchased this month in April 2024, the 12-month return will be reduced to 4.39% from 5.34%.

Those drawbacks give Carolyn McClanahan, a certified financial planner with Life Planning Partners in Jacksonville, Fla., pause.

“How to allocate your fixed income depends on your needs. When will you need the cash and how much fixed income allocation do you have in your portfolio?” she said. “We are currently mostly keeping people in high-yield cash and short-term fixed income such as CDs and high-yield bank savings accounts.”

As for Tipswatch.com’s Enna, he’s still all in.

“I bonds remain a solid investment for people looking for inflation protection, and are still competitive for people looking simply for near-term yield,” he said. “Even if inflation is now gradually heading lower, I bonds protect you against any future surge in U.S. inflation. I’m opting to buy our full allocation of I bonds and have set April 26 as the purchase date on TreasuryDirect.”